ITEM 1A. RISK FACTORS.
Risks Inherent in Our Business
Marine transportation is an inherently risky business.
Our vessels and their cargoes are at risk of being damaged or lost because of events such as:
· marine disasters;
· bad weather;
· mechanical failures;
· grounding, fire, explosions and collisions;
· human error; and
· war and terrorism.
All of these hazards can result in death or injury to persons, loss of property, environmental damages, delays or rerouting. If one of our vessels were involved in an accident, with the potential risk of environmental contamination, the resulting media coverage could have a material adverse effect on our business, financial condition and results of operations.
On November 11, 2005, one of our double-hulled tank barges, the DBL 152, struck submerged debris in the U.S. Gulf of Mexico, causing significant damage. The submerged debris was determined to be a service platform which collapsed during Hurricane Rita in September 2005. At the time of the incident, the barge was carrying approximately 120,000 barrels of No. 6 fuel oil, a heavy oil product. Although the final amount has not been determined, we believe much of the oil escaped into the ocean.
Our affiliate, EW Transportation LLC, and its predecessors have been named, together with a large number of other companies, as co-defendants in 39 civil actions by various parties alleging unspecified damages from past exposure to asbestos and second-hand smoke aboard some of the vessels that it contributed to us in connection with the initial public offering of our common units. EW Transportation LLC and its predecessors have been dismissed from 38 of these lawsuits for an aggregate sum of approximately $47,000 and are pursuing settlement of the other case. We may be subject to litigation in the future involving these plaintiffs and others alleging exposure to asbestos due to alleged failure to properly encapsulate friable asbestos or remove friable asbestos on our vessels, as well as for exposure to second-hand smoke and other matters.
A decline in demand for, and level of consumption of, refined petroleum products could cause demand for tank vessel capacity and charter rates to decline, which would decrease our revenues and profitability.
The demand for tank vessel capacity is influenced by the demand for refined petroleum products and other factors including:
· global and regional economic and political conditions;
· developments in international trade;
· changes in seaborne and other transportation patterns, including changes in the distances that cargoes are transported;
· environmental concerns; and
· competition from alternative sources of energy, such as natural gas, and alternate transportation methods.
Any of these factors could adversely affect the demand for tank vessel capacity and charter rates. Any decrease in demand for tank vessel capacity or decrease in charter rates could adversely affect our business, financial condition and results of operations.
In addition, we operate our tank vessels in markets that have historically exhibited seasonal variations in demand and, as a result, in charter rates. For example, movements of certain clean oil products, such as motor fuels, generally increase during the summer driving season. In those same regions, movements of black oil products and certain clean oil products, such as heating oil, generally increase during the winter months, while movements of asphalt products generally increase in the spring through fall months. Unseasonably mild winters can result in significantly lower demand for heating oil in the northeastern United States. Meanwhile, our operations along the West Coast and in Alaska historically have been subject to seasonal variations in demand that vary from those exhibited in the East Coast and Gulf Coast regions. In addition, unpredictable weather patterns and variations in oil reserves disrupt vessel scheduling. Seasonality could materially affect our business, financial condition and results of operations in the future.
Our business would be adversely affected if we failed to comply with the Jones Act provisions on coastwise trade, or if those provisions were modified, repealed or waived.
We are subject to the Jones Act and other federal laws that restrict maritime transportation between points in the United States to vessels built and registered in the United States and owned and manned by U.S. citizens. We are responsible for monitoring the ownership of our common units and other partnership interests. If we do not comply with these restrictions, we would be prohibited from operating our vessels in U.S. coastwise trade, and under certain circumstances we would be deemed to have undertaken an unapproved foreign transfer, resulting in severe penalties, including permanent loss of U.S. coastwise trading rights for our vessels, fines or forfeiture of the vessels. For information about the Jones Act and other maritime laws, please read “Regulation - Coastwise Laws” in Item 1 of this report.
In the past, interest groups have lobbied Congress to repeal the Jones Act to facilitate foreign flag competition for trades and cargoes currently reserved for U.S.-flag vessels under the Jones Act and cargo preference laws. We believe that interest groups may continue efforts to modify or repeal the Jones Act and cargo preference laws currently benefiting U.S.-flag vessels. If these efforts are successful, it could result in increased competition, which could reduce our revenues and cash available for distribution.
The Secretary of the Department of Homeland Security is vested with the authority and discretion to waive the coastwise laws to such extent and upon such terms as he may prescribe whenever he deems that such action is necessary in the interest of national defense. In response to the effects of Hurricane Katrina, the Secretary of the Department of Homeland Security waived the coastwise laws generally for the transportation of petroleum products from September 1 to September 19, 2005 and from September 26, 2005 to October 24, 2005. In addition, the Secretary of the Department of Homeland Security has waived without a specific termination date the coastwise laws generally for the transportation of petroleum released from the Strategic Petroleum Reserve undertaken in response to circumstances arising from Hurricane Katrina. Any waiver of the coastwise laws, whether in response to natural disasters or otherwise, could result in increased competition from foreign tank vessel operators, which could reduce our revenues and cash available for distribution.
We may not be able to grow or effectively manage our growth.
A principal focus of our strategy is to continue to grow by expanding our business in the East, West and Gulf Coast regions and to expand into other geographic markets. Our future growth will depend upon a number of factors, some of which we can control and some of which we cannot. These factors include our ability to:
· identify businesses engaged in managing, operating or owning vessels for acquisitions or joint ventures;
· identify vessels for acquisition;
· consummate acquisitions or joint ventures;
· integrate any acquired businesses or vessels successfully with our existing operations;
· hire, train and retain qualified personnel to manage and operate our growing business and fleet;
· identify new geographic markets;
· improve our operating and financial systems and controls; and
· obtain required financing for our existing and new operations.
A deficiency in any of these factors would adversely affect our ability to achieve anticipated levels of cash flows or realize other anticipated benefits. In addition, competition from other buyers could reduce our acquisition opportunities or cause us to pay a higher price than we might otherwise pay.
Increased competition in the domestic tank vessel industry could result in reduced profitability and loss of market share for us.
Contracts for our vessels are generally awarded on a competitive basis, and competition in the markets we serve is intense. The most important factors determining whether a contract will be awarded include:
· availability and capability of the vessels;
· ability to meet the customer’s schedule;
· price;
· safety record;
· reputation; and
· experience.
Some of our competitors may have greater financial resources and larger operating staffs than we do. As a result, they may be able to make vessels available more quickly and efficiently, transition to double-hull barges from single-hull barges more rapidly, and withstand the effects of declines in charter rates for a longer period of time. They may also be better able to weather a downturn in the oil and gas industry. As a result, we could lose customers and market share to these competitors.
We also face competition from refined petroleum product pipelines. Long-haul transportation of refined petroleum products is generally less costly by pipeline than by tank vessel. The construction of new pipeline segments to carry petroleum products into our markets, including pipeline segments that connect with existing pipeline systems, and the conversion of existing non-refined petroleum product pipelines, could adversely affect our ability to compete in particular locations.
We rely on a limited number of customers for a significant portion of our revenues. The loss of any of these customers could adversely affect our business and operating results.
Our customers consist primarily of major oil companies, oil traders and refineries. The portion of our revenues attributable to any single customer changes over time, depending on the level of relevant activity by the customer, our ability to meet the customer’s needs and other factors, many of which are beyond our control. Two customers accounted for 20% and 15%, respectively, of our consolidated revenues for fiscal 2006. If we were to lose either of these customers or if either of these customers significantly reduced its use of our services, our business and operating results could be adversely affected.
Voyage charters may not be available at rates that will allow us to operate our vessels profitably.
During fiscal 2006, we derived approximately 21% of our revenue from single voyage charters. Voyage charter rates fluctuate significantly based on tank vessel availability, the demand for refined petroleum products and other factors. Increased dependence on the voyage charter market by us could result in a lower utilization of our vessels and decreased profitability. Future voyage charters may not be available at rates that will allow us to operate our vessels profitably.
We may not be able to renew time charters, consecutive voyage charters, contracts of affreightment and bareboat charters when they expire.
We received approximately 79% of our revenue from time charters, consecutive voyage charters, contracts of affreightment and bareboat charters during fiscal 2006. These arrangements, which are generally for periods of one year or more, may not be renewed, or if renewed, may not be renewed at similar rates. If we are unable to obtain new charters at rates equivalent to those received under the old charters, our profitability may be adversely affected.
We must make substantial expenditures to maintain the operating capacity of our fleet, which will reduce our cash available for distribution.
Tank vessels are subject to the requirements of the Oil Pollution Act of 1990, or OPA 90. OPA 90 mandates that all single-hull tank vessels operating in U.S. waters be removed from petroleum and petroleum product transportation services at various times through January 1, 2015, and provides a schedule for the phase-out of the single-hull vessels based on their age and size. As of June 30, 2006, approximately 67% of the barrel-carrying capacity of our tank vessel fleet was double-hulled in compliance with OPA 90. The remaining 33% (except for one 75,000-barrel vessel which will phase out in January 2009) will be in compliance with OPA 90 until January 2015. The capacity of certain of our single-hull vessels has already been effectively replaced by double-hull vessels placed into service in the past two years. We estimate that the current cost to replace our remaining single hull capacity with newbuildings or by retrofitting certain of our existing vessels ranges from $88.0 million to $92.0 million. This capacity can also be replaced by acquiring existing double-hull tank vessels as opportunities arise. At the time we make these expenditures, the actual cost could be higher due to inflation and other factors.
Marine transportation of refined petroleum products is a capital intensive business, requiring significant investment to maintain an efficient fleet and to stay in regulatory compliance. We estimate that, over the next five years, we will spend an average of approximately $15.3 million per year to drydock and maintain our tank vessels’ operating capacity. Periodically, we will also make expenditures to acquire or construct additional tank vessel capacity and to upgrade our overall fleet efficiency.
Please read “-Risks Related to Our Common Units-In calculating our available cash from operating surplus each quarter, we are required to deduct estimated maintenance capital expenditures, which may result in less cash available for distribution to unitholders than if actual maintenance capital expenditures were deducted” for information about our requirement to deduct estimated maintenance capital expenditures in calculating our available cash from operating surplus.
Capital expenditures and other costs necessary to operate and maintain a vessel vary depending on the age of the vessel and changes in governmental regulations, safety or other equipment standards.
Capital expenditures and other costs necessary to operate and maintain a vessel increase with the age of the vessel. In addition, changes in governmental regulations, safety or other equipment standards, as well as compliance with standards imposed by maritime self-regulatory organizations and customer requirements or competition, may require us to make additional expenditures. For example, we may be required to make significant expenditures for alterations or the addition of new equipment to satisfy requirements of the U.S. Coast Guard and the American Bureau of Shipping. In addition, we may be required to take our vessels out of service for extended periods of time, with corresponding losses of revenues, in order to make such alterations or to add such equipment. In the future, market conditions may not justify these expenditures or enable us to operate our older vessels profitably during the remainder of their economic lives.
In order to fund these capital expenditures, we will either incur borrowings or raise capital through the sale of debt or equity securities. Our ability to access the capital markets for future offerings may be
limited by our financial condition at the time as well as by adverse market conditions resulting from, among other things, general economic conditions and contingencies and uncertainties that are beyond our control. Our failure to obtain the funds for necessary future capital expenditures would limit our ability to continue to operate some of our vessels and could have a material adverse effect on our business and on our ability to make distributions to unitholders.
Our purchase of existing vessels carries risks associated with the quality of those vessels.
Our fleet renewal and expansion strategy includes the acquisition of existing vessels as well as the ordering of newbuildings. Unlike newbuildings, existing vessels typically do not carry warranties with respect to their condition. While we generally inspect any existing vessel prior to purchase, such an inspection would normally not provide us with as much knowledge of its condition as we would possess if the vessel had been built for us and operated by us during its life. Repairs and maintenance costs for existing vessels are difficult to predict and may be more substantial than for vessels we have operated since they were built. These costs could decrease our profits and reduce our liquidity.
We are subject to complex laws and regulations, including environmental regulations, that can adversely affect the cost, manner or feasibility of doing business.
Increasingly stringent federal, state and local laws and regulations governing worker health and safety and the manning, construction and operation of vessels significantly affect our operations. Many aspects of the marine industry are subject to extensive governmental regulation by the U.S. Coast Guard, the Department of Transportation, the Department of Homeland Security, the National Transportation Safety Board and the U.S. Customs Service, and to regulation by private industry organizations such as the American Bureau of Shipping. The U.S. Coast Guard and the National Transportation Safety Board set safety standards and are authorized to investigate vessel accidents and recommend improved safety standards. The U.S. Coast Guard is authorized to inspect vessels at will.
Our operations are also subject to federal, state, local and international laws and regulations that control the discharge of pollutants into the environment or otherwise relate to environmental protection. Compliance with such laws, regulations and standards may require installation of costly equipment or operational changes. Failure to comply with applicable laws and regulations may result in administrative and civil penalties, criminal sanctions or the suspension or termination of our operations. Some environmental laws often impose strict liability for remediation of spills and releases of oil and hazardous substances, which could subject us to liability without regard to whether we were negligent or at fault. Under OPA 90, owners, operators and bareboat charterers are jointly and severally strictly liable for the discharge of oil within the 200-mile exclusive economic zone around the United States. Additionally, an oil spill could result in significant liability, including fines, penalties, criminal liability and costs for natural resource damages. The potential for these releases could increase as we increase our fleet capacity. Most states bordering on a navigable waterway have enacted legislation providing for potentially unlimited liability for the discharge of pollutants within their waters.
Our insurance may not be adequate to cover our losses.
We may not be adequately insured to cover losses from our operational risks, which could have a material adverse effect on our operations. For example, a catastrophic oil spill or other disaster could exceed our insurance coverage. In addition, our affiliate, EW Transportation LLC, and its predecessors may not have insurance coverage prior to March 1986. If we were subject to claims related to that period, including claims from current or former employees, EW Transportation LLC may not have insurance to pay the liabilities, if any, that could be imposed on us. If we had to pay claims solely out of our own funds, it could have a material adverse effect on our financial condition. Furthermore, any claims covered by
insurance would be subject to deductibles, and since it is possible that a large number of claims could be brought, the aggregate amount of these deductibles could be material.
We may not be able to procure adequate insurance coverage at commercially reasonable rates in the future, and some claims may not be paid. In the past, stricter environmental regulations have led to higher costs for insurance covering environmental damage or pollution, and new regulations could lead to similar increases or even make this type of insurance unavailable. In addition, our insurance may be voidable by the insurers as a result of certain actions of ours.
Because we obtain some of our insurance through protection and indemnity associations, we also may be subject to calls, or premiums, in amounts based not only on our own claim records, but also the claim records of all other members of the protection and indemnity associations.
We may be subject to calls, or premiums, in amounts based not only on our own claim records but also the claim records of all other members of the protection and indemnity associations through which we receive insurance coverage for tort liability, including pollution-related liability. Our payment of these calls could result in significant expenses to us, which could reduce our profits or cause losses. Moreover, the protection and indemnity clubs and other insurance providers reserve the right to make changes in insurance coverage with little or no advance notice.
Terrorist attacks have resulted in increased costs and have disrupted our business. Continued hostilities in the Middle East or other sustained military campaigns may adversely impact our results of operations.
After the terrorist attacks of September 11, 2001, New York Harbor was shut down temporarily, resulting in the suspension of our local operations in the New York City area for four days and the loss of revenue related to these operations. The long-term impact that terrorist attacks and the threat of terrorist attacks may have on the petroleum industry in general, and on us in particular, is not known at this time. Uncertainty surrounding continued hostilities in the Middle East or other sustained military campaigns may affect our operations in unpredictable ways, including disruptions of petroleum supplies and markets, and the possibility that infrastructure facilities could be direct targets of, or indirect casualties of, an act of terror.
Changes in the insurance markets attributable to terrorist attacks may make certain types of insurance more difficult for us to obtain. Moreover, the insurance that may be available to us may be significantly more expensive than our existing insurance coverage. Instability in the financial markets as a result of terrorism or war could also affect our ability to raise capital.
We depend upon unionized labor for the provision of our services in certain geographic areas. Any work stoppages or labor disturbances could disrupt our business in those areas.
Certain of our seagoing personnel, comprising 51% of our total workforce, are employed under a contract with a division of the International Longshoreman’s Association that expires on June 30, 2008. Any work stoppages or other labor disturbances could have a material adverse effect on our business, financial condition and results of operations.
Our employees are covered by federal laws that may subject us to job-related claims in addition to those provided by state laws.
Some of our employees are covered by provisions of federal statutory and general maritime law. These laws typically operate to make liability limits established by state workers’ compensation laws inapplicable to these employees and to permit these employees and their representatives to pursue actions against employers for job-related injuries in federal courts. Because we are not generally protected by the
limits imposed by state workers’ compensation statutes, we may have greater exposure for claims made by these employees.
We depend on key personnel for the success of our business.
We depend on the services of our senior management team and other key personnel. In particular, our success depends on the continued efforts of Mr. Timothy J. Casey, the President and Chief Executive Officer of K-Sea General Partner GP LLC, and other key employees. The loss of the services of any key employee could have a material adverse effect on our business, financial condition and results of operations. We may not be able to locate or employ on acceptable terms qualified replacements for senior management or key employees if their services were no longer available.
Due to our lack of asset diversification, adverse developments in our marine transportation business would reduce our ability to make distributions to our unitholders.
We rely exclusively on the revenues generated from our marine transportation business. Due to our lack of asset diversification, an adverse development in this business would have a significantly greater impact on our business, financial condition and results of operations than if we maintained more diverse assets.
Changes in international trade agreements could affect our ability to provide marine transportation services at competitive rates.
Currently, vessel trade or marine transportation between two points within the same country, generally known as cabotage or coastwise trade, is not included in the General Agreement on Trade in Services or the North American Free Trade Agreement. In addition, the Jones Act restricts maritime cargo transportation between U.S. ports to U.S.-flag vessels qualified to engage in U.S. coastwise trade. If maritime services were deemed to include cabotage and included in the General Agreement on Trade in Services, the North American Free Trade Agreement or other multi-national trade agreements, transportation of maritime cargo between U.S. ports could be opened to foreign-flag vessels. Foreign vessels would have lower construction costs and would generally operate at significantly lower costs than we do in U.S. markets, which would likely have a material adverse effect on our ability to compete.
Risks Related to Our Common Units
We may not have sufficient cash from operations to enable us to pay the minimum quarterly distribution following establishment of cash reserves and payment of fees and expenses, including payments to our general partner.
We may not have sufficient available cash each quarter to pay the minimum quarterly distribution. The amount of cash we can distribute on our common units principally depends upon the amount of cash we generate from our operations, which will fluctuate from quarter to quarter based on, among other things:
· the level of consumption of refined petroleum products in the markets in which we operate;
· the prices we obtain for our services;
· the level of our operating costs, including payments to our general partner; and
· prevailing economic conditions.
Additionally, the actual amount of cash we have available for distribution depends on other factors such as:
· the level of capital expenditures we make, including for acquisitions, retrofitting of vessels and compliance with new regulations;
· the restrictions contained in our debt instruments and our debt service requirements;
· fluctuations in our working capital needs;
· our ability to make working capital borrowings; and
· the amount, if any, of reserves, including reserves for future capital expenditures and other matters, established by our general partner in its discretion.
The amount of cash we have available for distribution depends primarily on our cash flow, including cash flow from operations and working capital borrowings, and not solely on profitability, which will be affected by non-cash items. As a result, we may make cash distributions during periods when we record losses and may not make cash distributions during periods when we record net income.
K-Sea General Partner L.P. and its affiliates have conflicts of interest and limited fiduciary duties, which may permit them to favor their own interests to the detriment of our unitholders.
Affiliates of our general partner indirectly own the 2% general partner interest and a 41.1% limited partner interest in us and own and control the general partner of our general partner. Conflicts of interest may arise between K-Sea General Partner L.P. and its affiliates, on the one hand, and us and our unitholders, on the other hand. As a result of these conflicts, our general partner may favor its own interests and the interests of its affiliates over the interests of our unitholders. These conflicts include, among others, the following situations:
· our general partner is allowed to take into account the interests of parties other than us, such as our affiliates, in resolving conflicts of interest, which has the effect of limiting its fiduciary duty to our unitholders;
· our general partner may limit its liability and reduce its fiduciary duties, while also restricting the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty. As a result of purchasing common units, our unitholders consent to some actions and conflicts of interest that might otherwise constitute a breach of fiduciary or other duties under applicable state law;
· our general partner determines the amount and timing of asset purchases and sales, capital expenditures, borrowings, issuance of additional partnership securities and reserves, each of which can affect the amount of cash that is distributed to our unitholders;
· in some instances, our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to hasten the expiration of the subordination period;
· our general partner determines which costs incurred by it and its affiliates, including K-Sea General Partner GP LLC, are reimbursable by us;
· our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered on terms that are fair and reasonable to us or entering into additional contractual arrangements with any of these entities on our behalf;
· our general partner controls the enforcement of obligations owed to us by it and its affiliates; and
· our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
Even if unitholders are dissatisfied, they cannot remove our general partner without its consent.
Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Unitholders did not elect our general partner or the board of directors of its general partner and will have no right to elect our general partner or the board of directors of its general partner on an annual or other continuing basis. The board of directors of the general partner of our general partner is chosen by its members.
Furthermore, if the unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. Unitholders are currently unable to remove our general partner without its consent because our affiliates currently own sufficient units to be able to prevent the general partner’s removal. The vote of the holders of at least 662¤3% of all outstanding common and subordinated units voting together as a single class is required to remove our general partner. Also, if our general partner is removed without cause during the subordination period and units held by our general partner and its affiliates are not voted in favor of that removal, all remaining subordinated units will automatically be converted into common units and any existing arrearages on the common units will be extinguished. A removal of our general partner under these circumstances would adversely affect the common units by prematurely eliminating their distribution and liquidation preference over the subordinated units, which would otherwise have continued until we had met certain distribution and performance tests.
Cause is narrowly defined in our partnership agreement to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable for actual fraud, gross negligence or willful or wanton misconduct in its capacity as our general partner. Cause does not include most cases of charges of poor management of the business, so the removal of our general partner during the subordination period because of the unitholders’ dissatisfaction with our general partner’s performance in managing our partnership will most likely result in the termination of the subordination period.
Our general partner’s discretion in establishing cash reserves may reduce the amount of cash available for distribution to unitholders.
Our partnership agreement gives our general partner broad discretion in establishing financial reserves for the proper conduct of our business. These reserves also will affect the amount of cash available for distribution. Our general partner may establish reserves for distributions on the subordinated units, but only if those reserves will not prevent us from distributing the full minimum quarterly distribution, plus any arrearages, on the common units for the following four quarters. As described above under “-Risks Inherent in Our Business-We must make substantial expenditures to maintain the operating capacity of our fleet, which will reduce our cash available for distribution,” the partnership agreement requires our general partner to deduct from operating surplus each quarter estimated maintenance capital expenditures as opposed to actual expenditures, which could reduce the amount of available cash for distribution.
In calculating our available cash from operating surplus each quarter, we are required to deduct estimated maintenance capital expenditures, which may result in less cash available for distribution to unitholders than if actual maintenance capital expenditures were deducted.
Our partnership agreement requires us to deduct estimated maintenance capital expenditures from operating surplus each quarter, as opposed to actual maintenance capital expenditures, in order to reduce disparities in operating surplus caused by the fluctuating level of maintenance capital expenditures, such as drydocking. Because of the substantial capital expenditures we intend to make by January 1, 2015 to replace the operating capacity of our single-hull vessels, our annual estimated maintenance capital
expenditures for purposes of calculating operating surplus also includes $2.5 million to reduce the fluctuation in operating surplus that would otherwise be caused by the required expenditures.
The amount of estimated maintenance capital expenditures we deduct from operating surplus is subject to review and change by the board of directors of K-Sea General Partner GP LLC, with the concurrence of the conflicts committee of such board. In years when estimated maintenance capital expenditures are higher than actual maintenance capital expenditures, as we expect will be the case in some years until we actually make expenditures for the OPA 90 replacements and retrofitting, the amount of cash available for distribution to unitholders will be lower than if actual maintenance capital expenditures were deducted from operating surplus.
Please read “-Risks Inherent in Our Business-We must make substantial expenditures to maintain the operating capacity of our fleet, which will reduce our cash available for distribution” for information regarding substantial expenditures that we must make to maintain the operating capacity of our fleet.
We may issue additional common units without the approval of unitholders, which would dilute unitholders’ ownership interests.
During the subordination period, without the approval of our unitholders, our general partner may cause us to issue up to 2,082,500 additional common units. Our general partner may also cause us to issue an unlimited number of additional common units or other equity securities of equal rank with the common units, without unitholder approval, in a number of circumstances such as:
· the issuance of common units in connection with acquisitions or capital improvements that increase cash flow from operations per unit on a pro forma or estimated pro forma basis;
· issuances of common units to repay indebtedness, the cost of which to service is greater than the distribution obligations associated with the units issued in connection with the repayment of the indebtedness;
· the redemption of common units from the net proceeds of an issuance of common units;
· the conversion of subordinated units into common units;
· the conversion of units of equal rank with the common units into common units under some circumstances; issuances of common units under our employee benefit plans;
· the conversion of the general partner interest and the incentive distribution rights into common units as a result of the withdrawal or removal of our general partner; or
· the combination or subdivision of common units.
The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
· our unitholders’ proportionate ownership interest in us will decrease;
· the amount of cash available for distribution on each unit may decrease;
· because a lower percentage of total outstanding units will be subordinated units, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by our common unitholders will increase;
· the relative voting strength of each previously outstanding unit may be diminished; and
· the market price of the common units may decline.
After the end of the subordination period, we may issue an unlimited number of limited partner interests of any type without the approval of our unitholders. Our partnership agreement does not give our unitholders the right to approve our issuance of equity securities ranking junior to the common units at any time.
Our partnership agreement currently limits the ownership of our partnership interests by individuals or entities that are not U.S. citizens. This restriction could limit the liquidity of our common units.
In order to ensure compliance with Jones Act citizenship requirements, the board of directors of the general partner of our general partner has adopted a requirement that at least 85% of our partnership interests must be held by U.S. citizens. This requirement may have an adverse impact on the liquidity or market value of our common units, because unitholders will be unable to sell units to non-U.S. citizens. Any purported transfer of common units in violation of these provisions will be ineffective to transfer the common units or any voting, dividend or other rights in respect of the common units.
Our general partner has a limited call right that may require unitholders to sell their common units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than their then-current market price. As a result, unitholders may be required to sell their common units at an undesirable time or price and may not receive any return on their investment. Unitholders may also incur a tax liability upon a sale of their units. Our general partner is not obligated to obtain a fairness opinion regarding the value of the common units to be repurchased by it upon exercise of the limited call right. There is no restriction in our partnership agreement that prevents our general partner from issuing additional common units and exercising its call right. If our general partner exercised its limited call right, the effect would be to take us private and, if the units were subsequently deregistered, we would no longer be subject to the reporting requirements of the Securities Exchange Act of 1934, as amended.
Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units.
Our partnership agreement restricts unitholders’ voting rights by providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their transferees and persons who acquired such units with the prior approval of the board of directors of the general partner of our general partner, cannot vote on any matter. The partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders’ ability to influence the manner or direction of management.
Cost reimbursements due our general partner and its affiliates will reduce cash available for distribution to unitholders.
Prior to making any distribution on the common units, we will reimburse our general partner and its affiliates for all expenses they incur on our behalf, which will be determined by our general partner in its sole discretion. These expenses will include all costs incurred by the general partner and its affiliates in managing and operating us, including costs for rendering corporate staff and support services to us. In addition, our general partner and its affiliates may provide us with other services for which the general partner or its affiliates may charge us fees. The reimbursement of expenses and payment of fees, if any, to our general partner and its affiliates could adversely affect our ability to pay cash distributions to unitholders.
Unitholders may not have limited liability if a court finds that unitholder action constitutes control of our business.
As a limited partner in a partnership organized under Delaware law, a unitholder could be held liable for our obligations to the same extent as a general partner if such unitholder participates in the “control” of our business. Our general partner generally has unlimited liability for the obligations of the partnership, such as its debts and environmental liabilities, except for those contractual obligations of the partnership that are expressly made without recourse to our general partner. In addition, Section 17-607 of the Delaware Revised Uniform Limited Partnership Act provides that, under some circumstances, a unitholder may be liable to us for the amount of a distribution for a period of three years from the date of the distribution. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business.
Restrictions in our debt agreements may prevent us from engaging in some beneficial transactions or paying distributions.
As of June 30, 2006, we had outstanding debt of $193.4 million. Our payment of principal and interest on the debt will reduce cash available for distribution on our units. Our credit agreement prohibits the payment of distributions after the occurrence of the following events, among others, and receipt of notice from our lenders:
· failure to pay any principal, interest, fees, expenses or other amounts when due;
· default under any vessel mortgage;
· failure to notify the lenders of any oil spill or discharge of hazardous material, or of any action or claim related thereto;
· breach or lapse of any insurance with respect to the vessels;
· breach of certain financial covenants;
· breach by our general partner or any of our subsidiaries of the guarantees issued under our new credit agreement;
· failure to observe any other agreement, security instrument, obligation or covenant beyond specified cure periods in certain cases;
· default under other material indebtedness of our operating partnership, our general partner or any of our subsidiaries;
· bankruptcy or insolvency events involving us, our general partner or any of our subsidiaries;
· failure of any representation or warranty to be materially correct;
· a change of control, as defined in the applicable agreement;
· a material adverse effect, as defined in the applicable agreement, occurs relating to us or our business; and
· a judgment against us, our general partner or any of our subsidiaries in excess of certain allowances and not covered by insurance.
Any subsequent refinancing of our current debt or any new debt could have similar restrictions.
The control of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders so long as the third party satisfies the citizenship requirements of the Jones Act. Furthermore, there is no restriction in the partnership agreement on the ability of the partners of our general partner from transferring their respective partnership interests in our general partner to a third party that satisfies the citizenship requirements of the Jones Act. The new partners of our general partner would then be in a position to replace the board of directors and officers of the general partner of our general partner with their own choices and to control the decisions taken by the board of directors and officers.
Our affiliates may engage in activities that compete directly with us.
Pursuant to the omnibus agreement entered into in connection with the initial public offering of our common units, certain of our affiliates have agreed not to engage, either directly or indirectly, in the business of providing refined petroleum product marine transportation, distribution and logistics services in the United States to the extent such business generates qualifying income for federal income tax purposes. The omnibus agreement does not prohibit the equity owners of our affiliates from owning assets or engaging in businesses that compete directly or indirectly with us.
Tax Risks
The IRS could treat us as a corporation for tax purposes, which would substantially reduce cash available for distribution to unitholders.
The federal income tax benefit of an investment in us depends largely on our being treated as a partnership for federal income tax purposes. If less than 90% of our gross income for any taxable year is “qualifying income” from transportation or processing of crude oil, natural gas or products thereof, interest, dividends or similar sources, we will be a “publicly traded partnership” under Section 7704 of the Internal Revenue Code and taxable as a corporation for federal income tax purposes for that taxable year and all subsequent years. The IRS has not provided any ruling on this matter. If we were treated as a corporation for federal income tax purposes, we would pay tax on our income at corporate rates, currently 35%, distributions would generally be taxed again to unitholders as corporate distributions and no income, gains, losses, or deductions would flow through to unitholders. Because a tax would be imposed upon us as an entity, cash available for distribution to unitholders would be substantially reduced. Treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to unitholders and thus would likely result in a substantial reduction in the value of the common units.
Current law may change and cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to entity-level taxation. Our partnership agreement provides that, if a law is enacted or an existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to entity-level taxation for federal, state, or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts will be decreased to reflect the impact of that law on us. Finally, because of widespread state budget deficits, several states are evaluating ways to subject partnerships to entity level taxation through the imposition of state income, franchise and other forms of taxation. If any of these states were to impose a tax on us, the cash available for distribution to unitholders would be reduced.
A successful IRS contest of the federal income tax positions we take may adversely impact the market for our common units, and the costs of any contest will be borne by us and, therefore, indirectly by our unitholders and our general partner.
The IRS has not provided any ruling with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from our counsel’s conclusions expressed in this prospectus. It may be necessary to resort to administrative or court proceedings to sustain some or all of our counsel’s conclusions or the positions we take. A court may not agree with all of our counsel’s conclusions or the positions we take. Any contest with the IRS may materially and adversely impact the market for our common units and the prices at which common units trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner.
Unitholders may be required to pay taxes on income from us even if they do not receive any cash distributions from us.
Unitholders will be required to pay federal income taxes and, in some cases, state, local, and foreign income taxes on their share of our taxable income, whether or not they receive cash distributions from us. Unitholders may not receive cash distributions equal to their share of our taxable income or even the tax liability that results from that income.
Tax gain or loss on the disposition of our common units could be different than expected.
If a unitholder sells his common units, that unitholder will recognize gain or loss equal to the difference between the amount realized and the unitholder’s tax basis in those common units. Prior distributions in excess of the total net taxable income the unitholder was allocated for a common unit, which decreased the unitholder’s tax basis in that common unit, will, in effect, become taxable income to the unitholder if the common unit is sold at a price greater than the unitholder’s tax basis in that common unit, even if the price the unitholder receives is less than the unitholder’s original cost. A substantial portion of the amount realized, whether or not representing gain, may be ordinary income to unitholders. Should the IRS successfully contest some positions we take, unitholders could recognize more gain on the sale of common units than would be the case under those positions, without the benefit of decreased income in prior years. In addition, if unitholders sell their common units, they may incur a tax liability in excess of the amount of cash they receive from the sale.
Tax-exempt entities and non-U.S. persons face unique tax issues from owning common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, such as individual retirement accounts (known as IRAs) and non-U.S. persons, raises issues unique to them. For example, virtually all of our income allocated to organizations exempt from federal income tax, including individual retirement accounts and other retirement plans, will be unrelated business income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons will be required to file United States federal income tax returns and pay tax on their share of our taxable income. If you are a tax-exempt entity or a foreign person, you should consult your tax advisor before investing in our common units.
We registered as a tax shelter under prior law. This may increase the risk of an IRS audit of us or a unitholder.
Prior to the enactment of the American Jobs Creation Act of 2004, certain types of entities were required to register with the IRS as “tax shelters,” based on a perception that those entities might claim tax benefits that were unwarranted. We registered as a tax shelter under such prior law. The American Jobs
Creation Act of 2004 repealed the tax shelter registration requirement and replaced it with a regime that requires reporting, and will likely require registration, of certain “reportable transactions.” We do not expect to engage in any reportable transactions. Nevertheless, our registration as a tax shelter under prior law, or our future participation in a reportable transaction, might increase the likelihood that we will be audited, and any such audit might lead to tax adjustments.
Should our tax returns be audited, any adjustments to our tax returns may lead to adjustments to our unitholders’ tax returns and may lead to audits of unitholders’ tax returns. Our unitholders’ would be responsible for the consequences of any audits to their tax returns.
We treat each purchaser of common units as having the same tax benefits without regard to the units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.
Because we cannot match transferors and transferees of common units and because of other reasons, we will take depreciation and amortization positions that may not conform to all aspects of the Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to unitholders. It also could affect the timing of these tax benefits or the amount of gain from the sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to unitholders’ tax returns.
Unitholders may be subject to state, local and foreign taxes and return filing requirements as a result of investing in our common units.
In addition to federal income taxes, unitholders will likely be subject to other taxes, such as state and local income taxes, unincorporated business taxes and estate, inheritance, or intangible taxes that are imposed by the various jurisdictions in which we do business or own property. Unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of the various jurisdictions in which we do business or own property and may be subject to penalties for failure to comply with those requirements. We own property and conduct business in Alaska, New York, New Jersey, Washington and Virginia, all of which impose a state income tax. We currently conduct certain operations in Puerto Rico, Canada and Venezuela in a manner that we believe does not subject unitholders to direct liability to pay tax or file returns in those countries, but there can be no assurance that we will conduct our foreign operations in this manner in the future. Taxes we pay with respect to our foreign operations reduce the cash flow available for distribution to you. We may do business or own property in other states or foreign countries in the future. It is the responsibility of unitholders to file all federal, state, local, and foreign tax returns. Our counsel has not rendered an opinion on the state, local or foreign tax consequences of an investment in our common units.
We have subsidiaries that are treated as corporations for federal income tax purposes and subject to corporate-level income taxes.
We conduct a portion of our operations through subsidiaries that are, or are treated as, corporations for federal income tax purposes. Currently, those operations consist primarily of our bunkering activities and our operation of a Canadian flagged vessel. We may elect to conduct additional operations in corporate form in the future. These corporate subsidiaries will be subject to corporate-level tax, which will reduce the cash available for distribution to us and, in turn, to you. If the IRS were to successfully assert that these corporate subsidiaries have more tax liability than we anticipate or legislation was enacted that increased the corporate tax rate, our cash available for distribution to you would be further reduced.
The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.
We will be considered to have terminated for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. Our termination would, among other things, result in the closing of our taxable year for all unitholders and could result in a deferral of depreciation deductions allowable in computing our taxable income.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
None.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are a party to various suits in the ordinary course of business for monetary relief arising principally from personal injuries, collision or other casualty and to claims arising under vessel charters. All of these personal injury, collision and casualty claims against us are fully covered by insurance, subject to deductibles ranging from $10,000 to $100,000 in amount. We reserve on a current basis for amounts we expect to pay. Although the outcome of any individual claim or action cannot be predicted with certainty, we believe that any adverse outcome, individually or in the aggregate, would be substantially mitigated by applicable insurance or indemnification from previous owners of our assets, and would not have a material adverse effect on our financial position, results of operations or cash flows.
EW Transportation LLC and its predecessors have been named, together with a large number of other companies, as co-defendants in 39 civil actions by various parties, including former employees, alleging unspecified damages from past exposure to asbestos and second-hand smoke aboard some of the vessels that it contributed to us in connection with our initial public offering. EW Transportation LLC and its predecessors have been dismissed from 38 of these lawsuits for an aggregate sum of approximately $47,000, and are seeking to settle the other case. We may be subject to litigation in the future from these plaintiffs and others alleging exposure to asbestos due to alleged failure to properly encapsulate or remove friable asbestos on our vessels, as well as for exposure to second-hand smoke and other matters. For a related discussion of insurance coverage, please read “Business and Properties-Insurance Program” in Items 1 and 2 of this report.
In November 2005, one of our tank barges struck submerged debris in the U.S. Gulf of Mexico, causing significant damage which resulted in the barge eventually capsizing. At the time of the incident, the barge was carrying approximately 120,000 barrels of No. 6 fuel oil, a heavy oil product. Although the final amount has not been determined, we believe much of the oil escaped into the ocean. However, according to the National Oceanic and Atmospheric Administration, the likelihood of shoreline impact from the incident is low. We maintain significant protection and indemnity insurance for pollution-related costs and claims, including clean-up costs and environmental damages, and believe that such coverage will be adequate to cover the cost of the clean-up operations and any subsequent claims, fines or penalties.
One of our predecessors has also received notice that it is a potentially responsible party in a proceeding for the cleanup of hazardous substances at a site in Port Arthur, Texas. For more information, please read “Business and Properties-Regulation-Environmental-Solid Waste” in Items 1 and 2 of this report.
Our predecessors have agreed to indemnify us for certain liabilities. For more information, please read “Certain Relationships and Related Transactions-Omnibus Agreement-Indemnification” in Item 13 of this report.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.
No matters were submitted to a vote of security holders during the quarter ended June 30, 2006.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SECURITYHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Price of Common Units, Distributions and Related Unitholder Matters
Our common units have been listed on the New York Stock Exchange under the symbol “KSP” since January 9, 2004. Prior to January 9, 2004, our equity securities were not publicly traded. As of September 6, 2006, there were 5,754,900 outstanding common units, representing an aggregate 56.9% limited partner interest in us, which were held by 37 holders of record, representing approximately 5,000 beneficial owners. The following table sets forth, for the periods indicated, the high and low sales prices per common unit, as reported on the New York Stock Exchange, and the amount of cash distributions declared per common unit:
(1) Distributions are shown for the quarter with respect to which they were declared. For each of the indicated quarters for which distributions have been made, an identical per unit cash distribution was paid on the subordinated units.
The aggregate amount of distributions declared in respect of the 2006 and 2005 fiscal years on common units, the general partner interests, and subordinated units, totaled $24.4 million and $18.8 million, respectively.
Cash Distribution Policy
Within 45 days after the end of each quarter, we will distribute all of our available cash from operating surplus to unitholders of record on the applicable record date. Our available cash from operating surplus consists generally of all cash on hand at the end of the fiscal quarter, plus all cash on hand resulting from working capital borrowings made after the end of the quarter up to the date of determination of available cash, less the amount of cash that our general partner determines is necessary or appropriate to, among others:
· provide for the proper conduct of our business, including reserves for future capital and maintenance expenditures;
· comply with applicable law, any of our debt instruments, or other agreements; or
· provide funds for distributions to our unitholders and to our general partner for any one or more of the next four quarters.
Our ability to distribute available cash is contractually restricted by the terms of our credit facilities, which require us to maintain certain financial ratios and generally prohibit distributions to unitholders if
the distribution would cause an event of default, or an event of default is existing, under our credit facilities. Please read “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Amended Credit Agreement” in Item 7 of this report.
Subordination Period
During the subordination period, the common units have the right to receive distributions of available cash from operating surplus in an amount equal to the minimum quarterly distribution of $0.50 per quarter, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. Upon expiration of the subordination period, each outstanding subordinated unit will convert into one common unit and will participate pro rata with the other common units in distributions of available cash.
Definition of Subordination Period. The subordination period will extend until the first day of any quarter, beginning after December 31, 2008, that each of the following tests are met:
· distributions of available cash from operating surplus on each of the outstanding common units and subordinated units equaled or exceeded the minimum quarterly distribution for each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date;
· the “adjusted operating surplus,” as defined in our partnership agreement, generated during each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units and subordinated units during those periods on a fully diluted basis and the related distribution on the general partner interest during those periods; and
· there are no arrearages in payment of the minimum quarterly distribution on the common units.
Adjusted operating surplus is intended to reflect the cash generated from operations during a particular period and therefore excludes net increases in working capital borrowings and net drawdowns of reserves of cash generated in prior periods.
Early Conversion of Subordinated Units. Before the end of the subordination period, 50% of the subordinated units, or up to 2,082,500 subordinated units, may convert into common units on a one-for-one basis immediately after the distribution of available cash to the partners in respect of any quarter ending on or after:
· December 31, 2006 with respect to 25% of the subordinated units; and
· December 31, 2007 with respect to 25% of the subordinated units.
The early conversions will occur if at the end of the applicable quarter each of the following occurs:
· distributions of available cash from operating surplus on each of the outstanding common units and subordinated units equaled or exceeded the minimum quarterly distribution for each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date;
· the adjusted operating surplus generated during each of the three consecutive, non-overlapping four-quarter periods immediately preceding that date equaled or exceeded the sum of the minimum quarterly distributions on all of the outstanding common units and subordinated units during those periods on a fully diluted basis and the related distribution on the general partner interest during those periods; and
· there are no arrearages in payment of the minimum quarterly distribution on the common units.
However, the second early conversion of the subordinated units may not occur until at least one year following the first early conversion of the subordinated units.
Incentive Distribution Rights
Incentive distribution rights represent the right to receive an increasing percentage of quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and certain target distribution levels have been achieved. Our general partner currently holds the incentive distribution rights, but may transfer these rights separately from its general partner interest, subject to restrictions in the partnership agreement.
If for any quarter, we have distributed available cash from operating surplus a) to the common and subordinated unitholders an amount equal to the minimum quarterly distribution, and b) on the common units an amount necessary to eliminate any cumulative arrearages in payment of the minimum quarterly distribution, then we will distribute any additional available cash from operating surplus for that quarter among the unitholders and our general partner in the following manner:
· first, 98% to all unitholders, pro rata, and 2% to our general partner, until each unitholder receives a total of $0.55 per unit for that quarter;
· second, 85% to all unitholders, pro rata, and 15% to our general partner, until each unitholder receives a total of $0.625 per unit for that quarter;
· third, 75% to all unitholders, pro rata, and 25% to our general partner, until each unitholder receives a total of $0.75 per unit for that quarter; and
· thereafter, 50% to all unitholders, pro rata, and 50% to our general partner.
The percentage interests set forth above for our general partner include its 2% general partner interest and assume the general partner has not transferred the incentive distribution rights.
Issuer Purchases of Equity Securities
We did not repurchase any of our common units during the fourth quarter of fiscal 2006.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth selected historical financial and operating data of K-Sea Transportation Partners L.P. and its predecessors. On January 14, 2004, EW Transportation LLC contributed assets and liabilities constituting its business to us in connection with our initial public offering of common units. Therefore, the historical financial and operating data presented below are for EW Transportation LLC for all periods prior to January 14, 2004. The following table should be read in conjunction with the consolidated financial statements, including the notes thereto, included elsewhere in this report, and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following is a discussion of the historical consolidated financial condition and results of operations of K-Sea Transportation Partners L.P. and, prior to our January 14, 2004 initial public offering, of our predecessor company, EW Transportation LLC, and should be read in conjunction with our historical consolidated financial statements and notes thereto included elsewhere in this report.
GENERAL
We are a leading provider of refined petroleum product marine transportation, distribution and logistics services in the United States domestic marine transportation business. We currently operate a fleet of 61 tank barges, 2 tankers and 41 tugboats that serves a wide range of customers, including major oil companies, oil traders and refiners. With approximately 3.4 million barrels of capacity, we believe we currently operate the largest coastwise tank barge fleet in the United States, as measured by barrel-carrying capacity.
Demand for our services is driven primarily by demand for refined petroleum products in the East, West and Gulf Coast regions of the United States. We generate revenue by charging customers for the transportation and distribution of their products utilizing our tank vessels and tugboats. These services are generally provided under the following four basic types of contractual relationships:
· time charters, which are contracts to charter a vessel for a fixed period of time, generally one year or more, at a set daily rate;
· contracts of affreightment, which are contracts to provide transportation services for products over a specific trade route, generally for one or more years, at a negotiated per barrel rate;
· voyage charters, which are charters for shorter intervals, usually a single round-trip, that are made on either a current market rate or advance contractual basis; and
· bareboat charters, which are longer-term agreements that allow a customer to operate one of our vessels and utilize its own operating staff without taking ownership of the vessel.
In addition, a variation of a voyage charter is known as a “consecutive voyage charter.” Under this arrangement, consecutive voyages are performed for a specified period of time.
The table below illustrates the primary distinctions among these types of contracts:
(1) Under a consecutive voyage charter, the customer pays for idle time.
(2) See “Definitions” below.
For contracts of affreightment and voyage charters, revenue is recognized based upon the relative transit time in each period, with expenses recognized as incurred. Although contracts of affreightment and certain contracts for voyage charters may be effective for a period in excess of one year, revenue is recognized over the transit time of individual voyages, which are generally less than ten days in duration. For time charters and bareboat charters, revenue is recognized ratably over the contract period, with expenses recognized as incurred.
One of the principal distinctions among these types of contracts is whether the vessel operator or the customer pays for voyage expenses, which include fuel, port charges, pilot fees, tank cleaning costs and canal tolls. Some voyage expenses are fixed, and the remainder can be estimated. If we, as the vessel operator, pay the voyage expenses, we typically pass these expenses on to our customers by charging higher rates under the contract or re-billing such expenses to them. As a result, although voyage revenue from different types of contracts may vary, the net revenue that remains after subtracting voyage expenses, which we call net voyage revenue, is comparable across the different types of contracts. Therefore, we principally use net voyage revenue, rather than voyage revenue, when comparing performance between different periods. Since net voyage revenue is a non-GAAP measurement, it is reconciled to the nearest GAAP measurement, voyage revenue, under “Results of Operations” below.
SIGNIFICANT FISCAL 2006 EVENTS
Acquisition of Sea Coast Transportation
On October 18, 2005, we completed the acquisition, through a wholly owned subsidiary, of all of the membership interests in Sea Coast Transportation LLC (“Sea Coast”) from Marine Resources Group, Inc. (“MRG”) pursuant to the terms and conditions of a Membership Interest Purchase Agreement dated August 23, 2005 among us, MRG and Saltchuk Resources, Inc. Also on October 18, 2005, Sea Coast acquired four tugboats from MRG. Sea Coast is a provider of marine transportation and logistics services to major oil companies, oil traders and refiners along the West Coast of the United States and Alaska. The aggregate purchase price for Sea Coast and the four tugboats comprised $77.0 million in cash and 125,000 common units representing limited partner interests in us. The common units were valued at $4.4 million, as of the closing date. We financed the cash portion of the purchase price through additional borrowings under our amended credit agreement. A registration statement on Form S-3 with respect to the resale of the common units issued to MRG was declared effective by the Securities and Exchange Commission in February 2006.
Under the purchase method of accounting, we recorded an aggregate purchase price of $82.4 million, comprising $77.0 million of cash, $4.4 million in common units, and $1.0 million of direct expenses. We allocated the purchase price to the tangible assets, intangible assets, and liabilities acquired based on their fair values, which for the fixed assets and intangibles were based on consideration of independent appraisals. The purchased identifiable intangible assets are being amortized on a straight-line basis over their respective estimated useful lives. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill, which is not amortized but which will be reviewed annually for impairment.
Barge Incident
On November 11, 2005, one of our tank barges, the DBL 152, struck a submerged service platform in the U.S. Gulf of Mexico that had collapsed during Hurricane Rita in September 2005. To ensure the safety of all people involved and to mitigate environmental damage, we initiated, and completed in January 2006, a detailed response plan in coordination with the United States Coast Guard, other federal and state agencies, our own personnel and response contractors. At the time of the incident, the barge was carrying approximately 120,000 barrels of No. 6 fuel oil, a heavy oil product. Although the final amount has not
been determined, we believe much of the oil escaped into the ocean. However, according to the National Oceanic and Atmospheric Administration, the likelihood of shoreline impact from the incident is low.
The barge was declared a constructive total loss, and we have received the total $11.0 million insured value from our hull and machinery insurers. The excess of this insurance recovery over the net book value of the barge, totaling $0.4 million, is included as a net gain on disposal of vessel in our consolidated statements of operations for the year ended June 30, 2006.
We maintain significant protection and indemnity insurance for pollution-related costs and claims, including cleanup costs and environmental damages, with the West of England Ship Owners Insurance Association, a member of the International Group of Protection and Indemnity clubs, and we believe that such coverage will be adequate to cover the cost of the clean-up operations and any subsequent claims, fines or penalties. We do not maintain “loss of hire” insurance.
The cause of the incident is under investigation by the United States Coast Guard, and by us and our insurers. We, along with our insurers, are considering the appropriate legal action, including insurance and other recovery claims.
DEFINITIONS
In order to understand our discussion of our results of operations, it is important to understand the meaning of the following terms used in our analysis and the factors that influence our results of operations:
· Voyage revenue. Voyage revenue includes revenue from time charters, contracts of affreightment and voyage charters, where we, as vessel operator, pay the vessel operating expenses. Voyage revenue is impacted by changes in charter and utilization rates and by the mix of business among the types of contracts described in the preceding sentence.
· Voyage expenses. Voyage expenses include items such as fuel, port charges, pilot fees, tank cleaning costs and canal tolls, which are unique to a particular voyage. Depending on the form of contract and customer preference, voyage expenses may be paid directly by customers or by us. If we pay voyage expenses, they are included in our results of operations when they are incurred. Typically when we pay voyage expenses, we add them to our freight rates at an approximate cost.
· Net voyage revenue. Net voyage revenue is equal to voyage revenue less voyage expenses. As explained above, the amount of voyage expenses we incur for a particular contract depends upon the form of the contract. Therefore, in comparing revenues between reporting periods, we use net voyage revenue to improve the comparability of reported revenues that are generated by the different forms of contracts. Since net voyage revenue is a non-GAAP measurement, it is reconciled to the nearest GAAP measurement, voyage revenue, under “Results of Operations” below.
· Bareboat charter and other revenue. Bareboat charter and other revenue includes revenue from bareboat charters and from towing and other miscellaneous services.
· Vessel operating expenses. The most significant direct vessel operating expenses are wages paid to vessel crews, routine maintenance and repairs and marine insurance. We may also incur outside towing expenses during periods of peak demand and in order to maintain our operating capacity while our tugs are drydocked or otherwise out of service for scheduled and unscheduled maintenance.
· Depreciation and amortization. We incur fixed charges related to the depreciation of the historical cost of our fleet and the amortization of expenditures for drydockings. The aggregate number of drydockings undertaken in a given period, the size of the vessels and the nature of the work performed determine the level of drydocking expenditures. We capitalize expenditures incurred for
drydocking and amortize these expenditures over 36 months. We also amortize, over periods ranging from four to ten years, intangible assets in connection with vessel acquisitions.
· General and administrative expenses. General and administrative expenses consist of employment costs of shoreside staff and the cost of facilities, as well as legal, audit, insurance and other administrative costs.
· Total tank vessel days. Total tank vessel days is equal to the number of calendar days in the period multiplied by the total number of tank vessels operating or in drydock during that period.
· Scheduled drydocking days. Scheduled drydocking days are days designated for the inspection and survey of tank vessels, and identification and completion of required refurbishment work, as required by the U.S. Coast Guard and the American Bureau of Shipping to maintain the vessels’ qualification to work in the U.S. coastwise trade. Generally, drydockings are required twice every five years and last between 30 and 60 days, based upon the size of the vessel and the type and extent of work required.
· Net utilization. Net utilization is a primary measure of operating performance in our business. Net utilization is a percentage equal to the total number of days worked by a tank vessel or group of tank vessels during a defined period, divided by total tank vessel days for that tank vessel or group of tank vessels. Net utilization is adversely impacted by scheduled drydocking, scheduled and unscheduled maintenance and idle time not paid for by the customer.
· Average daily rate. Average daily rate, another key measure of our operating performance, is equal to the net voyage revenue earned by a tank vessel or group of tank vessels during a defined period, divided by the total number of days actually worked by that tank vessel or group of tank vessels during that period. Fluctuations in average daily rates result not only from changes in charter rates charged to our customers, but also from changes in vessel utilization and efficiency, which could result from internal factors, such as newer and more efficient tank vessels, and from external factors such as weather or other delays.
· Coastwise and local trades. Our business is segregated into coastwise trade and local trade. Our coastwise trade generally comprises voyages of between 200 and 1,000 miles by vessels with greater than 40,000 barrels of barrel-carrying capacity. These voyages originate from the mid-Atlantic states to points as far north as Canada and as far south as Cape Hatteras, from points within the Gulf Coast region to other points within that region or to the Northeast, and to and from points on the West Coast of the United States and Alaska. We also own two non-Jones Act tank barges that transport petroleum products internationally. Our local trade generally comprises voyages by smaller vessels of less than 200 miles. The term U.S. coastwise trade, as used generally for Jones Act purposes, would include our coastwise and local trades.
RESULTS OF OPERATIONS
The following table summarizes our results of operations for the periods presented (dollars in thousands, except average daily rates):
(a) Net voyage revenue is a non-GAAP measure which is defined above under “Definitions” and reconciled to Voyage revenue, the nearest GAAP measure, under “Voyage Revenue and Voyage Expenses” in the period-to-period comparisons below.
Fiscal Year Ended June 30, 2006 Compared to the Fiscal Year Ended June 30, 2005
Voyage Revenue and Voyage Expenses
Voyage revenue was $176.7 million for the fiscal year ended June 30, 2006, an increase of $57.9 million, or 49%, as compared to voyage revenue of $118.8 million for the fiscal year ended June 30, 2005. Voyage expenses were $38.0 million for the fiscal year ended June 30, 2006, an increase of $13.8 million, or 57%, as compared to voyage expenses of $24.2 million for the fiscal year ended June 30, 2005.
Net Voyage Revenue
Net voyage revenue was $138.7 million for the fiscal year ended June 30, 2006, an increase of $44.1 million, or 47%, as compared to net voyage revenue of $94.6 million for the fiscal year ended June 30, 2005. In our coastwise trade, net voyage revenue was $101.3 million for the fiscal year ended June 30, 2006, an increase of $32.7 million, or 48%, as compared to $68.6 million for the fiscal year ended June 30, 2005. Net utilization in our coastwise trade remained constant at 90% for each fiscal year. The acquisition of Sea Coast in October 2005 resulted in increased coastwise net voyage revenue of $23.0 million in fiscal 2006, compared to fiscal 2005. Other increases for the year ended June 30, 2006 included $14.0 million in coastwise net voyage revenue resulting from an increase in days worked by the following vessels: (1) the DBL 78, which was placed in service in June 2005, (2) the KTC 50, which was placed in service in January 2005, (3) the Spring Creek, which was in shipyard for most of the fiscal 2005 second quarter in preparation for a new time charter which commenced in January 2005, (4) the DBL 103, which was placed in service in January 2006, (5) the McCleary’s Spirit, a Canadian-flag vessel which was purchased in October 2005, and (6) the DBL 155, which returned to service in September 2004 after its double-hulling. These increases were partially offset by a $7.2 million decrease in coastwise net voyage revenue during fiscal 2006 resulting from the phase-out of the KTC 90 and KTC 96 in December 2004, and the loss of the DBL 152 as discussed above under “Significant Fiscal 2006 Events-Barge Incident”. Coastwise net voyage revenue also benefited from a 5% increase in average daily rates to $11,967 for the year ended June 30, 2006 from $11,369 for the year ended June 30, 2005, which accounted for approximately $3.6 million of increased net voyage revenue. Coastwise average daily rates were positively impacted by the continuing strong demand for petroleum products and increasing oil prices.
Net voyage revenue in our local trade for the year ended June 30, 2006 increased by $11.4 million, or 44%, to $37.4 million from $26.0 million for the year ended June 30, 2005. The acquisition of Sea Coast in October 2005 resulted in increased local net voyage revenue of $5.8 million for fiscal 2006. Additionally, local net voyage revenue increased by $3.0 million during the year ended June 30, 2006 due to the increased number of work days for vessels acquired in our Norfolk acquisition in December 2004. The newbuild barges DBL 28 and DBL 29, delivered during the third and fourth quarters of fiscal 2006, contributed $0.8 million of net voyage revenue. Net utilization in our local trade was 77% for the year ended June 30, 2006, compared to 79% for the year ended June 30, 2005. Average daily rates in our local trade increased 6% to $5,717 for the year ended June 30, 2006 from $5,418 for the comparative prior year, positively impacted by higher charter rates resulting from strong market conditions, which accounted for approximately $1.4 million of increased net voyage revenue.
Bareboat Charter and Other Revenue
Bareboat charter and other revenue was $6.1 million for the fiscal year ended June 30, 2006, compared to $2.6 million for the fiscal year ended June 30, 2005. Of this $3.5 million increase, $1.5 million resulted from increased revenue from our water treatment plant in Norfolk, and an additional $1.8 million was generated by outside chartering of tank barges by Sea Coast.
Vessel Operating Expenses
Vessel operating expenses were $77.3 million for the fiscal year ended June 30, 2006, an increase of $28.0 million, or 57%, as compared to $49.3 million for the fiscal year ended June 30, 2005. Vessel operating expenses as a percentage of net voyage revenue increased to 55.8% for the fiscal year ended June 30, 2006 from 52.1% for the fiscal year ended June 30, 2005, resulting mainly from a higher such percentage for the Sea Coast vessels acquired in October 2005. Four of the Sea Coast barges are chartered in, and we pay a charter fee that is included in vessel operating expenses. The charter fee increases the percentage of vessel operating expenses to net voyage revenue; however, there is no associated depreciation or interest expense. Vessel labor and related costs increased as a result of contractual labor rate increases and a higher average number of employees due to the operation of the additional barges described under “-Net Voyage Revenue” above, an additional tugboat purchased in October 2005, and integration of the additional vessels purchased in December 2004. Insurance costs and vessel repairs and supplies also increased as a result of the operation of the larger number of vessels. Outside towing expense increased by $1.8 million due to the need for additional tugboats to satisfy increased demand for our tank vessels, and to replace certain of our tugboats during coupling and re-powering projects.
Depreciation and Amortization
Depreciation and amortization was $26.8 million for fiscal 2006, an increase of $5.4 million, or 25%, as compared to $21.4 million for the fiscal year ended June 30, 2005. The increase resulted from additional depreciation and drydocking amortization on our newbuild and purchased vessels described above, plus $0.7 million in amortization of certain intangible assets acquired in our acquisition of Sea Coast.
General and Administrative Expenses
General and administrative expenses were $17.3 million for the fiscal year ended June 30, 2006, an increase of $6.1 million, or 54%, as compared to general and administrative expenses of $11.2 million for the fiscal year ended June 30, 2005. As a percentage of net voyage revenue, general and administrative expenses increased to 12.5% for the fiscal year ended June 30, 2006 from 11.8% for the fiscal year ended June 30, 2005. The $6.1 million increase reflected $4.7 million of increased personnel and facilities costs in support of our growth, including the Norfolk and Sea Coast acquisitions, and $0.3 million in costs related to a cancelled bond offering.
Interest Expense, Net
Net interest expense was $10.1 million for the year ended June 30, 2006, or $4.2 million higher than the year ended June 30, 2005. The increase resulted from higher average debt balances resulting from increased credit line and term loan borrowings in connection with the Norfolk vessel acquisitions in fiscal 2005, the Sea Coast acquisition in October 2005, and higher average interest rates.
Loss on Reduction of Debt
In connection with the redemption of the Title XI bonds, as described under “Title XI Bonds” below, we made a make-whole payment of $4.0 million. After writing off $2.7 million in unamortized deferred financing costs relating to these bonds, and after costs and expenses relating to the transaction, we recorded a loss on reduction of debt of $6.9 million. We recorded an additional $0.3 million of loss on reduction of debt in April 2006 resulting from the write-off of deferred financing costs relating to a downsizing of our revolving credit facility.
In connection with the refinancing of our revolving credit facility and repayment of certain term loans in March 2005, we incurred a $1.4 million loss on reduction of debt. Included in this amount was
$1.1 million in deferred financing costs related to the repaid debt that were written off, and $0.3 million of prepayment costs.
Provision (Benefit) For Income Taxes
For fiscal 2006, our effective tax rate increased to 7.6%, compared to 2.0% in fiscal 2005, owing to an increased amount of non U.S. taxes incurred relative to our operations in Puerto Rico, Venezuela and Canada. Our effective tax rate comprises the New York City Unincorporated Business Tax and foreign taxes on our operating partnership, plus federal, state, local and foreign corporate income taxes on the taxable income of the operating partnership’s corporate subsidiaries.
Net Income
Net income was $5.9 million for the fiscal year ended June 30, 2006, a decrease of $2.2 million compared to net income of $8.1 million for the fiscal year ended June 30, 2005. This decrease resulted primarily from the $7.2 million loss on reduction of debt, the $4.2 million increase in interest expense, net, and the $0.3 million increase in the provision for income taxes, which were partially offset by the $8.1 million increase in operating income. The year ended June 30, 2005 included a $1.4 million loss on reduction of debt.
Fiscal Year Ended June 30, 2005 Compared to the Fiscal Year Ended June 30, 2004
Voyage Revenue and Voyage Expenses
Voyage revenue was $118.8 million for the fiscal year ended June 30, 2005, an increase of $24.9 million, or 27%, as compared to voyage revenue of $93.9 million for the fiscal year ended June 30, 2004. Voyage expenses were $24.2 million for the fiscal year ended June 30, 2005, an increase of $7.9 million, or 48%, as compared to voyage expenses of $16.3 million for the fiscal year ended June 30, 2004.
Net Voyage Revenue
Net voyage revenue was $94.6 million for the fiscal year ended June 30, 2005, an increase of $17.0 million, or 22%, as compared to net voyage revenue of $77.6 million for the fiscal year ended June 30, 2004. In our coastwise trade, net voyage revenue was $68.6 million for the fiscal year ended June 30, 2005, an increase of $13.9 million, or 25%, as compared to $54.7 million for the fiscal year ended June 30, 2004. Net utilization in our coastwise trade increased to 90% for the fiscal year ended June 30, 2005 compared to 88% for the fiscal year ended June 30, 2004, due mainly to a decrease in scheduled drydocking days. Increases totaling $13.2 million in coastwise net voyage revenue in fiscal 2005 resulted from an increase in days worked by the following vessels during fiscal 2005 as compared to fiscal 2004: (1) the DBL 102, which was placed in service in January 2004, (2) the DBL 140, which was purchased in January 2004, (3) the DBL 105, which completed its modification for petroleum transportation and was placed in service in May 2004, (4) the DBL 155, which completed its double-hull retrofitting in September 2004, and (5) the return of the KTC 80 from bareboat charter in November 2003. These increases were partially offset by an aggregate $4.2 million decrease in net voyage revenue during fiscal 2005 resulting from the sale of the KTC 135 in April 2004 in anticipation of its OPA 90 phase-out, and the OPA 90 phase-out of the KTC 90 and KTC 96 in December 2004. Coastwise net voyage revenue also benefited from a 11% increase in average daily rates to $11,369 for the fiscal year ended June 30, 2005 from $10,230 for the fiscal year ended June 30, 2004, which accounted for approximately $6.1 million of increased net voyage revenue. Average daily rates were positively impacted by the continuing strong demand for petroleum products, increasing oil prices, and the addition of the several larger vessels described above, which generate higher average daily rates.
Net voyage revenue in our local trade for the fiscal year ended June 30, 2005 was $26.0 million, an increase of $3.1 million, or 14%, as compared to $22.9 million for the fiscal year ended June 30, 2004. The increase was mainly attributable to the barges acquired as part of our December 2004 vessel acquisition, which accounted for $2.4 million of the increase. Net utilization in our local trade was 79% for the fiscal year ended June 30, 2005 compared to 84% for the fiscal year ended June 30, 2004. Net utilization in fiscal 2005 was adversely impacted by higher unscheduled repair days for one of our small tankers and by low utilization on certain tank barges acquired in the December 2004 vessel acquisition. Average daily rates in our local trade improved slightly to $5,418 for the fiscal year ended June 30, 2005 from $5,400 for the fiscal year ended June 30, 2004.
Bareboat Charter and Other Revenue
Bareboat charter and other revenue was $2.6 million for the fiscal year ended June 30, 2005, compared to $1.9 million for the fiscal year ended June 30, 2004. Amounts for the fiscal 2005 period increased by $0.5 million due to revenue generated from chartering out of a chartered-in barge.
Vessel Operating Expenses
Vessel operating expenses were $49.3 million for the fiscal year ended June 30, 2005, an increase of $10.5 million, or 27%, as compared to $38.8 million for the fiscal year ended June 30, 2004. Vessel operating expenses as a percentage of net voyage revenue increased to 52.1% for the fiscal year ended June 30, 2005 from 50.0% for the fiscal year ended June 30, 2004. Vessel labor and related costs increased as a result of contractual labor rate increases and a higher average number of employees due to the operation of the additional barges described under “-Net Voyage Revenue” above, an additional tugboat purchased in January 2004, and integration of the additional vessels purchased in December 2004. Insurance costs and vessel repairs and supplies also increased as a result of the operation of the larger number of vessels. Outside towing expense increased by $2.5 million due to the need for additional tugboats to satisfy increased demand for our tank vessels, and to replace certain of our tugboats during coupling and re-powering projects. Fiscal 2005 vessel operating expenses also increased by $0.4 million for charter costs in connection with the bareboat charter revenue discussed above in “-Bareboat Charter and Other Revenue.”
Depreciation and Amortization
Depreciation and amortization was $21.4 million for the fiscal year ended June 30, 2005, an increase of $2.8 million, or 15%, as compared to $18.6 million for the fiscal year ended June 30, 2004. The increase resulted from additional depreciation on our newbuild and purchased vessels described above, plus additional depreciation recorded in the first quarter of fiscal 2005 to reduce the salvage value for the two single-hull vessels which phased out on December 31, 2004.
General and Administrative Expenses
General and administrative expenses were $11.2 million for the fiscal year ended June 30, 2005, an increase of $3.1 million, or 38%, as compared to general and administrative expenses of $8.1 million for the fiscal year ended June 30, 2004. As a percentage of net voyage revenue, general and administrative expenses increased to 11.8% for the fiscal year ended June 30, 2005 from 10.5% for the fiscal year ended June 30, 2004. The fiscal year ended June 30, 2005 included $1.9 million of additional professional fees and other costs incurred in connection with being a public company. These increased professional fees included $0.6 million in costs for compliance with the Sarbanes-Oxley Act of 2002, and $0.4 million of costs incurred in fiscal 2005 to provide income tax compliance information to our unitholders, neither of which were incurred in the prior year’s period.
Interest Expense, Net
Net interest expense was $5.9 million for the fiscal year ended June 30, 2005, $0.5 million lower than the fiscal year ended June 30, 2004. The decrease resulted from the significant reduction of higher cost borrowings in connection with the repayment of debt using the proceeds of our initial public offering in January 2004.
Loss on Reduction of Debt
In connection with the refinancing of our revolving credit facility and repayment of certain term loans in March 2005 as described below in “Liquidity and Capital Resources-Amended Credit Agreement” and “-Other Term Loans,” we incurred $1.4 million in loss on reduction of debt. Included in this amount was $1.1 million in deferred financing costs related to the repaid debt that were written off, and $0.3 million of prepayment costs.
In connection with our initial public offering in fiscal 2004, $73.9 million in predecessor company debt was repaid. Included in this amount was $6.3 million in prepayment and make-whole amounts, of which $3.3 million had previously been accrued by our predecessor as supplemental interest that would have been payable upon maturity of certain of these loans, resulting in a loss on prepayment of $3.0 million. In addition, $0.2 million in deferred financing costs related to the debt was also written off.
Provision (Benefit) For Income Taxes
For fiscal 2005, our effective tax rate was 2.0%, as compared to 16.5% (exclusive of the benefit discussed in the following paragraph) in fiscal 2004. The periods prior to our initial public offering on January 14, 2004 relate to our predecessor. Our effective tax rate comprises the New York City Unincorporated Business Tax and foreign taxes on our operating partnership, plus federal, state, and local corporate income taxes on the taxable income of the operating partnership’s corporate subsidiaries. Our effective tax rate for the fiscal year ended June 30, 2005 was lower than the rate for the fiscal year ended June 30, 2004 because a smaller portion of our pretax income was provided by our operating partnership’s corporate subsidiaries.
Certain net assets contributed to us in connection with our January 2004 initial public offering were transferred by our predecessor’s corporate subsidiaries. These net assets had tax bases that were lower than their carrying value for financial reporting purposes, which resulted in deferred tax liabilities relating to these temporary differences. Upon transfer to us, the future reversal of these differences will be subject to our effective tax rate, which is significantly lower than the effective tax rate of our predecessor’s corporate subsidiaries. The effect of the change in tax rates applicable to these differences is reflected as a one-time deferred tax benefit of $17.6 million for the fiscal year ended June 30, 2004.
Net Income
Net income was $8.1 million for the fiscal year ended June 30, 2005, a decrease of $13.1 million compared to net income of $21.2 million for the fiscal year ended June 30, 2004. The decrease resulted primarily from recognition in the 2004 period of the $17.6 million deferred tax benefit described in the preceding paragraph, partially offset by a $0.5 million decrease in interest expense, net, a $1.8 million decrease in loss on reduction of debt, and a $2.0 million increase in operating income.
LIQUIDITY AND CAPITAL RESOURCES
Operating Cash Flows. Net cash provided by operating activities was $20.8 million in fiscal 2006, $24.2 million in fiscal 2005 and $10.9 million in fiscal 2004. The decrease of $3.4 million in fiscal 2006, compared to fiscal 2005, resulted primarily from a $4.9 million increase in drydocking expenditures and a
$3.8 million negative impact from changes in operating working capital, partially offset by the improved operating income, after adjusting for non-cash expenses such as depreciation and amortization. The increase of $13.3 million in fiscal 2005, compared to fiscal 2004, also resulted primarily from improved operating income, after adjusting for non-cash expenses such as depreciation and amortization, and a $3.1 million positive impact from changes in operating working capital. The positive impact from working capital resulted mainly from increased accounts payable due to increased operating costs of a larger fleet, partially offset by increases in prepaid expenses such as fuel supplies and insurance premiums.
Investing Cash Flows. Net cash used in investing activities totaled $105.4 million in fiscal 2006, $55.9 million in fiscal 2005 and $59.2 million in fiscal 2004. The primary elements of these activities were acquisitions of vessels and companies, construction of new vessels and retrofitting of existing ones. We spent $76.5 million in cash, net, to acquire Sea Coast Transportation LLC (see below) in October 2005. Additionally, we spent $13.1 million, $30.7 million and $34.1 million on acquisitions of existing vessels in fiscal 2006, 2005 and 2004, respectively. During fiscal 2006, we acquired an 85,000-barrel integrated tug-barge unit for approximately $13.1 million, including transaction costs. During fiscal 2005, we acquired ten tank barges and seven tugboats from Bay Gulf Trading Company, Ltd. of Norfolk, Virginia and its affiliates. The purchase price of $20.9 million (excluding acquisition-related costs), included a water treatment facility in Norfolk. The fiscal 2005 acquisitions included the Norfolk vessels and also the DBL 78, which was acquired in June 2005. Construction expenditures for our tank vessel newbuilding program and rebuilding projects totaled $20.7 million in fiscal 2006, $16.8 million in fiscal 2005 and $26.5 million in fiscal 2004. Such construction expenditures in fiscal 2004 were funded by $10.7 million of withdrawals from our Title XI reserve account, which had been established with the proceeds of our original Title XI borrowings in 2002. Other capital expenditures of $9.1 million in fiscal 2006, $9.0 million in fiscal 2005 and $9.5 million in fiscal 2004 related primarily to repowering of, and installation of coupling systems on, certain tugboats, and expenditures related to upgrading the vessels acquired in December 2004. Capital expenditures made in the normal course of business are generally financed by cash from operations and, where necessary, borrowings under our revolving credit agreement.
Financing Cash Flows. Net cash provided by financing activities was $85.4 million in fiscal 2006, $31.4 million in fiscal 2005, and $48.6 million in fiscal 2004. In fiscal 2006, our primary financing activities were the issuance of $109.4 million in new term loans and $34.0 million in gross proceeds from the sale of 950,000 common units in October 2005. These proceeds were used to finance the Sea Coast acquisition and other investing activities described above. Additionally, we paid $36.8 million to redeem the principal balance of the Title XI bonds, and made $23.0 million of distributions to partners. We also amended our revolving credit facility (see “-Amended Credit Agreement” below) and increased our credit line borrowings by $6.9 million.
As a result of a restructuring of our financial agreement for the Title XI bonds in January 2004, we were required to make monthly reserve fund deposits which were used to make semi-annual debt service payments. The principal portion of such deposits, which are reflected as principal payments to Title XI reserve funds, were $0.7 million, $1.6 million and $0.7 million for fiscal 2006, 2005 and 2004, respectively. When we redeemed the Title XI bonds in November 2005, the balance of the Title XI reserve funds, totaling $2.9 million which are reflected as proceeds from Title XI reserve funds in Investing Cash Flows, was returned to us. For more information, please read “-Title XI Borrowings” below.
During fiscal 2005, we increased our credit line borrowings and term loans by a net of $36.8 million, primarily to finance vessel acquisitions. We also paid $18.2 million in distributions to our unitholders in fiscal 2005. In March 2005, we signed a new five-year $80.0 million credit agreement with a syndicate of banks, which replaced our then-existing $47.0 million credit agreement, which was repaid and terminated. On June 1, 2005, we issued and sold 500,000 common units in a private placement for gross proceeds of $16.0 million.
During fiscal 2004, we completed our initial public offering and used the gross proceeds to pay down term loans and credit line borrowings (including prepayment costs) that had been contributed to us by our predecessor, to pay underwriting fees, professional fees and other offering expenses, and to redeem the 665,000 common units received by our predecessor in connection with the transfer of net assets to us concurrent with the initial public offering. Also in fiscal 2004, we entered into $36.0 million of new term loans to finance the purchase of the DBL 140/Lincoln Sea and the DBL 105 rebuilding project. Finally, we paid $3.7 million in distributions to partners in fiscal 2004.
Oil Pollution Act of 1990. Tank vessels are subject to the requirements of OPA 90. OPA 90 mandates that all single-hull tank vessels operating in U.S. waters be removed from petroleum and petroleum product transportation services at various times through January 1, 2015, and provides a schedule for the phase-out of the single-hull vessels based on their age and size. At June 30, 2006, approximately 67% of the barrel-carrying capacity of our tank vessel fleet was double-hulled in compliance with OPA 90, and the remainder (except one 75,000-barrel vessel which phases out in January 2009) will be in compliance with OPA 90 until January 2015.
Ongoing Capital Expenditures. Marine transportation of refined petroleum products is a capital intensive business, requiring significant investment to maintain an efficient fleet and to stay in regulatory compliance. We estimate that, over the next five years, we will spend an average of approximately $14.5 million per year to drydock and maintain our tank vessels’ operating capacity. We expect such expenditures to approximate $14.4 million in fiscal 2007. In addition, we anticipate that we will spend $0.8 million annually for other general capital expenditures. Periodically, we also make expenditures to acquire or construct additional tank vessel capacity and/or to upgrade our overall fleet efficiency. For a further discussion of maintenance and expansion capital expenditures, please read footnote 3 to the table in “Selected Financial Data” in Item 6 of this report. The following table summarizes total maintenance capital expenditures, including drydocking expenditures, and expansion capital expenditures for the periods presented (in thousands):
In August 2005, we signed an agreement to construct two additional 28,000-barrel tank barges. One was delivered in August 2006 while the other is expected to be delivered in the second quarter of fiscal 2007. In November 2005, we signed an agreement to construct a new 100,000-barrel tank barge that is expected to be delivered in the third quarter of fiscal 2007. These three vessels are expected to cost, in the aggregate and after the addition of certain special equipment, approximately $24 million. In June 2006, we signed an agreement to construct an additional four new 28,000-barrel tank barges that are expected to be delivered in the first and second quarters of fiscal 2008. Also in August 2006, we signed an agreement to construct two 80,000-barrel tank barges that are expected to be delivered in the second and third quarters of fiscal 2008. These six vessels are expected to cost, in the aggregate and after addition of certain special equipment, approximately $50 million. We expect to finance these newbuildings from borrowings and cash from operations.
Additionally, we intend to retire, retrofit or replace 31 (including three chartered-in) single-hull tank vessels by December 2014, which at June 30, 2006 represented approximately 33% of our barrel-carrying capacity. The capacity of certain of these single-hulled vessels has already been effectively replaced by double-hulled vessels placed into service in the past two years. We estimate that the current cost to replace
the remaining capacity with newbuildings and by retrofitting certain of our existing vessels would range from $88.0 million to $92.0 million. This capacity can also be replaced by acquiring existing double-hulled tank vessels as opportunities arise. We are currently evaluating the most cost-effective means to replace this capacity.
Liquidity Needs. Our primary short-term liquidity needs are to fund general working capital requirements, distributions to unitholders, and drydocking expenditures while our long term liquidity needs are primarily associated with expansion and other maintenance capital expenditures. Expansion capital expenditures are primarily for the purchase of vessels, while maintenance capital expenditures include drydocking expenditures and the cost of replacing tank vessel operating capacity. Our primary sources of funds for our short term liquidity needs are cash flows from operations and borrowings under our credit facility, while our long term sources of funds are cash from operations, long term bank borrowings and other debt or equity financings.
We believe that cash flows from operations and borrowings under our credit agreement, described under “-Amended Credit Agreement” below, will be sufficient to meet our liquidity needs for the next 12 months.
Amended Credit Agreement. In March 2005, we entered into a new five-year $80.0 million revolving credit agreement with a syndicate of banks. The new credit agreement replaced our then-existing $47.0 million revolving credit agreement, which was repaid and terminated. On October 18, 2005, to partially finance the acquisition of Sea Coast (see “-Significant Fiscal 2006 Events” above), we amended our revolving credit agreement to increase the available borrowings to $120.0 million, of which $77.0 million was drawn down to pay the cash portion of the purchase price. On November 29, 2005, to fund the redemption of its Title XI bonds (see “Title XI Bonds” below), we further amended the revolving credit agreement to increase the maximum borrowings to $155.0 million. On April 3, 2006, we used the net proceeds from the issuance of $80.0 million in new term loans to repay outstanding borrowings under the revolving credit agreement, and further amended it to reduce the available borrowings, to release certain vessels from the collateral pool, and to reduce certain covenant requirements.
The amended credit agreement provides for available borrowings of $75.0 million, contains a $20.0 million sublimit for letters of credit and allows us to request an increase in the total borrowing availability by up to $25.0 million, up to a maximum of $100.0 million, so long as no default or event of default has occurred and is continuing. Obligations under the amended credit agreement are collateralized by a first priority security interest, subject to permitted liens, on certain of our vessels having an orderly liquidation value equal to at least 1.25 times the amount of the obligations (including letters of credit) outstanding. Borrowings under the amended credit agreement bear interest, at our option, at a rate per annum equal to (a) the greater of the prime rate and the federal funds rate plus 0.5% (a “base rate loan”), or (b) 30-day London Interbank Offered Rate (“LIBOR”) plus a margin based upon the ratio of Total Funded Debt to EBITDA, as defined in the agreement. We also incur commitment fees, payable quarterly, on the unused amount of the facility. The following table summarizes the rates of interest and commitment fees under the amended credit agreement:
Interest on a base rate loan is payable monthly over the five-year term of the agreement. Interest on a LIBOR-based loan is due, at our election, one, two, three or six months after such loan is made. Outstanding principal amounts are due upon termination of the agreement.
Loan proceeds under the amended credit agreement may be used for any purpose in the ordinary course of business, including vessel acquisitions, ongoing working capital needs and distributions. Amounts borrowed and repaid may be re-borrowed. Borrowings made for working capital purposes must be reduced to zero for a period of at least 15 consecutive days once each year.
The amended credit agreement contains covenants that include, among others:
· the maintenance of the following financial ratios (all as defined in the agreement):
· EBITDA to fixed charges of at least 1.85 to 1.00,
· total funded debt to tangible capitalization of no greater than 0.65 to 1.00, and
· total funded debt to EBITDA of no greater than (1) 4.00 to 1.00 for the period to and including December 31, 2006 and (2) 3.75 to 1.00 for the period from January 1, 2007 and thereafter;
· restrictions on creating liens on or disposing of the vessels securing the amended credit agreement, subject to permitted exceptions;
· restrictions on merging and selling assets outside the ordinary course of business;
· prohibitions on making distributions to limited or general partners of ours during the continuance of an event of default; and
· restrictions on transactions with affiliates and materially changing our business.
The amended credit agreement contains customary events of default. If a default occurs and is continuing, we must repay all amounts outstanding under the agreement. As of June 30, 2006, outstanding borrowings under the amended credit agreement totaled $54.0 million, none of which was related to borrowings for working capital purposes.
Other Term Loans. On April 3, 2006, we entered into an agreement with a lending institution to borrow $80.0 million, for which we pledged six tugboats and six tank barges as collateral. Borrowings are represented by six notes which have been assigned to other lending institutions. These loans bear interest at a rate equal to LIBOR on one-month Eurodollar deposits plus 1.40%, and are repayable in 84 monthly installments with the remaining principal payable at maturity. The agreement contains certain prepayment premiums. Borrowings outstanding on these loans totaled $79.7 million as of June 30, 2006. Also on April 3, 2006, we entered into an agreement with the lending institution to swap the one-month, LIBOR based, variable interest payments on the $80.0 million of loans for a fixed payment at a rate of 5.2275%, over the same terms as the loans. This swap will result in a fixed interest rate on the Notes of 6.6275% for their seven-year term. This swap contract has been designated as a cash flow hedge. Therefore, the unrealized gain of $1.1 million related to the change in fair value of the swap contract as of June 30, 2006 has been reflected in other comprehensive income. We used the proceeds of these loans to repay indebtedness under our amended credit agreement.
On December 19, 2005, one of our subsidiaries entered into a seven year Canadian dollar term loan to refinance purchase of an integrated tug-barge unit. The proceeds of $13.0 million were used to repay borrowings under the amended revolving credit agreement which had been used to finance purchase of the unit. The loan bears interest at a fixed rate of 6.59%, is repayable in 84 monthly installments of CDN 136,328 with the remaining principal amount payable at maturity, and is collateralized by the related tug-barge unit and one other tank barge. Borrowings outstanding on this loan total $13.3 million as of June 30, 2006.
In May 2006, we entered into an agreement to borrow up to $23.0 million to partially finance construction of two 28,000-barrel and one 100,000-barrel tank barges. During the construction period, the loan bears interest at 30-day LIBOR plus 1.40%; interest only is payable monthly through the earlier of May 12, 2007 or delivery of the final tank barge. Thereafter, monthly payments of principal, plus accrued interest, are payable over seven years, with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barges and (during the construction period only) 13 other tank vessels. Borrowings outstanding on this loan total $5.4 million at June 30, 2006.
In March 2005, we entered into an agreement to borrow up to $11.0 million to partially finance construction of a 100,000-barrel tank barge. The loan bears interest at 30-day LIBOR plus 1.05%, and is repayable in monthly principal installments of $65,500 with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barge. Borrowings outstanding on this loan totaled $10.7 million at June 30, 2006.
In March 2005, we entered into a three-year term loan in the amount of $11.7 million to refinance an existing loan. Our obligations under this agreement are secured by a first priority security interest in three vessels. The loan is repayable in monthly principal installments of $69,578, with the remaining principal amount repayable at maturity, plus accrued interest at an annual fixed rate of 6.25%. The loan agreement contains events of default and covenants that are customary for facilities of this type. Borrowings outstanding on this loan total $10.7 million at June 30, 2006.
In June 2005, we entered into an agreement to borrow up to $18.0 million to finance the purchase of an 80,000-barrel double-hull tank barge and construction of two 28,000-barrel double-hull tank barges. The loan bears interest at 30-day LIBOR plus 1.71%, and is repayable in monthly principal installments of $107,143 with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barges. Borrowings outstanding on this loan were $17.9 million at June 30, 2006.
To finance the January 2004 acquisition of a 140,000-barrel capacity double-hull tank barge and related tugboat, we entered into a seven-year, $25.0 million term loan. To finance the rebuilding of the DBL 105 and the retrofitting of the DBL 155, we entered into an agreement with a financial institution in May 2004 to provide $20.0 million of term loans to permanently finance these vessels upon completion of the respective projects. These term loans were repaid in March 2005 upon closing of the new revolving credit agreement, and a net loss of $1.4 million, representing prepayment fees and writeoff of the related deferred financing costs, was recorded in connection with this restructuring.
Title XI Borrowings. On June 7, 2002, to provide financing for four newbuild tank vessels, we privately placed $40.4 million of bonds (“Title XI bonds”), which were guaranteed by the Maritime Administration of the U.S. Department of Transportation, or MARAD, pursuant to Title XI of the Merchant Marine Act of 1936. The proceeds of $39.1 million, net of certain closing fees, were deposited in a reserve account with the U.S. Department of the Treasury and used to fund construction of the related vessels. On November 29, 2005, we redeemed the outstanding $36.8 million principal balance of bonds, paid $0.8 million of accrued interest, and made a make-whole payment of $4.0 million as required under the trust indenture. We funded the redemption using funds from our revolving credit agreement. After writing off $2.7 million in unamortized deferred financing costs, and after costs and expenses relating to the transaction, we recorded a loss on reduction of debt of $6.9 million. Retirement of the Title XI bonds
improved our borrowing flexibility, and eliminated certain restrictive covenants, collateral requirements, and working capital constraints.
Restrictive Covenants. The agreements governing our amended credit facility and term loans contain restrictive covenants that, among others, (a) prohibit distributions under defined events of default, (b) restrict investments and sales of assets, and (c) require us to adhere to certain financial covenants, including defined ratios of fixed charge coverage and funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization and loss on reduction of debt, as defined)
Issuances of Common Units. On October 14, 2005, we sold 950,000 common units in a public offering under our shelf registration statement. The net proceeds of $33.1 million from the offering, after payment of underwriting discounts and commissions but before payment of expenses, were used to repay borrowings under our amended credit agreement. On October 18, 2005, we issued 125,000 units to the seller in connection with our acquisition of Sea Coast (see“-Significant Fiscal 2006 Events” above). On June 1, 2005, we issued and sold 500,000 common units in a private placement for proceeds of $16.0 million, before expenses associated with the offering. A shelf registration statement with respect to the Sea Coast issuance and the June 2005 private placement was declared effective by the Securities and Exchange Commission in February 2006.
Contractual Obligations and Contingencies. Our contractual obligations at June 30, 2006 consisted of the following (in thousands):
Payments Due by Period
(1) Capital expenditures relating to shipyard payments for the construction of one new 100,000-barrel double-hull tank barge, two new 80,000-barrel double-hull tank barges, and six new 28,000-barrel double-hull tank barges.
Certain executive officers of K-Sea General Partner GP LLC have entered into employment agreements with K-Sea Transportation Inc., our indirect wholly owned corporate subsidiary. Each of these employment agreements had an initial term of one year, which is automatically extended for successive one-year terms unless either party gives 30 days written notice prior to the end of the term that such party desires not to renew the employment agreement. The employment agreements currently provide for an aggregate base annual salary of $850,000. In addition, each employee is eligible to receive an annual bonus award based upon our consolidated financial performance. If the employee’s employment is terminated without cause or if the employee resigns for good reason, the employee will be entitled to severance in an amount equal to the greater of (a) the product of 1.3125 (1.75 multiplied by .75) multiplied by the employee’s base salary at the time of termination or resignation and (b) the product of 1.75 multiplied by the remaining term of the employee’s non-competition provisions multiplied by the employee’s base salary at the time of termination or resignation.
We are a party to various claims and lawsuits in the ordinary course of business for monetary relief arising principally from personal injuries, collision or other casualty and to claims arising under vessel charters. All of these personal injury, collision and casualty claims are fully covered by insurance, subject to
deductibles ranging from $25,000 to $100,000. We accrue on a current basis for estimated deductibles we expect to pay.
EW Transportation LLC and its predecessors have been named, together with a large number of other companies, as co-defendants in 39 civil actions by various parties, including former employees, alleging unspecified damages from past exposure to asbestos and second-hand smoke aboard some of the vessels that it contributed to us in connection with our initial public offering. EW Transportation LLC and its predecessors have been dismissed from 38 of these lawsuits for an aggregate sum of approximately $47,000 and are seeking to settle the other case. We may be subject to litigation in the future involving these plaintiffs and others alleging exposure to asbestos due to alleged failure to properly encapsulate friable asbestos or remove friable asbestos on our vessels, as well as for exposure to second-hand smoke and other matters.
EW Transportation Corp., a predecessor to our partnership, and many other marine transportation companies operating in New York, have come under audit with respect to the New York State Petroleum Business Tax (“PBT”), which is a tax on vessel fuel consumed while operating in New York State territorial waters. An industry group in which we and EW Transportation Corp. participate is working towards an agreement in principle with the New York taxing authority on a calculation methodology for the PBT. We have accrued our estimated liability using the calculation methodology under discussion. In accordance with the agreements entered into in connection with our initial public offering, any liability resulting from the PBT prior to January 14, 2004 (the effective date of the initial public offering) is a retained liability of our predecessor.
Inflation
During the last three years, inflation has had a relatively minor effect on our financial results. Our contracts generally contain escalation clauses whereby certain cost increases, including labor and fuel, can be passed through to our customers.
Related Party Transactions
We lease our Staten Island office and pier facilities from, and charter certain vessels to, affiliates of an employee. Additionally, we utilize one of these affiliates for tank cleaning services. Please read note 8 to our audited consolidated financial statements included elsewhere in this report.
KSP Investors A L.P., KSP Investors B L.P., and KSP Investors C L.P. and their controlled affiliates have agreed to indemnify us for claims associated with certain retained liabilities. For more information regarding the indemnification obligations and other related party transactions, please read “Certain Relationships and Related Transactions” in Item 13 of this report.
Seasonality
We operate our tank vessels in markets that have historically exhibited seasonal variations in demand and, as a result, in charter rates. For example, movements of clean oil products, such as motor fuels, generally increase during the summer driving season. In certain regions, movements of black oil products and distillates, such as heating oil, generally increase during the winter months, while movements of asphalt products generally increase in the spring through fall months. Unseasonably cold winters result in significantly higher demand for heating oil in the northeastern United States. Meanwhile, our operations along the West Coast and in Alaska historically have been subject to seasonal variations in demand that vary from those exhibited in the East Coast and Gulf Coast regions. The summer driving season can increase demand for automobile fuel in all of our markets and, accordingly, the demand for our services. A decline in demand for, and level of consumption of, refined petroleum products could cause demand for tank vessel capacity and charter rates to decline, which would decrease our revenues and profitability. The
acquisition of Sea Coast provides seasonal diversity primarily relating to its Alaskan markets, which experience the greatest demand for petroleum products in the summer months, due to weather conditions.
CRITICAL ACCOUNTING POLICIES
The accounting treatment of a particular transaction is governed by generally accepted accounting principles, or GAAP, and, in certain circumstances, requires us to make estimates, judgments and assumptions that we believe are reasonable based upon information available. We base our estimates, judgments and assumptions on historical experience and known facts that we believe to be reasonable under the circumstances. Actual results may differ from these estimates under different assumptions and conditions. We believe that, of our significant accounting policies discussed in note 3 to our audited consolidated financial statements, the following may involve a higher degree of judgment.
Revenue Recognition
We earn revenue under contracts of affreightment, voyage charters, time charters and bareboat charters. For contracts of affreightment and voyage charters, revenue is recognized based upon the relative transit time in each period, with expenses recognized as incurred. Although contracts of affreightment and certain contracts for voyage charters may be effective for a period in excess of one year, revenue is recognized over the transit time of individual voyages, which are generally less than ten days in duration. For time charters and bareboat charters, revenue is recognized ratably over the contract period, with expenses recognized as incurred. Estimated losses on contracts of affreightment and charters are accrued when such losses become evident.
Depreciation
Vessels and equipment are recorded at cost, including capitalized interest where appropriate, and depreciated using the straight-line method over the estimated useful lives of the individual assets as follows: tank vessels-ten to twenty-five years; tugboats-ten to twenty years; and pier and office equipment-five years. For single-hull tank vessels, these useful lives are limited to the remaining period of operation prior to mandatory retirement as required by OPA 90. Also included in vessels are drydocking expenditures that are capitalized and amortized over three years. Major renewals and betterments of assets are capitalized and depreciated over the remaining useful lives of the assets. Maintenance and repairs that do not improve or extend the useful lives of the assets are expensed. To date, our experience confirms that these policies are reasonable, although there may be events or changes in circumstances in the future that indicate the recovery of the carrying amount of a vessel might not be possible. Examples of events or changes in circumstances that could indicate that the recoverability of a vessel’s carrying amount should be assessed might include a change in regulations such as OPA 90, or continued operating losses, or projections thereof, associated with a vessel or vessels. If events or changes in circumstances as set forth above indicate that a vessel’s carrying amount may not be recoverable, we would then be required to estimate the undiscounted future cash flows expected to result from the use of the vessel and its eventual disposition. If the sum of the undiscounted expected future cash flows is less than the carrying amount of the vessel, we would recognize an impairment loss to the extent the carrying value exceeds its fair value by appraisal. Our assumptions and estimates would include, but not be limited to, the estimated fair market value of the assets and their estimated future cash flows, which are based on additional assumptions such as asset utilization, length of service of the asset and estimated salvage values. Although we believe our assumptions and estimates are reasonable, deviations from the assumptions and estimates could produce a materially different result.
Amortization of Drydocking Expenditures
Drydocking expenditures are capitalized and amortized over three years. Drydocking of vessels is required by both the U.S. Coast Guard and by the applicable classification society, which in our case is the American Bureau of Shipping. Such drydocking activities include, but are not limited to, the inspection, refurbishment and replacement of steel, engine components, tailshafts, mooring equipment and other parts of the vessel. Amortization of drydocking expenditures is included in depreciation and amortization expense.
Accounts Receivable
We extend credit to our customers in the normal course of business. We regularly review our accounts, estimate the amount of uncollectible receivables each period, and establish an allowance for uncollectible amounts. The amount of the allowance is based on the age of unpaid amounts, information about the current financial strength of customers, and other relevant information. Estimates of uncollectible amounts are revised each period, and changes are recorded in the period they become known. Historically, credit risk with respect to our trade receivables has generally been considered minimal because of the financial strength of our customers.
Deferred Income Taxes
We provide deferred taxes for the tax effects of differences between the financial reporting and tax bases of assets and liabilities at enacted tax rates in effect in the jurisdictions where we operate for the years in which the differences are expected to reverse. A valuation allowance is provided, if necessary, for deferred tax assets that are not expected to be realized.
New Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123(R), “Share-Based Payment” (“FAS 123(R)”). FAS 123(R) revises FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. In addition to revising FAS 123, FAS 123(R) supersedes Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FASB Statement No. 95, “Statement of Cash Flows.” We adopted FASB 123(R) as of July 1, 2005, and account for our restricted unit awards under the new standard. To date, no unit options have been granted. The adoption did not have a material impact on our financial position, results of operations or cash flows.
On April 4, 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”). This interpretation clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. It also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. We adopted FIN 47 as of June 30, 2006, and such adoption did not have a significant impact on our financial position, results of operations or cash flows.
On June 2, 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections-a replacement of APB No. 20 and FAS No. 3” (“FAS 154”). FAS 154 replaces APB Opinion No. 20, “Accounting Changes” (“APB 20”) and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements” (“FAS 3”) and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement
includes specific transition provisions, those provisions should be followed. We are required to adopt FAS 154 as of July 1, 2006, and we do not expect that such adoption will have a significant impact on our financial position, results of operations or cash flows.
On February 16, 2006 the FASB issued FASB Statement No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140” (“FAS 155”). FAS 155 amends FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. We are required to adopt FAS 155 as of July 1, 2007, and do not expect that such adoption will have a significant impact on our financial position, results of operations or cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. We are currently analyzing FIN 48 and believe the adoption of FIN 48 will not have a material impact on our financial condition, results of operations or liquidity.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Our primary market risk is the potential impact of changes in interest rates on our variable rate borrowings. After considering the interest rate swap agreement discussed below, as of June 30, 2006 approximately $105.4 million of our long-term debt bears interest at fixed interest rates ranging from 6.25% to 6.63%. Borrowings under our amended credit agreement and certain other term loans, totaling $88.0 million at June 30, 2006, bear interest at a floating rate based on LIBOR, which will subject us to increases or decreases in interest expense resulting from movements in that rate. Based on our total outstanding floating rate debt as of June 30, 2006, the impact of a 1% change in interest rates would result in a change in interest expense, and a corresponding impact on income before income taxes, of approximately $0.9 million annually.
We utilize an interest rate swap to reduce our exposure to market risk from changes in interest rates. The primary objective of this contract is to reduce the aggregate risk of higher interest costs associated with variable rate debt. The interest rate swap contract we currently hold has been designated as a cash flow hedge and, accordingly, gains and losses resulting from changes in the fair value of this contract are recognized as other comprehensive income as required by SFAS No. 133. We are exposed to credit related losses in the event of non-performance by counterparties to these instruments, however the counterparties are major financial institutions and we consider such risk of loss to be minimal. We do not hold or issue derivative financial instruments for trading purposes.
As of June 30, 2006, we had one outstanding interest rate swap agreement which expires on May 1, 2013 concurrently with the hedged term loans. As of such date, the notional amount of the swap was $79.7 million, we are paying a fixed rate of 6.63%, and we are receiving a variable interest rate of 6.75%.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements set forth on pages to of this report are incorporated herein by reference.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
In accordance with Exchange Act Rules 13a-15 and 15d-15, we carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of June 30, 2006 to provide reasonable assurance that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.
Changes in Internal Control Over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the three months ended June 30, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
See page of this report for Management’s Report on Internal Control Over Financial Reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
K-Sea General Partner GP LLC, as the general partner of K-Sea General Partner L.P., our general partner, manages our operations and activities. Our general partner is not elected by our unitholders and is not subject to re-election on a regular basis. Unitholders are not entitled to elect the directors of K-Sea General Partner GP LLC or directly or indirectly participate in our management or operation.
Set forth below is information concerning the directors and executive officers of K-Sea General Partner GP LLC as of September 6, 2006. Executive officers and directors are elected for one-year terms.
James J. Dowling has served as our Chairman of the Board since July 2003, has served as Chairman of the Board of EW Transportation LLC (formerly K-Sea Transportation LLC) since January 2002 and has served as a director of EW Transportation LLC since its formation in April 1999. Mr. Dowling has been a Managing Director of Jefferies Capital Partners, a private investment firm, since January 2002, and is a director of various private companies in which Jefferies Capital Partners has an interest. Jefferies Capital Partners is the manager of Furman Selz Investors II L.P. and its affiliated entities, principal owners of our general partner.
Timothy J. Casey has served as our President, Chief Executive Officer and Director since July 2003. Mr. Casey has served as President, Chief Executive Officer and Director of EW Transportation LLC since April 1999. Mr. Casey is also a board member for American Waterways Operators and The Seamen’s Church Institute.
Anthony S. Abbate has served as a Director since February 2004. Mr. Abbate has been President and Chief Executive Officer of Interchange Financial Services Corporation, a bank holding company, since 1984 and President and Chief Executive Officer of its principal subsidiary, Interchange Bank, since 1981. Mr. Abbate also serves as Chairman of the Executive Committee of both Interchange Financial Services Corporation and Interchange Bank.
Barry J. Alperin has served as a Director since February 2004. Mr. Alperin is a business consultant who retired from Hasbro Inc. in 1996 after 11 years in various senior executive positions, including Vice Chairman and Director. Mr. Alperin is currently on the board of Henry Schein, Inc., a distributor of healthcare products to office-based practitioners, and The Hain Celestial Group, Inc., a natural and organic beverage, snack, specialty food and personal care products company.
Brian P. Friedman has served as a director since July 2003. Mr. Friedman has been a managing member of Jefferies Capital Partners, a private investment firm, and affiliated entities since 1997. Mr. Friedman also serves as Chairman of the Executive Committee of Jefferies & Company, Inc. Mr. Friedman serves as a director of Jefferies Group, Inc., an investment banking firm, Telex
Communications, Inc., a manufacturer of audio and wireless communications equipment, and various private companies in which Jefferies Capital Partners or its affiliates have an interest.
Frank Salerno has served as a Director since February 2004. From mid-1999 until his retirement in February 2004, Mr. Salerno was Managing Director and Chief Operating Officer of Merrill Lynch Investment Advisors-Americas Institutional Division, an investment advisory company.
John J. Nicola has served as our Chief Financial Officer since July 2003, and has served as Chief Financial Officer of EW Transportation LLC since July 2000. Mr. Nicola was employed from November 1993 to July 2000 by Maersk Sealand, a container shipping company, in various senior financial management roles, including Chief Financial Officer of Maersk’s East Coast and Gulf terminal operating subsidiary. Mr. Nicola is a Certified Public Accountant and a member of the American Institute of Certified Public Accountants.
Thomas M. Sullivan has served as our Vice President of Operations since July 2003. Mr. Sullivan served as Vice President of Operations for EW Transportation LLC since April 1999. Mr. Sullivan also served as Vessel Supervisor for EW Transportation LLC’s predecessor from March 1995 until April 1999.
Richard P. Falcinelli has served as our Vice President of Administration and Secretary since July 2003. Mr. Falcinelli has served as Vice President of Administration and Secretary of EW Transportation LLC since April 1999.
Gregory Haslinsky has served as our Vice President, Sales since October 2005 and has been employed by K-Sea Transportation since December 1999 in various sales capacities. Mr. Haslinsky was employed from November 1988 to November 1999 by Maritrans, a marine transportation company, holding various sales and marketing positions within the organization.
Charles Kauffman has served as our Vice President, Corporate Development since the acquisition of Sea Coast Transportation in October 2005. Mr. Kauffman was employed from February 1984 to October 2005 by Saltchuk Resources Inc., a privately held maritime company, where he held various senior management positions, including President of Sea Coast Transportation since July 2002.
Meetings and Committees of the Board of Directors
Meetings
K-Sea General Partner GP LLC’s board of directors held six meetings during fiscal 2006. During fiscal 2006, each director attended at least 75% of the aggregate of (1) the total number of meetings of the board of directors of K-Sea General Partner GP LLC and (2) the total number of meetings held by all committees of such board on which he served.
Audit Committee
K-Sea General Partner GP LLC has a standing audit committee consisting of Messrs. Abbate, Alperin (Chairman) and Salerno. The board of directors of K-Sea General Partner GP LLC has determined that all members of the audit committee are independent within the meaning of the listing standards of the New York Stock Exchange and the applicable rules of the Securities and Exchange Commission. In addition, the board of directors of K-Sea General Partner GP LLC has determined that Mr. Abbate is an audit committee financial expert within the meaning of the rules of the Securities and Exchange Commission.
The primary responsibilities of the audit committee are to assist the board of directors of K-Sea General Partner GP LLC in overseeing (1) the integrity of our financial statements, (2) our independent registered public accounting firm’s qualifications, independence, and performance, (3) the effectiveness of our internal controls and procedures and our internal audit function, and (4) our compliance with legal
and regulatory requirements. The audit committee has the sole authority to appoint, retain and terminate our independent registered public accounting firm, which reports directly to the audit committee.
The audit committee has established procedures for the receipt, retention and treatment of complaints we receive regarding accounting, internal accounting controls or auditing matters and the confidential, anonymous submission by our employees of concerns regarding questionable accounting or auditing matters.
Compensation Committee
K-Sea General Partner GP LLC has a standing compensation committee consisting of Messrs Alperin, Dowling and Friedman. The compensation committee, among other tasks, determines and approves the chief executive officer’s compensation, makes recommendations to the board with respect to other executive officer compensation, and reviews from time to time the compensation and benefits of non-employee directors.
Conflicts Committee
K-Sea General Partner GP LLC has a standing conflicts committee consisting of Messrs. Abbate, Alperin and Salerno. The conflicts committee reviews specific matters that the board of directors of K-Sea General Partner GP LLC believes may involve conflicts of interest and takes such other action as may be required under the terms of our partnership agreement.
Director Independence
The board of directors of K-Sea General Partner GP LLC has determined that Messrs. Abbate, Alperin and Salerno are independent within the meaning of the listing standards for general independence of the New York Stock Exchange. Under the listing standards, the audit committee is required to be composed solely of directors who are independent. The standards for audit committee membership include additional requirements under rules of the SEC.
The listing standards relating to general independence consist of both a requirement for a board determination that the director has no material relationship with the listed company and a listing of several specific relationships that preclude independence. To assist it in making determinations of independence, the board has adopted categorical standards as permitted under the listing standards. Although the board considers all relevant facts and circumstances in assessing whether a director is independent, relationships falling within the categorical standards are not required to be disclosed or separately discussed in this report in connection with the board’s independence determinations. A relationship falls within the categorical standards adopted by the board if it:
· is a type of relationship addressed in
· the rules of the SEC requiring proxy statement disclosure of relationships and transactions, or
· the provisions of the New York Stock Exchange Listed Company Manual listing relationships that preclude a determination of independence,
but under those rules neither requires disclosure nor precludes a determination of independence, or
· consists of charitable contributions by us to an organization where a director is an executive officer and does not exceed the greater of $1 million or 2% of the organization’s gross revenue in any of the last three years.
None of the independent directors had relationships relevant to an independence determination that were outside the scope of the board’s categorical standards.
Because we are a limited partnership, the listing standards of the New York Stock Exchange do not require K-Sea General Partner GP LLC to have a majority of independent directors or a nominating/corporate governance or compensation committee.
Code of Business Conduct and Ethics
The board of directors of K-Sea General Partner GP LLC has adopted a code of business conduct and ethics for all employees, including our principal executive officer and principal financial and accounting officer. If any amendments are made to the code or if K-Sea General Partner GP LLC grants any waiver, including any implicit waiver, from a provision of the code that the SEC or the New York Stock Exchange (“NYSE”) requires us to disclose, we will disclose the nature of such amendment or waiver on our website or in a current report on Form 8-K.
Corporate Governance Guidelines
The board of directors of K-Sea General Partner GP LLC has also adopted corporate governance guidelines in accordance with the rules of the New York Stock Exchange.
Availability of Corporate Governance Documents
Copies of the board committee charters, code of business conduct and ethics and corporate governance guidelines are available, without charge, on our website at www.k-sea.com and in print, free of charge, upon written request to the Secretary, K-Sea General Partner GP LLC, One Tower Center Blvd., 17th Floor, East Brunswick, New Jersey 08816.
Annual Certification
We have filed the required certifications under Section 302 of the Sarbanes-Oxley Act of 2002 as Exhibits 31.1 and 31.2 to this report. For fiscal 2005, we submitted to the NYSE the CEO certification required by Section 303A.12(a) of the NYSE’s Listed Company Manual. For fiscal 2006, we expect to submit this certification to the NYSE within 30 days after filing this report.
Executive Sessions of the Board of Directors
Messrs. Abbate, Alperin, Dowling, Friedman and Salerno, who are non-management directors of K-Sea General Partner GP LLC, meet at regularly scheduled executive sessions without management. These meetings are chaired on a rotating basis by the chairmen of the audit committee and compensation committee. Persons wishing to communicate with our non-management directors may do so by writing to them at K-Sea General Partner GP LLC, c/o Board of Directors, One Tower Center Blvd., 17th Floor, East Brunswick, New Jersey 08816.
Messrs. Abbate, Alperin, and Salerno, who are independent non-management directors of K-Sea General Partner GP LLC, meet at least annually in executive sessions without management and the other directors. Mr. Abbate serves as the presiding director at those executive sessions.
Communications with Independent Directors
Persons wishing to communicate with our independent non-management directors may do so by writing to them at K-Sea General Partner GP LLC, c/o Board of Directors, One Tower Center Blvd., 17th Floor, East Brunswick, New Jersey 08816.
Payments to our General Partner
K-Sea General Partner LP does not receive any management fee or other compensation in connection with its management of us; however, K-Sea General Partner LP or its affiliates who perform services for us and/or our subsidiaries are reimbursed at cost for all expenses incurred on our behalf which are necessary or appropriate to the conduct of our business. These costs totaled approximately $7,290 and $0 during fiscal 2006 and fiscal 2005, respectively. We also directly pay the fees of the independent directors of K-Sea General Partner GP LLC and reimburse meeting-related expenses of all directors of K-Sea General Partner GP LLC.
Section 16(a) Beneficial Ownership Reporting Compliance
Section 16(a) of the Securities Exchange Act of 1934 requires our officers and directors, and persons who own more than 10% of a registered class of our equity securities, to file reports of beneficial ownership and changes in beneficial ownership with the SEC. Officers, directors and greater than 10% unitholders are required by SEC regulations to furnish us with copies of all Section 16(a) forms.
Based solely on our review of the copies of such forms we received, or representations from certain reporting persons that no Form 4s were required for those persons, we believe that during the fiscal year ended June 30, 2006, all of our officers, directors, and greater than 10% beneficial owners complied on a timely basis with all applicable filing requirements under Section 16(a) of the Securities Exchange Act of 1934, except that a Form 3 for Mr. Haslinsky and one Form 4 for Mr. Salerno were filed late.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The following table sets forth the annual salary, bonus and all other compensation awards and payouts made to our President and Chief Executive Officer, and our four other most highly compensated executive officers, in respect of fiscal 2006, 2005 and 2004:
Summary Compensation Table(1)
(1) K-Sea Transportation Partners L.P. and K-Sea General Partner GP LLC, the general partner of our general partner, were formed in July 2003; however, neither paid compensation to its directors or
officers prior to January 14, 2004, the closing date of our initial public offering. The data in the table above for fiscal 2004 reflects payments to our executive officers by us and by our predecessor companies in respect of fiscal 2004.
(2) Bonuses are earned based on the results of operations for each fiscal year and are reported above for the fiscal year in which they were earned. Bonuses for the fiscal year ended June 30, 2006 have not yet been awarded.
(3) Represents the value of the executive officer’s restricted unit awards under the K-Sea Transportation Partners L.P. Long-Term Incentive Plan (calculated by multiplying the closing market price of our common units on the date of grant by the number of restricted units awarded). Restricted units, as part of the company’s long-term compensation plan, are awarded periodically by the Compensation Committee to directors, officers and certain other employees as a means to reward achievement of performance objectives. Restricted unit awards were made on October 1, 2004 and April 4, 2006; however, there is no preset timetable for future awards. As of June 30, 2006, Mr. Casey had 27,000 restricted units with a value of $868,050, each of Messrs. Nicola, Sullivan and Falcinelli had 9,000 restricted units with a value of $289,350, and Mr. Haslinsky had 7,000 restricted units with a value of $225,050. These restricted units will vest in four equal installments beginning in October 2006. Each restricted unit includes an associated distribution equivalent right, which entitles the recipient to receive an amount in cash equal to, and at the same time as, the cash distributions made by us with respect to a common unit during the period such restricted unit is outstanding.
(4) Consists of contributions to our 401(k) and money purchase defined contribution plans.
Unit Option Awards
No unit options have been awarded to date.
Employment Agreements
Timothy J. Casey, John J. Nicola, Thomas M. Sullivan and Richard P. Falcinelli have entered into employment agreements with K-Sea Transportation Inc., our indirect wholly owned corporate subsidiary. The following is a summary of the material provisions of those employment agreements, copies of which have been previously filed as exhibits. All of these employment agreements are substantially similar, with certain exceptions as set forth below.
The employment agreements contemplate that each employee will serve as an officer of K-Sea General Partner GP LLC and other affiliates. Each of the employment agreements had an initial term of one year. The term of each employment agreement is automatically extended for successive one-year terms unless either party gives 30-days written notice prior to the end of the term that such party desires not to renew the employment agreement.
Mr. Casey receives a base annual salary of $250,000 and each of Messrs. Nicola, Falcinelli and Sullivan receive a base annual salary of $200,000. Under the employment agreement, each employee is eligible to receive an annual bonus award based upon the financial performance of us and our subsidiaries. The board of directors of K-Sea General Partner GP LLC will determine the amount of any bonus award and may issue additional awards to each employee in the amounts and at the times it so determines. Further, each employee is entitled to an automobile and certain other benefits.
If the employee’s employment is terminated without cause (as defined in the employment agreement) or if the employee resigns for good reason (as defined in the employment agreement), the employee will be entitled to severance in an amount equal to the greater of (a) the product of 1.3125 (1.75 multiplied by .75) multiplied by the employee’s base salary at the time of termination or resignation and (b) the product of 1.75 multiplied by the remaining term of the employee’s non-competition provisions multiplied
by the employee’s base salary at the time of termination or resignation. In addition, K-Sea Transportation Inc. will pay on behalf of each employee the premiums necessary to provide coverage continuation rights under certain insurance policies for a one-year period after termination or resignation.
The employment agreements also provide for a non-competition period that will continue for two years after the termination of the employee’s employment, except that the non-competition period may terminate earlier as determined by the board of directors of K-Sea General Partner GP LLC if (a) the employee is terminated other than for cause and (b) such termination does not occur within 30 days after a “change in control,” as defined therein. During the non-competition period, the employee is generally prohibited from engaging in any business that competes with us or our affiliates in areas in which we conduct business as of the date of termination and from soliciting or inducing any of our employees to terminate their employment with us or accept employment with anyone else or interfere in a similar manner with our business.
Mr. Haslinsky, our other named executive officer, does not have an employment agreement and is paid an annual base salary of $150,000.
Long-Term Incentive Plan
K-Sea General Partner GP LLC has adopted the K-Sea Transportation Partners L.P. Long-Term Incentive Plan for directors and employees of K-Sea General Partner GP LLC and its affiliates, including K-Sea Operating Partnership L.P. and K-Sea Transportation Inc. The long-term incentive plan permits the grant of awards covering an aggregate of 440,000 common units in the form of unit options and restricted units. The plan is administered by the compensation committee of the board of directors of K-Sea General Partner GP LLC, and will continue in effect until the earlier of the date determined by the board of directors of K-Sea General Partner GP LLC or the date common units are no longer available for the payment of awards under the plan.
K-Sea General Partner GP LLC’s board of directors or its compensation committee at its discretion are able to terminate, suspend or discontinue the long-term incentive plan at any time with respect to any units for which a grant has not yet been made. K-Sea General Partner GP LLC’s board of directors or its compensation committee also have the right to alter or amend the long-term incentive plan or any part thereof from time to time, including increasing the number of units that may be granted subject to unitholder approval as required by the exchange upon which the common units are listed at that time. However, no change in any outstanding grant may be made that would materially impair the rights of the participant without the consent of the participant.
Restricted Units. A restricted unit is a “phantom” unit that entitles the grantee to receive a common unit upon the vesting of the phantom unit or, in the discretion of the compensation committee, cash equivalent to the fair market value of a common unit. The compensation committee may determine to make grants under the plan to employees and directors containing such terms as the compensation committee shall determine under the plan, including the period over which restricted units granted to employees and directors will vest. The compensation committee will be able to base its vesting determination upon the achievement of specified performance objectives. In addition, subject to additional or contrary provisions in a unit award agreement, the restricted units will vest upon a change in control of K-Sea Transportation Partners L.P. or our general partner.
If a grantee’s employment or membership on the board of directors terminates for any reason, the grantee’s restricted units will be automatically forfeited unless, and to the extent, the compensation committee provides otherwise or unless otherwise provided in a written employment agreement between the grantee and K-Sea General Partner GP LLC or its affiliates. Common units to be delivered upon the vesting of restricted units may be common units acquired by the general partner of our general partner in the open market, common units already owned by the general partner of our general partner, common
units acquired by the general partner of our general partner directly from us or any other person or any combination of the foregoing, as determined by the compensation committee at its discretion. K-Sea General Partner GP LLC will be entitled to reimbursement by us for the cost incurred in acquiring common units. Thus, the cost of the restricted units will be borne by us. If we issue new common units upon vesting of the restricted units, the total number of common units outstanding will increase. The compensation committee, in its discretion, may grant tandem distribution equivalent units (“DERs”) with respect to restricted units, which entitle the recipient to receive an amount in cash equal to, and at the same time as, the cash distributions made by us with respect to a common unit during the period such restricted unit is outstanding.
Unit Options. The long-term incentive plan will permit the grant of options covering common units. The compensation committee will be able to make grants under the plan to employees and directors containing such terms as the committee determines. Unit options will not have an exercise price that is less than the fair market value of the units on the date of grant. In general, unit options granted will become exercisable over a period determined by the compensation committee. In addition, the unit options will become exercisable upon a change in control of K-Sea Transportation Partners L.P. or K-Sea Operating Partnership L.P. or upon the achievement of specified performance objectives. Unless otherwise provided in an award agreement, unit options may be exercised only by the participant during his lifetime or by the person to whom the participant’s right will pass by will or the laws of descent and distribution.
If a grantee’s employment or membership on the board of directors terminates for any reason, the grantee’s unvested options will be automatically forfeited unless, and to the extent, the compensation committee provides otherwise or unless otherwise provided in a written employment agreement between the grantee and K-Sea General Partner GP LLC or its affiliates. Upon exercise of a unit option, K-Sea General Partner GP LLC will acquire common units in the open market or directly from us or any other person or use common units that it already owns, or any combination of the foregoing, as determined by the compensation committee in its discretion. K-Sea General Partner GP LLC will be entitled to reimbursement by us for the difference between the cost incurred in acquiring these common units and the proceeds received from an optionee at the time of exercise. Thus, the cost of the unit options will be borne by us. If we issue new common units upon exercise of the unit options, the total number of common units outstanding will increase, and the general partner of our general partner will pay us the proceeds it receives from the optionee upon exercise of the unit option. The unit option plan has been designed to furnish additional compensation to employees and directors and to align their economic interests with those of common unitholders.
Unit Purchase Plan
We have a unit purchase plan for employees of our general partner and its affiliates. The number of common units initially available for purchase under this plan was 200,000. The unit purchase plan is intended to serve as a means of encouraging participants to invest in common units and to encourage participants to devote their best efforts to the business of the partnership. Our general partner pays the brokerage commissions, transfer taxes and other costs and expenses of the plan. All common units acquired under the plan will be subject to a one-year holding period from the date of purchase. If a participant sells or otherwise disposes of his common units during this one-year holding period, the participant will thereafter be precluded from participating in the unit purchase plan until the first unit purchase period following the first anniversary of the date of the pledge, transfer, sale or other distribution of common units. The plan is administered by the compensation committee of the board of directors of K-Sea General Partner GP LLC. The plan may be terminated at any time by the compensation committee and will automatically terminate when all of the available common units under the plan have been purchased. The plan may be amended from time to time by the compensation committee.
Director Compensation
K-Sea General Partner GP LLC pays no additional remuneration to its employees for serving as directors. The following table provides information on compensation and reimbursement practices for independent directors of K-Sea General Partner GP LLC (Messrs. Abbate, Alperin and Salerno):
(1) The board of directors of K-Sea General Partner GP LLC established compensation and reimbursement policies for fiscal 2006 at its regularly scheduled meeting on September 8, 2005. These policies will apply to subsequent fiscal years unless changed by the board of directors of K-Sea General Partner GP LLC or the compensation committee thereof.
(2) Additional fee is only $500 if the audit committee meeting occurs on the same day as a board meeting.
(3) Restricted units vest on the first anniversary of the date of grant, subject to earlier vesting in the event of a change in control, death, disability or retirement and to such other terms as are set forth in the award agreement, a form of which has been filed as an exhibit to this report. The date of grant for fiscal 2006 is September 8, 2005; the date of grant for subsequent fiscal years will be the date of the first regularly scheduled board meeting during such fiscal year. Grants of restricted units include associated DERs.
Neither Mr. Dowling nor Mr. Friedman has received any remuneration for serving as a director. We reimburse Mr. Dowling and Mr. Friedman for expenses attendant to board membership.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SECURITYHOLDER MATTERS.
A diagram depicting our current organizational structure is presented below.
K-Sea Transportation Partners L.P.
The following table sets forth the beneficial ownership of units of K-Sea Transportation Partners L.P. as of September 6, 2006 by beneficial owners of 5% or more of such units by each director and named executive officer of K-Sea General Partner GP LLC and by all directors and named executive officers as a group.
* Less than 1%.
(1) Unless otherwise noted, each beneficial owner has sole voting and dispositive power with respect to the common and subordinated units set forth opposite such holder’s name.
(2) Holders of restricted units do not have voting or investment power with respect to such units prior to vesting. Restricted units that are exercisable within 60 days of the date of this report are deemed outstanding for purposes of determining the beneficial ownership and computing the percentage ownership of such person, but are not deemed outstanding for purposes of computing the percentage ownership of any other person. Accordingly, the following common units that may be issued upon the vesting of restricted units are included in the table: Mr. Dowling-3,000; Mr. Casey-6,000; Mr. Nicola-2,000; Mr. Sullivan-2,000; Mr. Falcinelli-2,000; and Mr. Haslinsky-1,500.
(3) EW Transportation LLC is owned by individual investors, including certain of our directors and executive officers, and by KSP Investors A L.P., KSP Investors B L.P. and KSP Investors C L.P. (each, a “KSP Entity”). The table below sets forth the economic interest in, and beneficial ownership of equity interests of, EW Transportation LLC., which beneficial ownership includes units beneficially owned by EW Holding Corp. and EW Transportation Corp., its wholly owned subsidiaries. The address of EW Transportation LLC is One Tower Center Blvd. 17th FL, East Brunswick, New Jersey 08816.
(4) EW Holding Corp.’s beneficial ownership includes units beneficially owned by EW Transportation Corp., its wholly owned subsidiary. The address of each entity is One Tower Center Blvd. 17th FL, East Brunswick, New Jersey 08816.
(5) Based solely on a Schedule 13G/A filed with the Securities and Exchange Commission on February 10, 2006 by Tortoise Energy Infrastructure Corporation (“TYG”) and Tortoise Capital Advisors, L.L.C., an investment advisor to TYG and certain managed accounts (“TCA”). TCA, by virtue of an investment advisory agreement with TYG, has all investment and voting power over common units owned of record by TYG. TCA and TYG have reported that they share voting power and dispositive power over the common units owned of record by TYG. TCA also acts as an investment advisor to Tortoise Energy Capital Corporation (“TYY”) and certain managed accounts. Including shares owned of record by TYG and certain managed accounts, TCA has shared voting power with respect to 416,222 common units and shared dispositive power with respect to 956,346 common units. TYG has shared voting and dispositive power with respect to 571,300 common units. TCA is not the record owner of any common units and disclaims any beneficial interest in such common units. The address of each entity is 10801 Mastin Boulevard, Suite 222, Overland Park, Kansas 66210.
(6) Based solely on a Schedule 13G filed with the Securities and Exchange Commission on February 14, 2006 by Neuberger Berman Inc. (“Neuberger Inc.”). Such filing indicates that Neuberger Inc. has sole voting power with respect to 225,680 common units and shared voting power with respect to 295,750 common units. Neuberger Berman, LLC (“Neuberger LLC”) is deemed to be a beneficial owner since it has shared power to make decisions whether to retain or dispose, and in some cases the sole power to vote, the securities of many unrelated clients. Neuberger Berman, LLC does not, however, have any economic interest in the securities of those clients. Neuberger LLC and Neuberger Berman Management Inc. are deemed to be beneficial owners for since they both have shared power to make decisions whether to retain or dispose and vote the securities. Neuberger LLC and Neuberger Inc. serve as a sub-adviser and investment manager, respectively, of Neuberger Berman’s various mutual funds which hold such shares in the ordinary course of their business and not with the purpose nor with the effect of changing or influencing the control of the issuer.
(7) Mr. Friedman owns 51% of Park Avenue Transportation Inc., the general partner of each KSP Entity and, therefore, may be deemed to beneficially own the subordinated units held by EW Transportation LLC. The address of each KSP Entity and Park Avenue Transportation Inc. is 520 Madison Avenue, 12th Floor, New York, New York 10022.
EW Transportation LLC
The following table sets forth the economic interest in, and the beneficial ownership of equity interests of, EW Transportation LLC as of September 6, 2006:
* Less than 1%.
(1) Park Avenue Transportation Inc. is the general partner of each of KSP Investors A L.P., KSP Investors B L.P. and KSP Investors C L.P. (each, a “KSP Entity”) and, therefore, has sole voting and dispositive power with respect to the equity interests of EW Transportation LLC owned by each KSP Entity. Mr. Friedman owns 51% of the outstanding shares of capital stock of Park Avenue Transportation Inc., the general partner of each KSP Entity. In addition, Mr. Friedman has an economic interest in FS Private Investments LLC, which in turn has an economic interest in each KSP Entity.
(2) Mr. Dowling is a limited partner in KSP Investors C L.P. and has an effective 1.38% economic interest in EW Transportation LLC.
K-Sea General Partner GP LLC
The following table sets forth the economic interest in, and the beneficial ownership of equity interests of, K-Sea General Partner GP LLC, the general partner of our general partner, as of September 6, 2006:
* Less than 1%.
(1) Park Avenue Transportation Inc. is the general partner of each of KSP Investors A L.P., KSP Investors B L.P. and KSP Investors C L.P. (each, a “KSP Entity”) and, therefore, has sole voting and dispositive power with respect to the equity interests of K-Sea General Partner GP LLC owned by each KSP Entity. Mr. Friedman owns 51% of the outstanding shares of capital stock of the general partner of each KSP Entity.
(2) Mr. Dowling has an effective 1.38% economic interest in K-Sea General Partner GP LLC.
Equity Compensation Plan Information
The following table sets forth in tabular format a summary of our equity plan information as of September 6, 2006:
(1) The K-Sea Transportation Partners L.P. Long-Term Incentive Plan is our only equity compensation plan. No options, warrants or rights have been issued under this plan. For a description of the material
features of this plan, please read “Executive Compensation-Long-Term Incentive Plan” in Item 11 of this report.
(2) An aggregate of 110,250 restricted units have been issued under the K-Sea Transportation Partners L.P. Long-Term Incentive Plan.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
Distributions and Payments to Our General Partner and Its Affiliates
We generally distribute 98% of our available cash to our unitholders, including EW Transportation LLC, EW Holding Corp. and EW Transportation Corp. in their capacity as holders of an aggregate of 4,165,000 subordinated units, and the remaining 2% of our available cash to our general partner. If distributions exceed the $0.50 per unit minimum quarterly distribution and other higher target levels, our general partner is entitled to increasing percentages of the distributions, up to 50% of the distributions above the highest target level. We refer to the rights to the increasing distributions as “incentive distribution rights.” Please read “Market For Registrant’s Common Equity, Related Securityholder Matters and Issuer Purchases of Equity Securities-Incentive Distribution Rights” in Item 5 of this report. Assuming we pay the $0.50 per unit minimum quarterly distribution on all of our outstanding units, our general partner would receive an annual distribution of $404,894 on its 2% general partner interest, and affiliates of our general partner receive an annual distribution of approximately $8,330,000 on their subordinated units. In August 2006, the board of directors of the general partner of our general partner increased the quarterly cash distribution to $0.62 per common unit. If distributions continue at that level on all of our outstanding units, our general partner would receive an annual distribution of $935,544 on its 2% general partner interest and incentive distribution rights, and affiliates of our general partner would receive an annual distribution of approximately $10,329,200 on their subordinated units. No assurances can be made, however, that distributions will continue at that level.
Our general partner and its affiliates do not receive a management fee or other compensation for the management of our partnership. Our general partner and its affiliates are entitled to be reimbursed, however, for all direct and indirect expenses incurred on our behalf. Our general partner has sole discretion in determining the amount of these expenses. These reimbursed expenses totaled approximately $7,290 and $0 in fiscal 2006 and fiscal 2005, respectively.
If our general partner withdraws or is removed, its general partner interest and its incentive distribution rights will either be sold to the new general partner for cash or converted into common units, in each case for an amount equal to the fair market value of those interests.
Upon our liquidation, the partners, including our general partner, will be entitled to receive liquidating distributions according to their particular capital account balances.
Omnibus Agreement
We are a party to an omnibus agreement with KSP Investors A L.P. (“KSP A”), KSP Investors B L.P. (“KSP B”), KSP Investors C L.P. (“KSP C” and, together with KSP A and KSP B, the “KSP Entities”), EW Transportation LLC, EW Acquisition Corp., EW Holding Corp., EW Transportation Corp., K-Sea General Partner LP (our general partner), K-Sea General Partner GP LLC (the general partner of our general partner), K-Sea OLP GP LLC (the general partner of our operating partnership) and K-Sea Operating Partnership L.P. (our operating partnership).
Noncompetition
Under the omnibus agreement, neither the KSP Entities nor their controlled affiliates may engage, either directly or indirectly, in the business of providing refined petroleum product marine transportation, distribution and logistics services in the United States to the extent such business generates qualifying income for federal income tax purposes. The restriction does not apply to the assets that were retained by our predecessors at the closing of our initial public offering in January 2004. Except as provided above, neither the KSP Entities nor their controlled affiliates are prohibited from engaging in activities in which they compete directly or indirectly with us. Jefferies Capital Partners, and the funds it manages, are not prohibited from owning assets or engaging in businesses that compete directly or indirectly with us.
Indemnification
Under the omnibus agreement, the KSP Entities, EW Transportation LLC and the subsidiaries of EW Transportation LLC (collectively, “the Indemnitors”) have jointly and severally agreed to indemnify us until January 14, 2009 against certain environmental and toxic tort liabilities and, until January 14, 2014, against certain other toxic tort liabilities associated with the operation of the assets before January 14, 2004. Liabilities resulting from changes in law after the closing of our initial public offering are excluded from the environmental indemnity. We have agreed to indemnify the Indemnitors for events and conditions associated with the operation of our assets that occur on or after January 14, 2004 to the extent the Indemnitors are not required to indemnify us. There is an aggregate cap of $10 million on the amount of indemnity coverage provided by the Indemnitors for the environmental and toxic tort liabilities.
The Indemnitors have also agreed to indemnify us for liabilities related to:
· certain defects in title to the assets contributed to us and failure to obtain certain consents and permits necessary to conduct our business that arise before January 14, 2008;
· events and conditions associated with any assets retained by the Indemnitors or any of their respective affiliates, whether occurring before or after January 14, 2004;
· certain liabilities retained by EW Holding Corp., EW Transportation LLC and EW Transportation Corp.; and
· certain income tax liabilities attributable to the operation of the assets contributed to us prior to the time they were contributed to us in connection with our initial public offering.
Amendments
The omnibus agreement may not be amended without the prior approval of the conflicts committee if the proposed amendment will, in the reasonable discretion of our general partner, adversely affect holders of our common units.
Properties
We lease our Staten Island, New York office and pier facilities from, and charter certain vessels to, affiliates of an employee. Additionally, we utilize one of these affiliates for tank cleaning services. Please read note 8 to our audited consolidated financial statements included elsewhere in this report.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The following table presents fees for services rendered by PricewaterhouseCoopers LLP during fiscal 2006 and fiscal 2005.
(1) Fees for audit of annual financial statements and internal control over financial reporting under the Sarbanes Oxley Act of 2002, reviews of the related quarterly financial statements, and reviews of documents filed with the SEC.
(2) Fees for professional services for consultations related to financial accounting and reporting standards, compliance with the Sarbanes Oxley Act of 2002, and due diligence related to acquisitions.
(3) Fees related to professional services for tax compliance, tax advice and tax planning.
The audit committee has considered whether the provision of the non-audit services described above is compatible with maintaining the independence of PricewaterhouseCoopers LLP and determined that the provision of such services was compatible with maintaining such independence.
Audit Committee Policies and Procedures for Pre-approval of Audit and Non-Audit Services
Consistent with SEC policies regarding auditor independence, the audit committee is responsible for pre-approving all audit and non-audit services performed by the independent registered public accounting firm. In addition to its approval of the audit engagement, the audit committee takes action at least annually to authorize the performance by the independent registered public accounting firm of several specific types of services within the categories of audit-related services and tax services. Audit-related services include assurance and related services that are reasonably related to the performance of the audit or review of the financial statements. Authorized tax services include compliance-related services such as services involving tax filings, as well as consulting services such as tax planning, transaction analysis and opinions. Services are subject to pre-approval of the specific engagement if they are outside the specific types of services included in the periodic approvals covering service categories or if they are in excess of specified fee limitations. The audit committee may delegate pre-approval authority to subcommittees. During 2006, no pre-approval requirements were waived.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
(a)(1) Financial Statements.
See “Index to Financial Statements” set forth on page.
(a)(2) Financial Statement Schedules.
None.
(a)(3) Exhibits.
10.3.1*
-
K-Sea Transportation Partners L.P. Long-Term Incentive Plan (incorporated by reference to Exhibit 10.7 to the Partnership’s Quarterly Report on Form 10-Q for the period ended March 31, 2004).
10.3.2*
-
Form of Director Phantom Unit Award Agreement (incorporated by reference to Exhibit 10.1 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 7, 2004).
10.3.3*
-
Form of Employee Phantom Unit Award Agreement (incorporated by reference to Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 7, 2004).
10.4*
-
K-Sea Transportation Partners L.P. Employee Unit Purchase Plan (incorporated by reference to Exhibit 4.2 to the Partnership’s Registration Statement on Form S-8 (Registration No. 333-117251) filed on July 9, 2004).
10.5*
-
Employment Agreement, dated as of January 14, 2004, between K-Sea Transportation Inc. and Timothy J. Casey (incorporated by reference to Exhibit 10.9 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2003).
10.6*
-
Employment Agreement, dated as of January 14, 2004, between K-Sea Transportation Inc. and John J. Nicola (incorporated by reference to Exhibit 10.10 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2003).
10.7*
-
Employment Agreement, dated as of January 14, 2004, between K-Sea Transportation Inc. and Richard P. Falcinelli (incorporated by reference to Exhibit 10.11 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2003).
10.8*
-
Employment Agreement, dated as of January 14, 2004, between K-Sea Transportation Inc. and Thomas M. Sullivan (incorporated by reference to Exhibit 10.12 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2003).
10.9*
-
Form of Indemnification Agreement (incorporated by reference to Exhibit 10.12 to the Partnership’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005)
10.10.1*
-
Loan and Security Agreement dated as of March 24, 2005 by and among K-Sea Operating Partnership L.P., as Borrower, the Lenders party thereto, LaSalle Bank National Association, as Syndication Agent, and KeyBank National Association, as Administrative Agent and Collateral Trustee for the Lenders (incorporated by reference to Exhibit 10.1 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 30, 2005).
10.10.2*
-
Amendment No. 1 dated October 18, 2005 to Loan and Security Agreement dated March 24, 2005 by and among K-Sea Operating Partnership L.P., as Borrower, the Lenders party thereto, LaSalle Bank National Association, as Syndication Agent, and KeyBank National Association, as Administrative Agent and Collateral Trustee for the Lenders (incorporated by reference to Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on October 24, 2005).
10.10.3*
Amendment No. 2 dated November 29, 2005 to Loan and Security Agreement dated March 24, 2005 by and among K-Sea Operating Partnership L.P., as Borrower, the Lenders party thereto, LaSalle Bank National Association, as Syndication Agent, and KeyBank National Association, as Administrative Agent and Collateral Trustee for the Lenders (incorporated by reference to Exhibit 10.2 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2005).
10.10.4*
Amendment No. 3 dated April 3, 2006 to Loan and Security Agreement dated March 24, 2005 by and among K-Sea Operating Partnership L.P., as Borrower, the Lenders party thereto, LaSalle Bank National Association, as Syndication Agent, and KeyBank National Association, as Administrative Agent and Collateral Trustee for the Lenders (incorporated by reference to Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 7, 2006).
10.11*
-
Loan and Security Agreement dated as of March 24, 2005 by and between The CIT Group/Equipment Financing, Inc., as Lender, and K-Sea Operating Partnership L.P., as Borrower (incorporated by reference to Exhibit 10.2 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on March 30, 2005).
10.12*
Master Loan and Security Agreement dated as of April 3, 2006 by and among K-Sea Operating Partnership L.P., as Borrower, Key Equipment Finance Inc., as Lender, and K-Sea Transportation Partners L.P., K-Sea Transportation Inc. and Sea Coast Transportation LLC, as Guarantors (incorporated by reference to Exhibit 10.1 to the Partnership’s Current Report on Form 8-K filed with the Securities and Exchange Commission on April 7, 2006).
21.1
-
List of subsidiaries.
23.1
-
Consent of PricewaterhouseCoopers LLP.
31.1
-
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
-
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1
-
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2
-
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.1*
-
Loan Agreement, dated as of March 17, 2005, between K-Sea Operating Partnership L.P. and First Union Commercial Corporation (incorporated by reference to Exhibit 10.3 to the Partnership’s Quarterly Report on Form 10-Q for the period ended March 31, 2005).
99.2*
-
Loan Agreement, dated as of June 28, 2005, between K-Sea Operating Partnership L.P. and Citizens Asset Finance, a d/b/a of Citizens Leasing Corporation (incorporated by reference to Exhibit 10.16 to the Partnership’s Annual Report on Form 10-K for the fiscal year ended June 30, 2005).
99.3*
Loan Agreement dated December 19, 2005 between K-Sea Canada Corp. (as Borrower) and Citizens Leasing Corp. d/b/a Citizens Asset Finance (as Lender) (incorporated by reference to Exhibit 10.3 to the Partnership’s Quarterly Report on Form 10-Q for the period ended December 31, 2005).
99.4
Loan Agreement dated as of May 12, 2006 among K-Sea Operating Partnership L.P., as Borrower, Citizens Leasing Corporation, as Lender, and Citizens Leasing Corporation, as agent and collateral trustee for the other lenders that may become parties to the loan agreement.
* Incorporated by reference, as indicated.
 Management contract, compensatory plan or arrangement.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated:
INDEX TO CONSOLIDATED STATEMENTS
Management’s Report on Internal Control Over Financial Reporting
Our management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) of the Securities and Exchange Act of 1934. Management assessed the effectiveness of our internal control over financial reporting as of June 30, 2006 based on the framework in “Internal Control-Integrated Framework,” issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on that assessment, management concluded that our internal control over financial reporting was effective as of June 30, 2006, based on those criteria.
Management excluded Sea Coast Transportation LLC from its assessment of internal control over financial reporting as of June 30, 2006 because it was acquired in a purchase business combination during fiscal 2006. Sea Coast Transportation LLC is a wholly-owned subsidiary whose total assets and total revenues represent $90.2 million and $39.3 million, respectively, of the related consolidated financial statement amounts as of and for the year ended June 30, 2006.
Management’s assessment of the effectiveness of our internal control over financial reporting as of June 30, 2006 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting firm, as stated in their report which is included under the heading “Report of Independent Registered Public Accounting Firm” on page.
Report of Independent Registered Public Accounting Firm
To the General Partner and Unitholders of K-Sea Transportation Partners L.P.
We have completed integrated audits of K-Sea Transportation Partners L.P.’s 2006 and 2005 consolidated financial statements and of its internal control over financial reporting as of June 30, 2006, and an audit of its 2004 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of K-Sea Transportation Partners L.P. and its subsidiaries at June 30, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 2006 in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company’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 the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements 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 our opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing on page, that the Company maintained effective internal control over financial reporting as of June 30, 2006 based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of June 30, 2006 based on criteria established in Internal Control-Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance
of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
As described in Management’s Report on Internal Control over Financial Reporting, management has excluded Sea Coast Transportation LLC from its assessment of internal control over financial reporting as of June 30, 2006 because it was acquired by the Company in a purchase business combination during fiscal 2006. We have also excluded Sea Coast Transportation LLC from our audit of internal control over financial reporting. Sea Coast Transportation LLC is a wholly-owned subsidiary whose total assets and total revenues represent $90.2 million and $39.3 million, respectively, of the related consolidated financial statement amounts as of and for the year ended June 30, 2006.
/s/ PRICEWATERHOUSEcOOPERS Llp
Florham Park, New Jersey
August 15,
K-SEA TRANSPORTATION PARTNERS L.P.
CONSOLIDATED BALANCE SHEETS
(in thousands)
See accompanying notes to consolidated financial statements.
K-SEA TRANSPORTATION PARTNERS L.P.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per unit amounts)
See accompanying notes to consolidated financial statements.
K-SEA TRANSPORTATION PARTNERS L.P.
CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL/MEMBERS’ EQUITY
(in thousands)
See accompanying notes to consolidated financial statements.
K-SEA TRANSPORTATION PARTNERS L.P.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
See accompanying notes to consolidated financial statements.
K-SEA TRANSPORTATION PARTNERS L.P.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except unit and per unit amounts)
Note 1: Basis of Presentation
On July 8, 2003, K-Sea Transportation Partners L.P. (the “Partnership”) was formed to own and operate the refined petroleum product marine transportation, distribution and logistics business conducted by K-Sea Transportation LLC (since renamed EW Transportation LLC, or “EW LLC”) and its subsidiaries K-Sea Acquisition Corp., EW Holding Corp. and K-Sea Transportation Corp. (since renamed EW Transportation Corp.) (collectively, the “Predecessor”). The Partnership and its predecessor companies have since 1959 engaged in the transportation of refined petroleum products in the northeastern United States and Gulf of Mexico and reports as one operating segment. On January 14, 2004, the Predecessor contributed assets and liabilities constituting the business of the Predecessor to the Partnership in connection with the initial public offering of common units representing limited partner interests in the Partnership (the “common units”). In exchange for these assets and liabilities, the Predecessor received 665,000 common units and 4,165,000 subordinated units representing limited partner interests in the Partnership. The transfer to the Partnership of the assets and liabilities constituting the business of the Predecessor represented a reorganization of entities under common control and was recorded at historical cost. The net assets transferred were $5,334 greater than the net assets of the Predecessor due to the retention by the Predecessor of certain net liabilities. The consolidated financial statements included herein are for the Predecessor for all periods prior to January 14, 2004.
Note 2: Initial Public Offering
On January 14, 2004, the Partnership completed its initial public offering of 3,625,000 common units at a price of $23.50 per unit. On January 21, 2004, the Partnership sold an additional 540,000 common units to the underwriters in connection with the exercise of their over-allotment option. Total gross proceeds from these sales were $97,877, before offering costs and underwriting fees of $11,776. Concurrent with these sales, the Partnership redeemed the 665,000 common units held by EW LLC (see note 1) at a cost of $14,592. The proceeds retained by the Partnership relating to the sale of the common units in the initial public offering, totaling $83,285, were used to repay $73,941 in outstanding term and revolving credit debt, including prepayment fees and make-whole amounts, and to pay $5,939 in underwriting fees and $3,405 in professional fees and other offering expenses.
After the initial public offering and related redemption, there were 4,165,000 common units and 4,165,000 subordinated units outstanding. As described in the Partnership’s partnership agreement, during the subordination period the subordinated units are not entitled to receive any distributions until the common units have received their minimum quarterly distribution plus any arrearages from prior quarters. The subordination period will end once the Partnership meets certain financial tests described in the partnership agreement, but it generally cannot end before December 31, 2008. When the subordination period ends, all subordinated units will convert into common units on a one-for-one basis, and the common units will no longer be entitled to arrearages. If the Partnership meets certain financial tests described in the partnership agreement, 25% of the subordinated units can convert into common units on or after December 31, 2006, and an additional 25% can convert into common units on or after December 31, 2007.
The Partnership’s general partner, K-Sea General Partner L.P., holds 202,447 general partner units (representing a 2% general partner interest) and certain incentive distribution rights in the Partnership. Incentive distribution rights represent the right to receive an increasing percentage of cash distributions after the minimum quarterly distribution, any cumulative arrearages on common units, and certain target
distribution levels have been achieved. The target distribution levels entitle the general partner to receive 15% of quarterly cash distributions in excess of $0.55 per unit until all unitholders have received $0.625 per unit, 25% of quarterly cash distributions in excess of $0.625 per unit until all unitholders have received $0.75 per unit, and 50% of quarterly cash distributions in excess of $0.75 per unit. The Partnership is required to distribute all of its available cash from operating surplus, as defined in the partnership agreement. On May 1, 2006, the Partnership’s general partner amended and restated the partnership agreement of the Partnership to, among other things, provide that additional contributions by the general partner to the Partnership upon the issuance of additional limited partner interests are not mandatory. Previously the general partner was required to make a capital contribution to the Partnership upon the issuance of new limited partner interests to maintain its 2% interest. If the general partner does not make additional capital contributions upon the issuance of new common units, the general partner’s percentage interest in the Partnership will decrease accordingly.
Note 3: Summary of Significant Accounting Policies
Basis of Consolidation. These consolidated financial statements are for the Partnership and its wholly owned subsidiaries. For all periods prior to January 14, 2004, the business was operated by the Predecessor, and therefore the consolidated financial statements are for the Predecessor (see note 1) for those periods. All material inter-company transactions and balances have been eliminated in consolidation.
Cash and Cash Equivalents. The Partnership considers all highly liquid investments with original maturities of three months or less to be cash equivalents.
Vessels and Equipment. Vessels and equipment are recorded at cost, including capitalized interest where appropriate, and depreciated using the straight-line method over the estimated useful lives of the individual assets as follows: tank vessels-ten to twenty-five years; tugboats-ten to twenty years; and pier and office equipment-five years. For single-hull tank vessels, such useful lives are limited to the remaining period of operation prior to mandatory retirement as required by the Oil Pollution Act of 1990 (“OPA 90”). OPA 90 requires that the 31(including three chartered-in) single-hull vessels currently operated by the Partnership, representing approximately 33% of total barrel-carrying capacity as of June 30, 2006, be retired or retrofitted to double-hull by December 31, 2014.
Included in vessels and equipment are drydocking expenditures that are capitalized and amortized over three years. Drydocking of vessels is required both by the United States Coast Guard and by the applicable classification society, which in the Partnership’s case is the American Bureau of Shipping. Such drydocking activities include, but are not limited to, the inspection, refurbishment and replacement of steel, engine components, tailshafts, mooring equipment and other parts of the vessel.
Major renewals and betterments of assets are capitalized and depreciated over the remaining useful lives of the assets. Leasehold improvements are capitalized and depreciated over the shorter of their useful lives or the remaining term of the lease. Maintenance and repairs that do not improve or extend the useful lives of the assets are expensed.
The Partnership assesses impairment on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amounts. An impairment loss would be recognized to the extent the carrying value exceeds fair value by appraisal.
When property items are retired, sold or otherwise disposed of, the related cost and accumulated depreciation are removed from the accounts with any gain or loss on the dispositions included in income. Assets to be disposed of are reported at the lower of their carrying amounts or fair values, less the estimated costs of disposal.
Fuel Supplies. Fuel used to operate the Partnership’s vessels, and on hand at the end of the period, is recorded at cost. Such amounts totaled $3,158 and $2,473 as of June 30, 2006 and 2005, respectively, and are included in prepaid expenses and other current assets in the consolidated balance sheets.
Deferred Financing Costs. Direct costs associated with obtaining long-term financing are deferred and amortized over the terms of the related financings. Deferred financing costs are stated net of accumulated amortization which, at June 30, 2006 and 2005, amounted to $187 and $815, respectively.
Goodwill. Goodwill represents the excess of the purchase price over the fair value of the net assets of the acquired business at the date of the acquisition. The Partnership tests for impairment at least annually using a two-step process. The first step identifies potential impairment by comparing the fair value of a reporting unit with its book value, including goodwill. If the fair value of the reporting unit exceeds the carrying amount, goodwill is not impaired and the second step is not necessary. If the carrying value exceeds the fair value, the second step calculates the possible impairment loss by comparing the implied fair value of goodwill with the carrying amount. If the implied fair value of goodwill is less than the carrying amount, a write-down is recorded.
Intangible Assets. Included in other assets are intangible assets acquired as part of business combinations which are recorded at fair value at their acquisition date and are amortized on a straight-line basis over their estimated useful lives. The Partnership reviews intangible assets to evaluate whether events or changes have occurred that would suggest an impairment of carrying value. An impairment would be recognized when expected undiscounted future operating cash flows are lower than the carrying value. Intangible assets are stated net of accumulated amortization, which at June 30, 2006 and 2005 amounted to $2,690 and $1,154, respectively.
Revenue Recognition. The Partnership earns revenue under contracts of affreightment, voyage charters, time charters and bareboat charters. For contracts of affreightment and voyage charters, revenue is recognized based upon the relative transit time in each period, with expenses recognized as incurred. Although contracts of affreightment and certain contracts for voyage charters may be effective for a period in excess of one year, revenue is recognized over the transit time of individual voyages, which are generally less than ten days in duration. For time charters and bareboat charters, revenue is recognized ratably over the contract period, with expenses recognized as incurred. Estimated losses on contracts of affreightment and charters are accrued when such losses become evident.
Use of Estimates. The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements, and revenues and expenses during the reporting period. The most significant estimates relate to depreciation of the vessels, liabilities incurred from workers’ compensation, commercial and other claims, the allowance for doubtful accounts and deferred income taxes. Actual results could differ from these estimates.
Concentrations of Credit Risk. Financial instruments which potentially subject the Partnership to concentrations of credit risk are primarily cash and cash equivalents and trade accounts receivable. The Partnership maintains its cash and cash equivalents on deposit at a financial institution in amounts that, at times, may exceed insurable limits.
With respect to accounts receivable, the Partnership extends credit based upon an evaluation of a customer’s financial condition and generally does not require collateral. The Partnership maintains an allowance for doubtful accounts for potential losses, totaling $690 and $667 at June 30, 2006 and 2005, respectively, and does not believe it is exposed to concentrations of credit risk that are likely to have a material adverse effect on its financial position, results of operations or cash flows. For the fiscal years
ended June 30, 2006, 2005 and 2004, the Partnership’s allowance for doubtful amounts was impacted by additional charges of $232, $213, and $100, and write-offs of $209, $117 and $5, respectively.
Currency Translation. Assets and liabilities related to the Partnership’s Canadian subsidiary are translated at the exchange rate prevailing on the balance sheet date, and revenues and expenses are translated at the weighted average exchange rate for the period. Translation gains and losses represent other comprehensive income and are reflected in partners’ capital.
Derivative instruments. The Partnership utilizes derivative financial instruments to reduce interest rate risks. The Partnership does not hold or issue derivative financial instruments for trading purposes. Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities, (“SFAS No. 133), as amended, establishes accounting and reporting standards for derivative instruments and hedging activities. It requires that an entity recognize all derivatives as either assets or liabilities in the statement of financial condition and measure those instruments at fair value. Changes in the fair value of those instruments are reported in earnings or other comprehensive income depending on the use of the derivative and whether it qualifies for hedge accounting. The accounting for gains and losses associated with changes in the fair value of the derivative and the effect on the consolidated financial statements will depend on its hedge designation and whether the hedge is highly effective in achieving offsetting changes in fair value of cash flows of the asset or liability hedged.
Income Taxes. The Partnership’s effective tax rate comprises the New York City Unincorporated Business Tax and foreign taxes on its operating partnership, plus federal, state, local and foreign corporate income taxes on the taxable income of the operating partnership’s corporate subsidiaries. Prior to the initial public offering, EW LLC was a limited liability company and treated as a partnership for income tax purposes. Accordingly, it was not responsible for federal, state and local income taxes, as its profits and losses were passed directly to its members for inclusion in their income tax returns. EW LLC was subject to the New York City Unincorporated Business Tax, and its subsidiaries were C corporations that were subject to federal, state and local income taxes.
Deferred taxes represent the tax effects of differences between the financial reporting and tax bases of the Partnership’s and Predecessor’s assets and liabilities, as applicable, at enacted tax rates in effect for the years in which the differences are expected to reverse. The recoverability of deferred tax assets is evaluated and a valuation allowance established when it is more likely than not that some portion or all of the deferred tax assets will not be realized.
Unit-Based Compensation. The Partnership has adopted a long-term incentive plan that permits the granting of awards to directors and employees in the form of restricted units and unit options. The Partnership recognizes compensation cost for the restricted units on a straight-line basis over the vesting periods of the awards, which range from four to five years. No unit options have been granted.
Net Income per Unit. Basic net income per unit is determined by dividing net income, after deducting the amount of net income allocated to the general partner interest from its issuance date of January 14, 2004, as described below, by the weighted average number of units outstanding during the period. For periods prior to January 14, 2004, such units are equal to the common and subordinated units received by the Predecessor in exchange for the net assets contributed to the Partnership, or 4,830,000 units. Diluted net income per unit is calculated in the same manner as basic net income per unit, except that the weighted average number of outstanding units is increased to include the dilutive effect of outstanding unit options or restricted units granted under the Partnership’s long-term incentive plan. For diluted net income per unit, the weighted average units outstanding were increased by 67, 47 and 7 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively, due to the dilutive effect of restricted units.
As required by Emerging Issues Task Force Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128, Earnings per Share” (“EITF 03-6”), which is effective
for periods beginning after March 31, 2004, the general partner’s interest in net income is calculated as if all net income for the year was distributed according to the terms of the partnership agreement, regardless of whether those earnings would or could be distributed. The partnership agreement does not provide for the distribution of net income; rather, it provides for the distribution of available cash, which is a contractually defined term that generally means all cash on hand at the end of each quarter after establishment of cash reserves. Unlike available cash, net income is affected by non-cash items, such as deferred tax benefits.
As described in note 2 above, the general partner’s incentive distribution rights entitle it to receive an increasing percentage of distributions when the quarterly cash distribution exceeds $0.55 per unit. For purposes of EITF 03-6, the Partnership must treat net income as if it were distributable. Therefore, since net income exceeded $0.55 per unit in the third quarter of fiscal 2004 due to recognition in that quarter of a deferred tax benefit of $17,561, the assumed distribution of all net income, pursuant to EITF 03-6, results in use of the increasing percentages to calculate the general partner’s interest in net income for the quarter ended March 31, 2004. Notwithstanding the foregoing, the deferred tax benefit is not included in the calculation of available cash under the partnership agreement and, therefore, the general partner did not and will not receive any incentive distributions of available cash as a result of such deferred tax benefit.
Distributions per Unit. Distributions to limited partners were $2.32 and $2.145 per unit for the years ended June 30, 2006 and 2005, respectively.
Reclassifications. In 2006, the Partnership classified prepayment costs paid for the reduction of debt as a component of operating activities and has reclassified prior periods to conform to this presentation. For the years ended June 30, 2005 and 2004, prepayment costs of $293 and $6,192, respectively, were reclassified from financing activities to operating activities.
Note 4: Acquisition of Sea Coast Transportation
On October 18, 2005, the Partnership completed the acquisition, through its wholly owned subsidiary, K-Sea Operating Partnership L.P. (“K-Sea OLP”), of all of the membership interests in Sea Coast Transportation LLC (formerly Sea Coast Towing, Inc.) (“Sea Coast”) from Marine Resources Group, Inc. (“MRG”). Also on October 18, 2005, Sea Coast acquired four tugboats from MRG. Sea Coast is a provider of marine transportation and logistics services to major oil companies, oil traders and refiners along the West Coast of the United States and Alaska. The aggregate purchase price for Sea Coast and the four tugboats comprised $77,000 in cash and 125,000 common units representing limited partner interests in the Partnership. The Partnership financed the cash portion of the purchase price through additional borrowings under its amended credit agreement, as described in note 6 below. A registration statement on Form S-3 with respect to the resale of the common units issued to MRG was declared effective by the Securities and Exchange Commission in February 2006.
Under the purchase method of accounting, the Partnership has included Sea Coast’s results of operations from October 18, 2005, the date of acquisition, through June 30, 2006. The aggregate recorded purchase price was $82,382, comprising $77,000 of cash, $4,376 in common units (based on the market value of the 125,000 common units at the acquisition date), and $1,006 of direct expenses. The Partnership allocated the purchase price to the tangible assets, intangible assets, and liabilities acquired based on their fair values, which for the fixed assets and intangibles were based on consideration of independent appraisals. The purchased identifiable intangible assets are being amortized on a straight-line basis over their respective estimated useful lives. The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill, which is not amortized but which will be reviewed annually for impairment. The amount of goodwill that is deductible for tax purposes was $14,693. The total purchase price has been allocated as follows:
As of June 30, 2006, the identifiable intangible assets purchased in the Sea Coast acquisition included those in the table below. Amortization expense for the customer relationships and the covenant not to compete for the year ended June 30, 2006 were $647 and $75, respectively; the annual amortization expense is $970 and $112, respectively.
Pro Forma Financial Information
The unaudited financial information in the table below summarizes the combined results of operations of the Partnership and Sea Coast, on a pro forma basis, as though the acquisition had been completed as of the beginning of each period presented. This pro forma financial data is presented for information purposes only and is not necessarily indicative of the results of operations that would have been achieved had the acquisition actually taken place at the beginning of each period. The unaudited pro forma financial information for the year ended June 30, 2006 combines the historical results of the Partnership with the historical results of Sea Coast for the fiscal 2006 period preceding the October 18, 2005 acquisition. The unaudited pro forma financial information for the year ended June 30, 2005 combines the historical results of the Partnership and Sea Coast for that period.
Note 5: Vessels and Equipment and Construction in Progress
At June 30, 2006 and 2005, vessels and equipment and construction in progress comprised the following:
Depreciation and amortization of vessels and equipment for the fiscal years ended June 30, 2006, 2005 and 2004 was $25,274, $20,584 and $18,256, respectively. Such depreciation and amortization includes amortization of drydocking expenditures for the fiscal years ended June 30, 2006, 2005 and 2004 of $7,391, $6,823 and $7,421, respectively.
As described in note 4, on October 18, 2005 the Partnership acquired Sea Coast, including $55,931 of vessels, pier and office equipment. On October 20, 2005, the Partnership acquired an 85,000-barrel integrated tug-barge unit for $13,105, including transaction costs.
On March 15, 2006 and May 11, 2006, the Partnership took delivery of two new 28,000-barrel tank barges, the DBL 28 and DBL 29. On December 30, 2005, the Partnership took delivery of a new 100,000-barrel tank barge, the DBL 103. The total cost, after addition of certain special equipment and integration with existing tugboats, plus capitalized interest, was approximately $23,421. In addition, in the Partnership has also entered into agreements with a shipyard for the construction of additional new tank barges as follows:
· In August 2005, the Partnership signed an agreement to construct two additional 28,000-barrel tank barges; one was delivered in August 2006 while the other is expected to be delivered in the second quarter of fiscal 2007. In November 2005, the Partnership signed an agreement to construct a new 100,000-barrel tank barge that is expected to be delivered in the third quarter of fiscal 2007. These three vessels are expected to cost, after the addition of certain special equipment, approximately $24,000.
· In June 2006, the Partnership signed an agreement to construct an additional four new 28,000-barrel tank barges that are expected to be delivered in the first and second quarters of fiscal 2008. In August 2006, the Partnership signed an agreement to construct two 80,000-barrel tank barges that are also expected to be delivered in the second and third quarters of fiscal 2008. These six vessels are expected to cost, after addition of certain special equipment, approximately $50,000.
Construction in progress at June 30, 2006 comprises expenditures on these new tank barges.
On December 8, 2004, the Partnership acquired ten tank barges and seven tugboats. The purchase price of $21,184 (including acquisition related costs) included a water treatment facility. The transaction was financed using the Partnership’s available credit lines and the purchase price was allocated to the individual assets acquired based on consideration of independent appraisals. These assets are included in vessels and equipment, net, in the consolidated balance sheet.
On June 28, 2005, the Partnership acquired an 80,000-barrel capacity double-hull tank barge for a purchase price of $10,000, excluding certain modifications made to the barge. The acquisition was financed using borrowings under a new term loan. The vessel is included in vessels and equipment, net, in the consolidated balance sheet.
In September 2004, the Partnership completed the double-hulling of the KTC 155, now renamed the DBL 155, and accepted delivery of the vessel. On January 29, 2004, the Partnership acquired a 140,000-barrel capacity double-hull tank barge and an 8,000 horsepower tugboat, both built in 2000. The purchase price of $34,120 was financed using available cash and $25,048 in borrowings under a new term loan. The Partnership also signed a new multi-year contract with the sellers to transport petroleum products in the northeastern United States. The portion of the purchase price in excess of the fair value of the vessels, as determined by appraisal, was allocated to the related contract and is included in other assets. Such amount is being amortized over the contract period.
During fiscal 2004, the Partnership also completed the rebuilding of the DBL 105 for petroleum transportation. This vessel, along with a tugboat, was purchased in fiscal 2003 for $3,539, funded by credit line borrowings.
Barge Incident
On November 11, 2005, one of the Partnership’s tank barges, the DBL 152, struck submerged debris in the U.S. Gulf of Mexico, causing significant damage which resulted in the barge eventually capsizing. The barge was declared a constructive total loss, and the Partnership has received the total $11,000 insured value from its hull and machinery insurers. The excess of this insurance recovery over the net book value of the barge, totaling $415, is included as a net gain on disposal of vessels in the consolidated statements of operations for the year ended June 30, 2006.
Note 6: Financing
Amended Credit Agreement
On March 24, 2005, the Partnership entered into a new, five-year $80,000 revolving credit agreement with a syndicate of banks. The new credit agreement replaced the Partnership’s existing $47,000 revolving credit agreement, which was repaid and terminated. On October 18, 2005, to partially finance the acquisition of Sea Coast from MRG (see note 4), the Partnership amended the revolving credit agreement to increase the available borrowings to $120,000, of which $77,000 was drawn down to pay the cash portion of the purchase price. On November 29, 2005, to fund the redemption of its Title XI bonds (see Title XI Bonds” below), the Partnership further amended the revolving credit agreement to increase the maximum borrowings to $155,000. On April 3, 2006, the Partnership used the net proceeds from the issuance of $80,000 in new term loans to repay outstanding borrowings under the amended credit agreement, and further amended it to reduce the available borrowings, to release certain vessels from the collateral pool, and to reduce certain covenant requirements.
The amended credit agreement provides for available borrowings of $75,000, contains a $20,000 sublimit for letters of credit and allows the Partnership to request an increase in the total borrowing availability by up to $25,000, up to a maximum of $100,000, so long as no default or event of default has occurred and is continuing. Obligations under the amended credit agreement are collateralized by a first priority security interest, subject to permitted liens, on certain of the Partnership’s vessels having an orderly liquidation value equal to at least 1.25 times the amount of the obligations (including letters of credit) outstanding. Borrowings under the amended credit agreement bear interest, at the option of the Partnership, at a rate per annum equal to (a) the greater of the prime rate (8.25% at June 30, 2006) and the federal funds rate (5.25% at June 30, 2006) plus 0.5% (a “base rate loan”), or (b) the 30-day London Interbank Offered Rate, or LIBOR (5.33% at June 30, 2006), plus a margin of 0.825% to 1.825% based upon the ratio of Total Funded Debt to EBITDA, as defined in the agreement. The Partnership also incurs commitment fees, payable quarterly, on the unused amount of the facility at a rate ranging from 0.15% to 0.30% based upon the ratio of Total Funded Debt to EBITDA, as defined in the agreement. As of June 30, 2006, outstanding borrowings under this facility totaled $54,015.
Term Loans and Capital Lease Obligation
Term loans and capital lease obligations outstanding at June 30, 2006 and 2005 were as follows. Descriptions of these borrowings are included below:
On April 3, 2006, the Partnership entered into an agreement with a lending institution under which the Partnership borrowed $80,000, for which it pledged six tugboats and six tank barges as collateral. Borrowings are represented by six notes which have been assigned to other lending institutions. These loans bear interest at a rate equal to LIBOR on one-month Eurodollar deposits plus 1.40%, and are repayable in 84 monthly installments with the remaining principal payable at maturity. The agreement contains certain prepayment premiums. Borrowings outstanding on these loans total $79,696 as of June 30, 2006. Also on April 3, 2006, the Partnership entered into an agreement with the lending institution to swap the one-month, LIBOR based, variable interest payments on the $80,000 of loans for a fixed payment at a rate of 5.2275%, over the same terms as the loans. This swap will result in a fixed interest rate on the Notes of 6.6275% for their seven-year term. This swap contract has been designated as a cash flow hedge. Therefore, the unrealized gain of $1,136 related to the change in fair value of the swap contract as of June 30, 2006 has been reflected in other comprehensive income. The Partnership used the proceeds of these loans to repay indebtedness under its amended credit agreement.
On December 19, 2005, one of the Partnership’s subsidiaries entered into a seven year Canadian dollar term loan to refinance purchase of an integrated tug-barge unit. The proceeds of $13,000 were used to repay borrowings under the amended credit agreement which had been used to finance purchase of the unit. The loan bears interest at a fixed rate of 6.59%, is repayable in 84 monthly installments of CDN $136 with the remaining principal amount payable at maturity, and is collateralized by the related tug-barge unit and one other tank barge. Borrowings outstanding on this loan total $13,345 as of June 30, 2006.
In May 2006, the Partnership entered into an agreement to borrow up to $23,000 to partially finance construction of two 28,000-barrel and one 100,000-barrel tank barges. During the construction period, the loan bears interest at 30-day LIBOR plus 1.40%; interest only is payable monthly through the earlier of May 12, 2007 or delivery of the final tank barge. Thereafter, monthly payments of principal, plus accrued interest, are payable over seven years, with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barges and (during the construction period only) 13 other tank vessels. Borrowings outstanding on this loan total $5,430 at June 30, 2006.
In March 2005, the Partnership entered into an agreement to borrow up to $11,000 to partially finance construction of a 100,000-barrel tank barge. The loan bears interest at 30-day LIBOR plus 1.05%, and is repayable in monthly principal installments of $66 with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barge. Borrowings outstanding on this loan totaled $10,675 at June 30, 2006.
In March 2005 the Partnership entered into a three-year term loan in the amount of $11,700. The loan bears interest at a fixed rate of 6.25% annually, and is repayable in monthly principal installments of $70 with the remaining principal amount payable at maturity. The loan is collateralized by three vessels and the proceeds were used to refinance an existing term loan. Borrowings outstanding on this loan total $10,656 at June 30, 2006.
In June 2005, the Partnership entered into an agreement to borrow up to $18,000 to finance the purchase of an 80,000-barrel double-hull tank barge and construction of two 28,000-barrel double-hull tank barges. The loan bears interest at 30-day LIBOR plus 1.71%, and is repayable in monthly principal installments of $107 with the remaining principal amount payable at maturity. The loan is collateralized by the related tank barges. Borrowings outstanding on this loan were $17,893 at June 30, 2006.
To partially finance the acquisition of an integrated tug-barge unit in January 2004, the Partnership entered into a seven-year, $25,048 term loan. In May 2004, the Partnership entered into an agreement with a financial institution for $20,000 of loans to provide term financing for two vessel rebuilding and retrofitting projects. These term loans were repaid in March 2005 upon closing of the new credit agreement and three-year term loan described above, and a net loss of $1,359, representing prepayment fees and write-off of the related deferred financing costs, was recorded in connection with these transactions
In connection with the Partnership’s initial public offering, all of the Predecessor’s debt, exclusive of $12,950 in subordinated notes, was contributed to the Partnership. The contributed short-term and long-term debt (excluding the Title XI bonds, as described below) aggregated $73,941, and was repaid using proceeds of the offering. Such repayments included $6,041 in prepayment and make-whole amounts, of which $3,274 had previously been accrued by the Predecessor as supplemental interest which would have been payable upon maturity of certain of these loans, resulting in a loss on prepayment of $2,767. In addition, $240 in deferred financing costs related to the contributed debt was also written off. In the fourth quarter of fiscal 2004, an additional $151 was paid as a final adjustment to the make-whole payment.
Title XI Bonds
On June 7, 2002, the Predecessor issued bonds aggregating $40,441, in four series, through a private placement for the purpose of providing long-term financing for the construction of four new double-hull tank vessels. The bonds were guaranteed by the Maritime Administration of the U.S. Department of Transportation (“MARAD”) pursuant to Title XI of the Merchant Marine Act of 1936 (the “Title XI bonds”). The guarantee agreements, including a restructuring thereof in connection with the Partnership’s initial public offering in January 2004, required that funds be maintained in a restricted account (the “Title XI escrow account”) at the U.S. Department of Treasury as additional collateral. As of June 30, 2005, the Title XI escrow account had a balance of $2,760, of which $1,190 is included in the consolidated balance sheet under prepaid expenses and other current assets, with the remaining $1,570 included in other assets.
On November 29, 2005, the Partnership redeemed the outstanding $36,787 principal balance of Title XI bonds, paid $828 of accrued interest, and made a make-whole payment of $3,953 as required under the Trust Indenture. The Partnership funded the redemption using funds from its amended credit agreement. After writing off $2,702 in unamortized deferred financing costs relating to the Title XI bonds, and after costs and expenses relating to the transaction, the Partnership recorded a loss on reduction of debt of $6,898. Retirement of the Title XI bonds improved the Partnership’s borrowing flexibility, and eliminated certain restrictive covenants, collateral requirements, and working capital constraints.
At June 30, 2006 and 2005, Title XI bonds outstanding comprised the following:
Restrictive Covenants
The agreements governing the amended credit agreement and the term loans contain restrictive covenants that, among others, (a) prohibit distributions under defined events of default, (b) restrict investments and sales of assets, and (c) require the Partnership to adhere to certain financial covenants, including defined ratios of fixed charge coverage and funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization and loss on reduction of debt, as defined).
Interest
Interest expense, net of amounts capitalized, and interest income, was as follows:
The weighted average interest rate on the Title XI bonds and term loans was 6.6% and 5.8% at June 30, 2006 and 2005, respectively, which debt is subject to prepayment fees. Interest payable totaled $1,124 and $1,125 as of June 30, 2006 and 2005, respectively, and is included in accrued expenses and other current liabilities in the consolidated balance sheets. At June 30, 2006 and 2005, accounts payable included book overdrafts of $1,555 and $853, respectively, representing outstanding checks.
Maturities of Long-Term Debt
As of June 30, 2006, maturities of long-term debt for each of the next five years were as follows:
Equity Financing
On October 14, 2005, the Partnership closed a public offering of 950,000 common units. Net proceeds of $33,060 from the offering, after payment of underwriting discounts and commissions but before payment of expenses associated with the offering, were used to repay borrowings under the Partnership’s revolving credit agreement. In addition, as described in note 4, the Partnership issued 125,000 common units to the sellers, valued at $4,376, in a transaction not involving a public offering. On June 1, 2005, the Partnership issued and sold 500,000 common units in a private placement for proceeds of $16,000, before expenses associated with the offering. The proceeds were used to repay indebtedness incurred under the Partnership’s amended credit facility in connection with its December 2004 vessel acquisition. A registration statement on Form S-3 with respect to this private placement and the issuance of units in connection with the Sea Coast acquisition (see note 4) was filed and declared effective by the Securities and Exchange Commission in February 2006.
Note 7: Income Taxes
The components of the provision (benefit) for income taxes for the fiscal years ended June 30, 2006, 2005 and 2004 are as follows:
Certain net assets contributed to the Partnership at the time of the initial public offering in January 2004 were transferred by EW LLC’s corporate subsidiaries. These net assets had tax bases that were lower than their carrying values for financial reporting purposes, which resulted in deferred tax liabilities relating to these temporary differences. The future reversal of these differences will be subject to the Partnership’s effective tax rate, which is significantly lower than the effective tax rate of EW LLC’s corporate subsidiaries. The effect of the change in tax rates applicable to these differences is reflected as a deferred tax benefit of $17,561 for the fiscal year ended June 30, 2004.
A reconciliation of income tax expense, as computed using the federal statutory income tax rate of 34%, to the Partnership and Predecessor provisions (benefits) for income taxes for the fiscal years ended June 30, 2006, 2005 and 2004 is as follows:
Significant components of deferred income tax liabilities and assets as of June 30, 2006 and 2005 are as follows:
The Partnership had temporary differences at June 30, 2006 primarily related to the excess of the book basis of vessels and equipment over the related tax basis in the amount of $101,012. This amount will result in taxable income, in the years these differences reverse, that will be included in the overall allocation of taxable income to the unitholders of the Partnership.
A valuation allowance was established in fiscal 2005 due primarily to the uncertainty of realizing certain net operating loss carry-forwards of the Partnership’s corporate subsidiaries. This valuation allowance was reversed during fiscal 2006 due to elimination of this uncertainty.
At June 30, 2006, the Partnership had New York City Unincorporated Business Tax net operating losses of $6,618 and its corporate subsidiaries had federal net operating losses of $745 which begin to expire in 2024, state net operating losses of $708 which begin to expire in 2011, and foreign net operating losses of $766 which begin to expire in 2016.
Note 8: Commitments and Contingencies
The Partnership leases its New York office and pier facilities from an affiliate of an employee under an agreement which extends through April 2009. Terms of the agreement provide for annual rental payments of $400 annually through April 2009, which increased as of May 1, 2004 from $352 annually. Rent expense was $400, $400 and $360 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. In addition, a subsidiary of the Partnership leases office and pier facilities and a water
treatment facility in Virginia under an agreement with a third party that extends through January 2010. The Virginia lease agreement requires annual rental payments of $250 through January 8, 2010. The subsidiary receives $84 from sublease of a portion of the Virginia property which extends to December 31, 2009. The subsidiary has an option to buy the Virginia premises for an aggregate purchase price of $4,200. Rent expense, net of the sublease, for the fiscal years ended June 30, 2006 and 2005 was $166 and $97, respectively. The Partnership and subsidiary are also responsible for real estate taxes, insurance and all other costs associated with occupying these properties. Effective July 1, 2006, the Partnership also leases office space in New Jersey under an agreement with a third party that extends through December 2013. The New Jersey lease requires rental payments totaling $18 through December 2006, followed by annual rental payments of $234 through December 2008, $245 through December 2010 and $254 through December 2013.
In connection with the acquisition of Sea Coast Transportation LLC, the Partnership assumed agreements with the port authority in Seattle, Washington covering the lease of terminal facilities and docking rights for its vessels. The lease expires in October 2008 with a renewal option for one additional five-year term. The lease requires monthly payments of $26 with escalation each year based on the consumer price index. Rent expense for the year ended June 30, 2006 was $208. Additionally, the Partnership leases four barges under non-cancelable operating leases which expire in February 2007 through August 2009. The future minimum lease payments for the four barge operating leases as of June 30, 2006 are as follows:
Charter expenses were $2,092 for the barge operating leases for the year ended June 30, 2006.
Included in total revenues are time charter and bareboat charter revenues of $60,582, $21,747 and $9,751 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. Such revenues include $513, $513, and $778 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively, related to vessels chartered to an affiliate of an employee. The Partnership also utilizes such affiliate for tank cleaning services at a cost of $1,609, $2,318 and $2,916 for the years ended June 30, 2006, 2005 and 2004, respectively. The Partnership’s time charters and bareboat charters extend over various periods which expire between 2006 and 2009.
At June 30, 2006, minimum contractually agreed future revenue under time and bareboat charters was as follows:
The Partnership has entered into employment agreements with certain of its executive officers. Each of the employment agreements had an initial term of one year, which is automatically extended for successive one-year terms unless either party gives 30-days written notice prior to the end of the term that such party desires not to renew the employment agreement. The employment agreements currently provide for annual base salaries aggregating $850. In addition, each employee is eligible to receive an annual bonus award based upon the consolidated financial performance of the Partnership. If the employee’s employment is terminated without cause or if the employee resigns for good reason, the employee will be entitled to severance in an amount equal to the greater of (a) the product of 1.3125 (1.75 multiplied by .75) multiplied by the employee’s base salary at the time of termination or resignation and (b) the product of 1.75 multiplied by the remaining term of the employee’s non-competition provisions multiplied by the employee’s base salary at the time of termination or resignation.
EW Transportation Corp., a predecessor to the Partnership, and many other marine transportation companies operating in New York have come under audit with respect to the New York State Petroleum Business Tax (“PBT”), which is a tax on vessel fuel consumed while operating in New York State territorial waters. An industry group in which EW Transportation Corp. and the Partnership participate is working towards an agreement in principle with the New York taxing authority on a calculation methodology for the PBT. The Partnership accrued an estimated liability using the calculation methodology under discussion. In accordance with the agreements entered into in connection with the Partnership’s initial public offering, any liability resulting from the PBT prior to January 14, 2004 (the effective date of the initial public offering) is a retained liability of the predecessor.
As discussed in note 5, one of the Partnership’s tank barges struck submerged debris in the U.S. Gulf of Mexico, causing significant damage which resulted in the barge eventually capsizing. At the time of the incident, the barge was carrying approximately 120,000 barrels of No. 6 fuel oil, a heavy oil product. Although the final amount has not been determined, the Partnership believes much of the oil escaped into the ocean. The Partnership maintains significant protection and indemnity insurance for pollution-related costs and claims, including clean-up costs and environmental damages, and believes that such coverage will be adequate to cover the cost of the clean-up operations and any subsequent claims, fines or penalties.
The Partnership is the subject of various claims and lawsuits in the ordinary course of business for monetary relief arising principally from personal injuries, collisions and other casualties. Although the outcome of any individual claim or action cannot be predicted with certainty, the Partnership believes that any adverse outcome, individually or in the aggregate, would be substantially mitigated by applicable insurance or indemnification from previous owners of the Partnership’s assets, and would not have a material adverse effect on the Partnership’s financial position, results of operations or cash flows. The Partnership is also subject to deductibles with respect to its insurance coverage that range from $25 to $100 per incident and provides on a current basis for estimated payments thereunder.
Note 9: Long-term Incentive Plan
In January 2004, K-Sea General Partner GP LLC, the general partner of the Partnership’s general partner, adopted the K-Sea Transportation Partners L.P. Long-term Incentive Plan (the “Plan”) for directors and employees of K-Sea General Partner GP LLC and its affiliates. The Plan currently permits the grant of awards covering an aggregate of 440,000 common units in the form of restricted units and unit options and is administered by the Compensation Committee of the Board of Directors of K-Sea General Partner GP LLC. The Board of Directors of K-Sea General Partner GP LLC, in its discretion, may terminate the Plan at any time with respect to any restricted units for which a grant has not yet been made, and also reserves the right to alter or amend the Plan from time to time, including increasing the number of common units with respect to which awards may be granted subject to unitholder approval as required by the New York Stock Exchange. No change in any outstanding grant may be made, however, which would materially impair the rights of the participant without the consent of such participant. Subject to
certain exceptions, restricted units are subject to forfeiture if employment is terminated prior to vesting. As the restricted units vest, K-Sea General Partner GP LLC has the option to either acquire common units in the open market for delivery to the recipient or distribute newly issued common units from the Partnership. In all cases, K-Sea General Partner GP LLC is reimbursed by the Partnership for such expenditures.
Unit compensation expense amounted to $652, $413 and $23, for the years ended June 30, 2006, 2005 and 2004, respectively. As of June 30, 2006, there was $2,642 of unamortized compensation cost related to non-vested restricted units, which is expected to be recognized over a remaining weighted-average vesting period of 3.7 years. A summary of the status of the Partnership’s restricted unit awards as of June 30, 2006 and 2005, and of changes in restricted units outstanding under the Partnership’s long-term incentive plan during the year ended June 30, 2006, is as follows:
Note 10: Retirement Plans
The Partnership has a money purchase pension plan, and also a defined contribution plan that qualifies under Section 401(k) of the Internal Revenue Code. These plans cover all eligible employees. Under the terms of the money purchase pension plan, the Partnership contributes five percent of each eligible employee’s annual compensation, as defined in the plan document. The 401(k) plan provides that eligible employees may make contributions, subject to Internal Revenue Code limitations, and the Partnership will match the first two percent of employee compensation contributed, subject to a maximum amount. For the money purchase plan, expenses totaled $1,127, $1,000 and $836 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively. For the 401(k) plan, expenses totaled $499, $443 and $402 for the fiscal years ended June 30, 2006, 2005 and 2004, respectively.
In connection with the purchase of Sea Coast, the Partnership acquired an additional defined contribution plan that qualifies under Section 401(k) of the Internal Revenue Code. The plan covers all eligible employees and provides that eligible employees may make contributions, subject to Internal Revenue Code limitations, and the Partnership will match the first 25% of employee compensation contributed, up to a maximum of 4%. In addition, the plan allows for an annual discretionary employer contribution up to 4% of an employee’s annual compensation. Employer contribution expenses under this plan totaled $372 from the acquisition date through June 30, 2006.
Accrued expenses for the money purchase plan totaled $1,251 and $1,077 as of June 30, 2006 and 2005, respectively, and are included in accrued expenses and other current liabilities in the consolidated balance sheets. Additionally, accrued expenses for payroll-related costs totaled $3,048 and $1,431 as of June 30, 2006 and 2005, respectively, which are also included in accrued expenses and other current liabilities in the consolidated balance sheets.
Note 11: Major Customers
Two customers accounted for 20% and 15% of consolidated revenues for the fiscal year ended June 30, 2006, two customers accounted for 26% and 16% of consolidated revenues for the fiscal year
ended June 30, 2005, and two customers accounted for 28% and 14% of consolidated revenues for the fiscal year ended June 30, 2004.
Note 12: Fair Value of Financial Instruments
As of June 30, 2006, the fair value of long-term debt was approximately $193,353 based on the borrowing rates currently available to the Partnership for bank loans with similar terms and average maturities. The fair value of the Partnership’s other financial instruments approximated their cost bases as such instruments are short-term in nature or were recently negotiated.
Note 13: New Accounting Pronouncements
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB Statement No. 123(R), “Share-Based Payment” (“FAS 123(R)”). FAS 123(R) revises FASB Statement No. 123, “Accounting for Stock-Based Compensation” (“FAS 123”) and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. In addition to revising FAS 123, FAS 123(R) supersedes Accounting Principles Board (“APB”)Opinion No. 25, “Accounting for Stock Issued to Employees”, and amends FASB Statement No. 95, “Statement of Cash Flows.” The Partnership is required to adopt FASB 123(R) as of July 1, 2005. The Partnership adopted FAS 123(R) as of July 1, 2005 and accounts for its restricted unit awards under the new standard; to date, no unit options have been granted. The adoption did not have a material impact on the Partnership’s financial position, results of operations or cash flows.
On April 4, 2005, the FASB issued Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations, an interpretation of FASB Statement No. 143” (“FIN 47”). This interpretation clarifies that an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation when incurred if the liability’s fair value can be reasonably estimated. It also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Partnership adopted FIN 47 as of June 30, 2006, and such adoption did not have a significant impact on its financial position, results of operations or cash flows.
On June 2, 2005, the FASB issued FASB Statement No. 154, “Accounting Changes and Error Corrections-a replacement of APB No. 20 and FAS No. 3” (“FAS 154”). FAS 154 replaces APB Opinion No. 20, “Accounting Changes” (“APB 20”) and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements” and changes the requirements for the accounting for and reporting of a change in accounting principle. This Statement applies to all voluntary changes in accounting principle. It also applies to changes required by an accounting pronouncement in the unusual instance that the pronouncement does not include specific transition provisions. When a pronouncement includes specific transition provisions, those provisions should be followed. The Partnership is required to adopt FAS 154 as of July 1, 2006, and does not expect that such adoption will have a significant impact on its financial position, results of operations or cash flows.
On February 16, 2006 the FASB issued FASB Statement No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140” (“FAS 155”). FAS 155 amends FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”. The Partnership is required to adopt FAS 155 as of July 1, 2007, and does not expect that such adoption will have a significant impact on its financial position, results of operations or cash flows.
In June 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes-an interpretation of FASB Statement No. 109 (“FIN 48”). FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with
FASB Statement No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Partnership is currently analyzing FIN 48 and believes the adoption of FIN 48 will not have a material impact on the Partnership’s financial condition, results of operations or liquidity.
Note 14: Quarterly Results of Operations (Unaudited)
The following summarizes certain quarterly results of operations for each of the fiscal years ended June 30, 2006 and 2005: