ITEM 3. LEGAL PROCEEDINGS.
EAST LINE CIVIL LITIGATION AND FERC PROCEEDING In August 1992, two East Line refiners, Navajo Refining Company ("Navajo") and El Paso Refinery, L.P. ("El Paso"), filed separate, though similar, civil lawsuits (the "East Line Civil Litigation") against the Partnership arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson, Arizona from El Paso, Texas. The Navajo action also sought an injunction to prohibit the Partnership from reversing the direction of flow (from westbound to eastbound) of its six-inch diameter pipeline between Phoenix and Tucson. In addition, El Paso filed a protest/complaint with the FERC in September 1992 seeking to block the reversal of the six-inch pipeline and challenging the Partnership's proration policy as well as the Partnership's existing East Line rates (the "FERC Proceeding").
EAST LINE CIVIL LITIGATION - -------------------------- The civil actions brought by Navajo and El Paso (El Paso Refining, Inc., and El Paso Refinery, L.P. v. Santa Fe Pacific Pipelines, Inc. and Santa Fe Pacific Pipeline Partners, L.P., No. 92-9144, County Court No. 5, El Paso County, filed August 1992) were filed in New Mexico and Texas, respectively, seeking actual, punitive and consequential damages arising from the Partnership's alleged failure to provide additional pipeline capacity to Phoenix and Tucson from El Paso. Generally, the lawsuits allege that the refiners proceeded with significant refinery expansions under the belief that the Partnership would provide additional pipeline capacity to transport their product into Arizona, and that they were damaged by their inability to ship additional volumes into that highly competitive market. This belief of Navajo and El Paso was purportedly based on alleged oral representations made by General Partner personnel and from language contained in a January 1989 settlement agreement with Navajo, relating to a 1985 FERC rate case.
On July 28, 1993, the Partnership reached a settlement with Navajo whereby Navajo agreed to dismiss its pending civil litigation in New Mexico and to withdraw any challenge to the direction of flow of the six-inch pipeline, including any such challenge in the FERC proceeding. The Partnership agreed to
make certain cash payments to Navajo over three years and to undertake and complete an additional pipeline capacity expansion between El Paso and Phoenix if certain events related to volume levels and proration of pipeline capacity should occur within five years of the date of the agreement.
El Paso's August 1992 civil action, as amended, claims unspecified actual damages, which appear to include the $190 million cost of its refinery expansion, plus punitive and consequential damages. In addition, on October 4, 1995, El Paso's general partner, El Paso Refining, Inc. ("EPRI"), filed a Second Amended Petition seeking unspecified damages arising from alleged unfulfilled representations of Partnership management with respect to future East Line capacity, alleging that such representations had been relied upon in negotiating the terms by which EPRI exchanged its refinery assets for ownership interests in El Paso in 1989.
In October 1992, El Paso filed a petition for reorganization under Chapter 11 of the federal bankruptcy laws and halted refinery operations. In November 1993, the El Paso bankruptcy was converted from a Chapter 11 to a Chapter 7 proceeding. During 1994, the bankruptcy trustee for El Paso retained legal counsel for purposes of pursuing this litigation. Initial rounds of written discovery and witness depositions were conducted by both parties in late-1994 and in 1995, and discovery will continue in 1996.
To date, there have been no hearings before the court and there is no pre-trial schedule. Management anticipates that this matter will not come to trial prior to mid-1997. The Partnership believes that the allegations of El Paso and EPRI are without merit and intends to vigorously defend itself in this action.
FERC PROCEEDING - --------------- At various points following El Paso's September 1992 filing, other customers of the Partnership, including Chevron U.S.A. Products Company ("Chevron"), Navajo, ARCO Products Company ("ARCO"), Texaco Refining and Marketing Inc. ("Texaco"), Refinery Holding Company, L.P. (a partnership formed by El Paso's long-term secured creditors that purchased El Paso's refinery in May 1993), Mobil Oil Corporation and Tosco Corporation, have filed separate complaints challenging, and/or motions to intervene in proceedings initiated by others challenging, the Partnership's rates on its East and West Lines and, in certain cases, also claiming that a gathering enhancement charge at the Partnership's Watson, California pump station is in violation of the Interstate Commerce Act. In subsequent procedural rulings, the FERC has consolidated these challenges and ruled that they must proceed as a complaint proceeding, with the burden of proof being placed on the complaining parties, who must show that the Partnership's rates and practices at issue violate the requirements of the Interstate Commerce Act.
In December 1995, Texaco filed a new complaint concerning charges associated with the use of the Partnership's Watson, California gathering enhancement facilities and of certain lines upstream of its Watson station origin point, and ARCO filed a similar complaint on January 16, 1996. Texaco and ARCO have asked that these complaints not be consolidated with the other proceedings described above. The Partnership has denied the allegations in these complaints.
In June 1994, the complainants filed their cases-in-chief with the FERC, seeking reparations for shipments between 1990 and 1993 aggregating in the range of $15 million to $20 million, as well as tariff rate reductions of between 40% and 50% for future shipments. In August 1994, the FERC Staff submitted its case-in-chief in the FERC proceeding, employing rate-making methodologies similar in several respects to those presented by the complainants. In subsequent filings, the complainants revised their requested relief to seek reparations for shipments between 1990 and 1994 aggregating
approximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter.
Both the FERC Staff and several of the complainants argued, among other things, against the Partnership's entitlement to an income tax allowance in its cost of service. They also utilized the Partnership's capital structure at the time of its formation in December 1988, or a hypothetical capital structure, for the purpose of establishing the Partnership's 1985 starting rate base under FERC Opinion 154-B. In addition, the FERC Staff and the complainants would generally exclude most or all of the Partnership's civil and regulatory litigation expense from its cost of service calculations. Each of these positions is adverse to the Partnership's position regarding its existing rate structure.
On June 15, 1995, the FERC issued a decision in an unrelated rate proceeding involving Lakehead Pipe Line Company, Limited Partnership ("Lakehead"), ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income that is attributable to limited partnership interests held by individuals. In July 1995, Lakehead requested rehearing of the decision by the FERC, and that request is currently pending. Should this ruling be upheld and applied in the Partnership's rate proceeding, the Partnership believes it would currently allow the Partnership to include a substantial portion of the Partnership's income tax allowance in its cost of service, rather than the full entitlement that was reflected in the Partnership's case-in-chief and subsequent testimony in its FERC proceeding. Management intends to vigorously defend its entitlement to a full income tax allowance in its cost of service.
Successive rounds of testimony have been filed by the respective parties, including the Partnership, regarding the above summarized issues and other matters relevant to the appropriateness of the Partnership's tariffs and rates. Among other things, certain of the parties submitted revised cases based on the Partnership's 1994 costs and revenues. The Partnership's surrebuttal presentation responded to those cases, defending the Partnership's current rates based on 1994 data, with certain normalizing adjustments including a significant adjustment to reflect an extensive pipe reconditioning program that was begun in 1994. The present procedural schedule calls for hearings before the FERC Administrative Law Judge to commence in April 1996, with an initial decision not expected before late 1996 or early 1997.
The Energy Policy Act of 1992 ("EPACT") established as "just and reasonable" existing oil pipeline rates that were in effect without challenge for 365 days prior to the bill's enactment in October 1992, with an exception being allowed for parties, such as Navajo, that were prohibited from filing challenges during that period due to the terms of settlement agreements. In October 1993, with respect to Chevron's complaint, the FERC ruled that the Partnership's West Line rates are deemed "just and reasonable" under EPACT (i.e., are "grandfathered") and may only be challenged upon a showing of a substantial change in the economic circumstances which were a basis for the rate ("changed circumstances"). In December 1994, ARCO, Texaco and Chevron filed testimony in which they sought to demonstrate the required "changed circumstances" in order to challenge the Partnership's West Line rates, citing such factors as increased West Line volumes. On April 20, 1995, the United States Court of Appeals for the District of Columbia Circuit dismissed petitions for review of the FERC's grandfathering rulings that had been filed by ARCO and Texaco, on the ground that those rulings are not yet final orders and, therefore, are not yet subject to judicial review.
The Partnership believes that its rates and practices are lawful under FERC precedent and will continue its vigorous defense of that position. However, because of the complexity of the issues involved and the
nature of FERC rate-making methodology, which is subject to interpretation and leaves certain issues for determination on a case-by-case basis, it is possible that the rates at issue in the FERC proceeding will not ultimately be upheld. If the FERC were to reach adverse decisions on the issues in the proceeding which result in significant reparations being paid and a significant reduction in the Partnership's current tariffs, such adverse outcome could have a material adverse effect on the Partnership's results of operations, financial condition and ability to maintain its quarterly cash distribution at the current level.
ENVIRONMENTAL MATTERS
The Partnership is subject to environmental cleanup and enforcement actions from time to time. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site. Since August 1991, the Partnership, along with several other respondents, has been involved in one cleanup ordered by the United States Environmental Protection Agency ("EPA") related to ground water contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven ground water hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies.
With respect to the Sparks remediation, the EPA approved the respondents' remediation plan in September 1992. In January 1995, remediation system design, engineering and permitting activities began, and the remediation system began operations in September 1995. During 1995, a Joint Defense, Mediation and Arbitration Agreement Among Defendants was entered into by eight participants, which establishes remediation cost allocation percentages among the participants.
The investigation and remediation at and adjacent to the Partnership's storage facilities and truck loading terminal in Sparks, Nevada was also the subject of a lawsuit brought in January 1991 entitled Nevada Division of Environmental Protection v. Santa Fe Pacific Pipelines, Inc., Southern Pacific Transportation Company, Shell Oil Company, Time Oil Company, Berry-Hinckley Terminal, Inc., Chevron U.S.A., Inc., Texaco Refining and Marketing, Inc., Air BP, a division of BP Oil, Unocal Corporation, and Golden Gate Petroleum Company, Case No. CV91- 546, in the Second Judicial District Court of the State of Nevada in and for the County of Washoe (the "Court"). This lawsuit was subsequently joined by the County of Washoe Health District (the "County") and the City of Sparks, Nevada (the "City"). These various parties sought remediation of the contamination at and adjacent to the Sparks terminal as well as unspecified, but potentially significant, damages and statutory penalties. In addition, the Partnership was named as one of the defendants in a number of other lawsuits brought by property owners seeking unspecified, but potentially substantial, damages for, among other things, alleged property value diminishment attributable to soil or groundwater contamination arising from the defendants' operations. In October 1994, a ruling by the Court consolidated all of the outstanding cases against the respondent group for trial purposes. In February 1995, the Court established a procedural schedule which called for the trial to commence in January 1996.
On July 27, 1995, the Partnership and seven other defendants (the "defendant group") entered into a Stipulation and Consent Decree with the State of Nevada, Division of Environmental Protection (the "State"), which was subsequently approved by the Court, settling all claims made by the State in the above- referenced lawsuit, and under which the defendant group agreed to pay the State a total principal amount of $10 million in eleven equal payments over ten years. The defendant group has also entered
into a settlement agreement with the County whereby the defendant group will pay the County the sum of $150,000 in settlement of all of the claims brought by the County in its lawsuit.
On September 22, 1995, the defendant group reached a settlement agreement with the City, subsequently approved by the Sparks City Council, whereby, among other things, the defendant group paid the City the sum of $5.6 million, including attorney fees, in December 1995 and agreed to purchase an annuity that will fund four annual payments to the City of $1.625 million (aggregating $6.5 million) in the years 2002 through 2005 in settlement of all of the City's claims related to the Sparks environmental site. In addition, the defendant group agreed to use its best efforts to install an enhanced remediation system to accelerate the cleanup of the environmental site and agreed to donate certain water rights to the City if and as needed. In addition, during the months of September through December 1995, the defendant group reached agreements in principle and, in some cases, final agreements, to settle the claims of the seven property owners who had filed lawsuits seeking damages alleged to be attributable to the environmental contamination. These settlement agreements involve various terms, including cash payments, environmental and property value diminishment indemnifications, loan guarantees and the purchase of certain properties.
The Partnership's share of the settlements with the City and the property owners will be determined in an arbitration proceeding expected to be held during 1996. The Partnership's estimated share of the costs of all of the settlement agreements associated with the Sparks litigation was included in its 1995 provisions for environmental costs aggregating $24 million.
During the quarter ended December 31, 1995, the Partnership entered into a stipulation with the California Department of Fish and Game, the County of San Diego and the United States Department of Fish and Wildlife to settle all of the agencies' claims arising from a December 1994 product release at the Partnership's facilities in Mission Valley, California. In accordance with this stipulation, in January 1996, the Partnership paid $30,000 in fines and approximately $160,000 in area restorations, and reimbursed approximately $70,000 in oversight costs of the three governmental agencies.
As of December 31, 1995, the Partnership is in the process of negotiating with the California Department of Fish and Game to settle the Department's claims arising from three separate product releases from Partnership facilities. Management does not believe that the total cost of any fines or other amounts payable associated with these product releases, either individually or in the aggregate, will be material to the Partnership's results of operations or financial condition, but such amounts may be in excess of $100,000 per occurrence.
The Partnership and the General Partner have initiated two legal actions against a total of 34 past and present insurance carriers (SFPP, L.P., Santa Fe Pacific Pipeline Partners, L.P. and Santa Fe Pacific Pipelines, Inc. vs. Agricultural Insurance Company, et al. and SFPP, L.P., Santa Fe Pacific Pipeline Partners, ------ L.P. and Santa Fe Pacific Pipelines, Inc. vs. Associated International Insurance Company, et al., Superior Court of the State of California for the County of San ------ Mateo, Docket Nos. 395109 and 395121, respectively, filed January 1996). These actions seek a judicial determination that the insurance policies issued by the defendant insurers provide coverage to the Partnership and General Partner for certain costs, liabilities and settlements relating to approximately 25 environmental sites, including Sparks, Nevada. To date, the costs at issue in these actions have been borne by the Partnership and General Partner. Although there is no assurance that the Partnership will be successful in these actions, management intends to vigorously pursue these claims. The defendant insurers are still in the process of filing initial responsive pleadings and affirmative defenses, and discovery has not yet begun.
OTHER The Partnership and Southern Pacific Transportation Company ("SPTC") are engaged in a judicial proceeding to determine the extent, if any, to which the rent payable by the Partnership for the use of pipeline easements on rights-of-way held by SPTC should be adjusted pursuant to existing contractual arrangements (Southern Pacific Transportation Company vs. Santa Fe Pacific Corporation, SFP Properties, Inc., Santa Fe Pacific Pipelines, Inc., SFPP, L.P., et al., Superior -- --- Court of the State of California for the County of San Francisco, filed August 31, 1994). Under an agreement entered into among the parties in 1994, the amount of annual rent for such easements for the first year of the ten-year period that began January 1, 1994 is to be based on the fair market value of the easements, with the rent for subsequent years to be subject to annual inflation adjustments. SPTC has asserted in this proceeding that the amount of the easement rent should be increased from the current level of approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership does not believe that the evidence provided by SPTC to date supports an annual rent in excess of the amounts accrued; however, it is not presently possible to predict with certainty the outcome of this matter.
The Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these other matters cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, either individually or in the aggregate, when finally resolved, will have a material adverse effect on the annual results of operations, financial condition or liquidity of the Partnership.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matters were submitted to a vote of security holders during the fourth quarter of 1995.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. Information as to the principal markets on which the Registrant's common units are traded, the high and low sales prices of such units and distributions declared on such units for the two years ended December 31, 1995, and the approximate number of record holders of such units is set forth in Note 8 to the Partnership's consolidated financial statements on page of this Report.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA. The following table sets forth selected consolidated financial data for the Partnership:
(a) Effective January 1, 1992, the Partnership adopted new accounting standards for postretirement and postemployment benefits (Statements of Financial Accounting Standards Nos. 106 and 112).
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
RESULTS OF OPERATIONS
1995 COMPARED WITH 1994 - ----------------------- The Partnership reported 1995 net income of $40.4 million, or $2.04 per unit, compared to net income of $76.9 million, or $3.93 per unit, in 1994, with the variance being primarily attributable to special items recorded in both years. Results of operations included provisions for environmental and litigation costs aggregating $34.0 million in 1995 and a $3.1 million credit resulting from changes in eligibility requirements for postretirement medical benefits in 1994. Excluding the 1995 provisions and the 1994 credit, adjusted net income was $73.3 million, or $3.70 per unit, in 1995, compared to $73.9 million, or $3.78 per unit, in 1994.
Total 1995 revenues of $233.7 million were 2.5% above 1994 levels. Trunk revenues of $183.3 million were $3.9 million higher than in 1994 primarily due to growth in total volumes transported. Commercial volumes were about 1.5% higher, and military volumes 5% lower, than in 1994, and the average length of haul was slightly higher. Deliveries to most of the markets served by the Partnership increased during 1995, although Southern California deliveries were lower as a result of competition from short-haul trucking to Los Angeles area terminals. The reduction in military volumes is largely attributable to the closure of Castle Air Force Base, in Central California. Storage and terminaling revenues were 1% higher than in 1994. Other revenues increased $1.3 million primarily due to new detergent additive services.
Total operating expenses of $157.7 million were $40.7 million higher in 1995 than in 1994, due largely to the 1995 provisions for environmental and litigation costs aggregating $34.0 million. Excluding the 1995 provisions, operating expenses would have been $6.7 million, or 6%, higher than in 1994, with higher general and administrative expenses ($4.7 million), power costs ($1.0 million), depreciation and amortization ($0.7 million) and field operating expenses ($0.5 million), partially offset by lower facilities costs ($0.3 million), accounting for that increase. General and administrative expenses were higher due to outside legal and consulting costs, primarily related to the FERC proceeding and litigation associated with the Sparks, Nevada environmental site, partially offset by lower employee health care and postretirement benefit costs. Power costs increased as the result of increased volumes and greater use of drag reducing agent to increase pipeline capacity on selected routes. The increase in depreciation and amortization resulted from the Partnership's expanding capital asset base, particularly short-lived software costs. The increase in field operating expenses is largely attributable to higher repairs and maintenance, including pipeline reconditioning. The decrease in facilities costs is largely attributable to lower property tax assessments and insurance premiums, partially offset by higher right-of-way rental costs. Excluding the 1995 provisions, environmental remediation and East Line litigation costs recorded as operating expense aggregated $7.0 million in 1995 and $3.8 million in 1994.
Other income, net decreased $2.1 million compared to 1994, primarily due to the $3.1 million postretirement benefit credit recorded in 1994, partially offset by higher interest income, which resulted from higher interest rates and cash balances.
1994 COMPARED WITH 1993 - ----------------------- The Partnership reported 1994 net income of $76.9 million, or $3.93 per unit, compared to net income of $41.6 million, or $2.13 per unit, in 1993. Results of operations included the previously mentioned $3.1 million credit in 1994 resulting from changes in eligibility requirements for postretirement medical benefits and, in 1993, provisions for environmental and litigation costs aggregating $27.0 million.
Excluding the 1994 credit and the 1993 provisions, adjusted net income of $73.9 million, or $3.78 per unit, in 1994 was 8.5% higher than adjusted net income of $68.1 million, or $3.48 per unit, in 1993.
Total 1994 revenues of $228.1 million were 4% above 1993 levels. Trunk revenues of $179.3 million were $7.5 million higher than in 1993 primarily due to a 5% growth in total volumes transported. Commercial and military volumes were 5% and 9% higher, respectively, than in 1993, and the average length of haul was even. Despite the higher pipeline volumes, storage and terminaling revenues were even with 1993. Other revenues increased $1.1 million due to higher tank rentals and new terminal services.
Total operating expenses of $117.0 million were $24.1 million lower than in 1993, due largely to the previously mentioned 1993 provisions for environmental and litigation costs aggregating $27.0 million. Excluding the 1993 provisions, operating expenses would have been $2.9 million, or 2.5%, higher than in 1993, with higher power costs ($1.8 million), facilities costs ($1.7 million), depreciation and amortization ($0.8 million) and general and administrative expenses ($0.4 million), partially offset by lower field operating expenses ($1.8 million), accounting for that increase. The increase in power costs resulted from higher volumes, increased power rates and greater use of drag reducing agent to increase pipeline capacity on selected routes. Facilities costs increased as a result of higher right-of-way rentals and property taxes. General and administrative expense increased less than 2% as the net result of higher legal expense and reduced overhead recoveries on recollectible projects for customers or governmental agencies, largely offset by lower East Line litigation, employee incentive compensation and information services costs. The decrease in field operating expenses is largely attributable to 1993 pipeline inspection costs associated with the potential conversion of one of the Partnership's pipelines to crude oil service and generally lower major maintenance expense. Excluding the 1993 provisions, environmental remediation and East Line litigation costs recorded as operating expense aggregated $3.8 million and $6.2 million in 1994 and 1993, respectively.
Other income, net increased significantly in 1994 as the result of a $3.1 million gain resulting from changes in eligibility requirements for postretirement medical benefits and higher interest income.
FINANCIAL CONDITION - LIQUIDITY AND CAPITAL RESOURCES For the year ended December 31, 1995, cash flow from operations totaled $83.7 million, compared to $90.0 million in 1994. Working capital cash requirements increased $2.8 million in 1995 due to timing differences in collections of trade and nontrade accounts receivable and payment of accrued obligations. Significant uses of cash in 1995 included cash distributions of $60.0 million and capital expenditures of $31.4 million, resulting in a net decrease in cash and cash equivalents of $7.7 million for the year. Total cash and cash equivalents of $41.2 million at December 31, 1995 included $15.4 million for the fourth quarter 1995 cash distribution, which was paid in February 1996.
Since the useful lives of the pipeline system and terminal properties are generally long and technological change is limited, replacement of facilities is relatively infrequent. The principal need for capital, therefore, has been in connection with capacity expansions, service enhancements, compliance with increasingly stringent environmental and safety regulations and installation of Supervisory Control and Data Acquisition ("SCADA") equipment and related operations systems software.
For the year ended December 31, 1995, Partnership capital expenditures aggregated $31.4 million. Capital expenditures for income enhancement projects, including capacity expansions, service enhancements and system upgrades, aggregated approximately $12 million in 1995. Capital
expenditures for environmental and safety projects included additions and modifications to storage tanks and vapor recovery systems to comply with more stringent regulations, oily water handling facilities and fire protection improvements. Such expenditures aggregated approximately $7 million in 1995 and are expected to increase over time in response to increasingly rigorous environmental and safety standards.
In January 1996, the Partnership completed the purchase, from Kinley Pipelines of California, of a 35-mile, 6-inch diameter pipeline that serves Lemoore Naval Air Station from the Partnership's Fresno, California terminal, for approximately $6 million. In addition to that acquisition, the planned 1996 capital program aggregates approximately $22 million, the majority of which will be invested in sustaining projects. The Partnership presently anticipates that ongoing capital expenditures will average approximately $30 million per year over the next five years. This amount could increase or decrease as the result of changing regulatory requirements or business opportunities associated with pipeline and facility expansions and acquisitions.
During 1995, the Partnership continued to investigate the feasibility of providing pipeline service from the San Francisco Bay area to Colton, in Southern California, by expanding the existing capacity on its North Line and building a new pipeline between Fresno and Colton. The level of shipper throughput commitments obtained to date is not sufficient to proceed and places the viability of this project in doubt. Management anticipates that a decision on the future of this project will be made during 1996.
The Partnership expects that it will generally finance its ongoing capital program with internally generated funds; however, the Partnership may use borrowed funds or proceeds from additional equity offerings to finance a portion of significant capital expenditures. Future capital expenditures will continue to depend on numerous factors, some of which are beyond the Partnership's control, including demand for refined petroleum products in the pipeline system's market areas, changes in product supply patterns, governmental regulations and the availability of sufficient funds from operations to fund such expenditures.
Due to the capital-intensive nature of the Partnership's business, inflation generally causes an understatement of operating expenses because depreciation is based on the historical costs of assets rather than their replacement costs.
Long-term debt aggregated $355 million at December 31, 1995 and consisted of $327 million of First Mortgage Notes (the "Notes") and a $28 million borrowing under the Partnership's bank term credit facility. The Partnership intends to refinance some or all of the Notes as the various series become payable. To facilitate such refinancing and provide for additional financial flexibility, the Partnership presently has available the multi-year term credit facility, with a $60 million aggregate limit, and a $20 million working capital facility with three banks. The term facility may continue to be used for refinancing a portion of the Notes and for capital projects, while the working capital facility is available for general short-term borrowing purposes.
OTHER MATTERS
RATE REGULATION The Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission ("FERC"). Intrastate common carrier operations in California are subject to regulation by the California Public Utilities Commission ("CPUC"). In 1995, rates subject to FERC and CPUC regulation accounted for approximately 55% and 45% of total transportation revenues, respectively.
In 1985, the FERC adopted a cost-based methodology for establishing allowable rates for liquid petroleum pipelines; however, this methodology continues to be subject to clarification in individual cases and leaves many issues for determination on a case-by-case basis. Effective January 1995, the FERC established a new rate-making methodology that allows oil pipelines to adjust their transportation rates as long as those rates do not exceed prescribed ceiling levels determined by applying an index equal to annual changes in the Producer Price Index for Finished Goods, minus one percent. Under this methodology, pipelines may apply for cost of service-based rates in those cases where the carrier can demonstrate that a "substantial divergence" exists between the rates that would be allowed under cost-based rate-making and the rates produced by indexation. In addition, carriers may establish market-based rates for those markets in which it can be demonstrated that they do not have significant market power. The access to cost-based and market-based rates is significant because the Partnership believes the index selected by the FERC does not adequately reflect historical cost of service increases and, accordingly, the Partnership may need to pursue cost-based or selective market-based rate adjustments in future rate filings. Interstate rate indexing had a minimal impact on Partnership revenues in 1995 and management does not expect that indexing will have a significant impact on trunk revenues in 1996.
EAST LINE CIVIL LITIGATION AND FERC PROCEEDING Certain of the Partnership's shippers have filed civil suits and initiated Federal Energy Regulatory Commission ("FERC") complaint proceedings alleging, among other things, that the shippers were damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's rates and charges on its East and West Lines are excessive. To date, the complainants have filed testimony in the FERC proceeding seeking reparations for shipments between 1990 and 1994 aggregating approximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter. Hearings before a FERC Administrative Law Judge are scheduled to commence in April 1996.
In July 1993, the Partnership reached a settlement with one of these shippers, Navajo Refining Company ("Navajo"), whereby, among other things, Navajo agreed to dismiss its pending civil litigation in New Mexico and the Partnership agreed to make certain cash payments to Navajo over three years. The remaining civil action, brought by El Paso Refinery, L.P. ("El Paso") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.
In June 1995, the FERC issued a decision in an unrelated oil pipeline rate proceeding involving Lakehead Pipe Line Company, Limited Partnership ("Lakehead") ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income attributable to limited partnership interests held by individuals. If this decision is upheld and applied in the Partnership's FERC proceeding, it would reduce the Partnership's allowable cost of service and, possibly, its revenues.
In 1993, the Partnership recorded a $12 million provision for litigation costs, reflecting the terms of the Navajo settlement and management's estimate of other costs related to the resolution of the FERC proceeding and El Paso's civil action, and, during the quarter ended December 31, 1995, recorded a $10 million provision to increase its existing reserves relating to the FERC proceeding, the El Paso action and certain other matters. In the interim, lesser amounts of litigation costs have, from time to time, been recorded as current period expense.
While the Partnership believes it has meritorious defenses in these matters, the complainants and plaintiffs are seeking amounts that, in the aggregate, substantially exceed the Partnership's reserves and, because of the uncertainties associated with litigation and FERC rate-making methodology, management cannot predict with certainty the ultimate outcome of these matters. As additional information becomes available, it may be necessary for the Partnership to record additional charges to earnings to maintain its reserves at a level deemed adequate at that time, and the costs associated with the ultimate resolution of these matters could have a material adverse effect on the Partnership's results of operations, financial condition, or ability to maintain its quarterly cash distribution at the current level.
ENVIRONMENTAL The Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site.
Along with several other respondents, the Partnership is presently involved in one cleanup ordered by the United States Environmental Protection Agency related to soil and groundwater contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven groundwater hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies and, from time to time, may be involved in groundwater investigations or remediations at the direction of other governmental agencies. The Partnership is also involved in soil and groundwater remediation projects, at and adjacent to various other terminal and pipeline locations, that have not been mandated by government agencies but are conducted in the ordinary course of business. In a number of remediation projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.
The Partnership accrues for environmental costs that relate to existing conditions caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at certain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.
The Partnership's environmental reserves are monitored on a regular basis by management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership conducted a comprehensive re-evaluation of its potential liabilities associated with remediation activities at a number of sites and recorded a $15 million provision to increase its reserve for environmental costs. During 1995, the Partnership, as a member of a defendant group, reached agreements in principle settling all of the claims for penalties and damages that had been asserted by several governmental agencies and property owners in lawsuits associated with the soil and groundwater contamination present in the vicinity of the Sparks, Nevada environmental site. The Partnership recorded provisions for environmental costs aggregating $24 million during 1995 largely to reflect its share of these settlement costs.
The Partnership's balance sheet at December 31, 1995 and 1994 includes reserves for environmental costs aggregating $37.1 million and $22.7 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, and the cost of performing preliminary environmental investigations at several locations, as well as estimable environmental damage claims, primarily associated with the Sparks environmental site. With respect to the costs accrued at December 31, 1995, the Partnership estimates that between $12.5 million and $15.0 million will be paid in 1996, approximately $2 million to $4 million will be paid per year over the following four years, and approximately $1 million or less will be paid per year over the subsequent five years.
Based on the information presently available, it is the opinion of management that the Partnership's environmental costs, to the extent they exceed recorded liabilities, will not have a material adverse effect on the Partnership's financial condition; nevertheless, it is possible that the Partnership's results of operations in particular quarterly or annual periods could be materially affected as additional information becomes available.
DEMAND FOR REFINED PETROLEUM PRODUCTS Demand for transportation and terminaling services is principally a function of product consumption and competition in markets served by the pipeline system. Commercial volumes are generally dependent upon such factors as prevailing economic conditions, demographic changes, transportation and terminaling alternatives and, to a lesser degree, product prices paid by end-users. Military volumes are dependent upon the level of activity at military bases served by the Partnership.
During 1995, the pipeline systems, on average, operated at approximately 75% of capacity. While capacity utilization on individual system segments generally ranged from 70% to 90% of capacity, the lines from the Los Angeles area to San Diego and Colton, California and from the San Francisco Bay area to Reno, Nevada operated at or near full capacity for a portion of the year. Overall, volumes have been moderately seasonal, with somewhat lower than average volumes being transported during the first and fourth quarters of each year, although deliveries to specific locations also experience seasonal variations.
OTHER The Partnership leases certain rights-of-way under an agreement that became subject to renegotiation effective January 1, 1994; however, to date, the Partnership and the lessor have been unable to reach an agreement on the base annual rental payments for the next ten-year period. In a judicial reference proceeding in this matter, the lessor has asserted that the amount of the easement rent should be increased from approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership has accrued for an increase in the annual rental effective January 1, 1994
and does not believe that the evidence provided by the lessor to date supports an annual rental in excess of the amounts accrued; however, it is not presently possible to predict with certainty the annual right-of-way rentals that will ultimately be payable.
During 1994, the Partnership began a long-term pipeline reconditioning program on its East Line and the Phoenix-to-Tucson segment of the West Line. In 1994 and 1995, the Partnership's field operating expenses included approximately $320,000 and $1,220,000, respectively, related to this program, which involves replacing the pipeline's original coating and performing repairs determined to be necessary. In 1996 and future years, the Partnership expects that an average of 30 miles of pipeline will be recoated annually, at an expected cost of approximately $3,000,000 per year.
In March 1995, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 121, "Accounting for the Impairment of Long- Lived Assets and for Long-Lived Assets to Be Disposed Of" ("FAS 121"), which prescribes accounting standards for the recognition and measurement of impairment in long-lived assets, such as properties, plant and equipment. Management does not expect that adoption of FAS 121, which is required no later than the first quarter of 1996, will have a significant effect on the Partnership's financial condition or results of operations.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The Partnership's consolidated financial statements, together with the report thereon of Price Waterhouse LLP dated January 26, 1996, are set forth on pages through of this Report.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None.
PART III
ITEM 10.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The Registrant has no officers, directors or employees. Set forth below is certain information concerning the directors and executive officers of the General Partner.
Edward F. Swift, age 72, is a director of the General Partner, Chairman of the Audit Committee and a member of the Compensation and Benefits Committee and Committee on Directors. He has been a consultant to Lehman Brothers (investment bankers) since 1990 and previously had been an advisory director of Shearson Lehman Hutton, Inc. (investment banker and broker-dealer) since 1988.
Orval M. Adam, age 65, is a director of the General Partner, Chairman of the Compensation and Benefits Committee and a member of the Audit Committee and Committee on Directors. He retired in January 1991 from his position as Senior Vice President and Chief Financial Officer of Santa Fe, which he held since April 1988. Mr. Adam is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.
Wilford D. Godbold, Jr., age 57, is a director of the General Partner and a member of the Audit Committee and Committee on Directors. Mr. Godbold has served as President and Chief Executive Officer of ZERO Corporation (container manufacturer) since 1984. Mr. Godbold is also a director of ZERO Corporation, Pacific Enterprises and Southern California Gas Company.
Michael A. Morphy, age 63, is a director of the General Partner and a member of the Audit Committee and Compensation and Benefits Committee. Mr. Morphy retired in 1985 from his position as Chairman and Chief Executive Officer of California Portland Cement Company (cement manufacturer). Mr. Morphy is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner, Santa Fe Energy Resources, Inc., First Interstate Bank of California and Cyprus Amax Minerals Company.
Robert D. Krebs, age 53, is a director of the General Partner, Chairman of the Committee on Directors and a member of the Compensation and Benefits Committee. Mr. Krebs has served as President and Chief Executive Officer of Burlington Northern Santa Fe Corporation ("BNSF") since September 1995, and, previously served as Chairman, President and Chief Executive Officer of Santa Fe since 1988. Mr. Krebs is also a director of BNSF, Burlington Northern Inc., Burlington Northern Railroad Company, Santa Fe Energy Resources, Inc., Santa Fe Pacific Gold Corporation, Phelps Dodge Corporation and Northern Trust Corporation.
Denis E. Springer, age 50, is a director of the General Partner and a member of the Compensation and Benefits Committee and Committee on Directors. Mr. Springer has been Senior Vice President and Chief Financial Officer of BNSF since September 1995 and, previously, served in those same positions at Santa Fe since October 1993. Mr. Springer previously served Santa Fe as Senior Vice President, Treasurer and Chief Financial Officer since January 1992, and as Vice President, Treasurer and Chief Financial Officer since January 1991. Mr. Springer is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner, Burlington Northern Inc. and Burlington Northern Railroad Company.
Irvin Toole, Jr., age 54, is President, Chief Executive Officer and Chairman of the Board of Directors of the General Partner. From November 1988 until election to his present position in September 1991, Mr. Toole served as Senior Vice President, Treasurer and Chief Financial Officer, and previously as Vice
President-Administration from February 1986 to November 1988. Mr. Toole is also Chairman of the Board of Directors of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.
Robert L. Edwards, age 40, is a director of the General Partner and has been Senior Vice President-Business Development and Planning of the General Partner since January 1995. Previously, Mr. Edwards was Senior Vice President, Treasurer and Chief Financial Officer from December 1991 through January 1995. Mr. Edwards served Santa Fe from July 1990 through November 1991 as Vice President- Administration. Prior to that, Mr. Edwards held various executive positions with Santa Fe and the General Partner since May 1985. Mr. Edwards is also a director of SFP Pipeline Holdings, Inc., the sole shareholder of the General Partner.
Barry R. Pearl, age 46, has been Senior Vice President, Treasurer and Chief Financial Officer of the General Partner since January 1995. Mr. Pearl previously served as Senior Vice President-Business Development and Planning between January 1992 and January 1995, as Vice President-Business Development and Planning between November 1988 and January 1992 and as Vice President- Operations between May 1986 and November 1988.
John M. Abboud, age 53, has been Senior Vice President-Operations and Engineering of the General Partner since 1985. In his current capacity, Mr. Abboud is responsible for operations, engineering and environmental affairs.
Lyle B. Boarts, age 52, has been Vice President-Human Resources of the General Partner since November 1988. Previously, Mr. Boarts was Director of Human Resources since June 1986.
R. Gregory Cunningham, age 50, has been Vice President-General Counsel since January 1994. Previously, he served as General Counsel of the General Partner since January 1991 and, prior to such date, as General Attorney since November 1985.
Burnell H. DeVos III, age 42, has served as Controller and Secretary of the General Partner since January 1993. Mr. DeVos was Assistant Controller of the General Partner from May 1989 through December 1992.
Patrick L. Avery, age 43, has served as Vice President-Environmental and Safety of the General Partner since October 1993. Mr. Avery was Corporate Environmental Manager at Amerada Hess Corporation from October 1992 to October 1993. Previously, he held various positions at ARCO Products Company since 1982, including Director-California Government Relations and Environmental Health and Safety Manager at ARCO's Los Angeles refinery.
William M. White, age 50, has served as Vice President-Engineering of the General Partner, with responsibility for engineering and construction, since January 1993. Mr. White previously was Manager-Northern District from May 1986 through December 1992.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION.
The directors, officers and employees of the General Partner receive no direct compensation from the Partnership for their services to the Partnership. The Partnership reimburses the General Partner for all direct costs incurred in managing the Partnership and all indirect costs (principally salaries and other general and administrative costs) allocable to the Partnership.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
(a) Security Ownership of Certain Beneficial Owners
To the best of the General Partner's knowledge, the following persons are the only persons who are beneficial owners of more than five percent of the Registrant's equity securities:
(1) As discussed in Items 1 and 2 of this Report, Santa Fe Pacific Pipelines, Inc. is also the general partner of the Partnership, referred to herein as the "General Partner," and is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation ("Santa Fe"). On September 22, 1995, Santa Fe and Burlington Northern Inc. consummated a business combination pursuant to which each became direct or indirect wholly owned subsidiaries of a new publicly-held company, Burlington Northern Santa Fe Corporation. Management believes that this merger will have no significant impact on the operations or financial condition of the Partnership or the General Partner.
(2) This information is based on a Securities and Exchange Commission Schedule 13-G report by J. P. Morgan & Co., Incorporated, dated January 31, 1996, and filed on February 9, 1996.
(3) This information is based on a Securities and Exchange Commission Schedule 13-G report by Pioneering Management Corporation, dated January 9, 1996, and filed on January 10, 1996.
(b) Security Ownership of Management
As of March 1, 1996, common units beneficially held by all directors and officers as a group represented less than 1% of the Partnership's outstanding units.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The Registrant and the Operating Partnership are managed by the General Partner pursuant to the Amended and Restated Agreement of Limited Partnership of the Partnership (the "Partnership Agreement"), and the Amended and Restated Agreement of Limited Partnership of the Operating Partnership (the "Operating Partnership Agreement"). Under the Partnership Agreement and Operating Partnership Agreement, the General Partner and certain related parties are entitled to reimbursement of all direct and indirect costs and expenses related to the business activities of the Partnership and the Operating Partnership. These costs and expenses include compensation and benefits payable to officers and employees of the General Partner, payroll taxes, corporate office building rentals, general and administrative costs, and legal and other professional services fees. These costs to the Partnership totaled $49.3 million, $44.2 million and $43.0 million in 1995, 1994 and 1993, respectively.
The Partnership Agreement provides for incentive distribution payments to the General Partner out of the Partnership's "Available Cash" (as defined in the Partnership Agreement) which increase as quarterly distributions to unitholders exceed certain specified targets. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all distributions of Available Cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $2,351,000 in 1995 and $1,202,000 in the years 1994 and 1993.
PART IV
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
(a) The following documents are filed as a part of this Report:
(2) Financial Statement Schedules: None.
(3) Exhibits: The following exhibits are filed as a part of this Report. With the exception of Exhibits 21, 24 and 27, all exhibits listed herein are incorporated by reference, with the location of the exhibit in the Registrant's previous filing being indicated parenthetically.
Exhibit Number Description - ------- -----------------------------------------------------------------------
3.1 Amended and Restated Agreement of Limited Partnership of the Registrant, dated as of December 19, 1988. (1988 Form 10-K - Exhibit 3.1) 3.2 Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of December 19, 1988. (1988 Form 10-K - Exhibit 3.2) 3.3 Certificate of Limited Partnership of the Registrant, dated as of August 23, 1988. (1988 Form 10-K - Exhibit 3.3) 3.4 Certificate of Limited Partnership of the Operating Partnership, dated as of August 23, 1988. (1988 Form 10-K - Exhibit 3.5) 3.5 Assumption Agreement between the Registrant and Santa Fe Pacific Pipelines, Inc., dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.4) 3.6 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of the Registrant, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.2) 3.7 Certificate of Amendment to Certificate of Limited Partnership of the Registrant, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.3) 3.8 Amendment No. 1 to Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.5) 3.9 Certificate of Amendment to Certificate of Limited Partnership of the Operating Partnership, dated as of December 7, 1989. (1989 Form 10-K - Exhibit 3.6) 3.10 Amendment No. 2 to Amended and Restated Agreement of Limited Partnership of the Operating Partnership, dated as of January 24, 1990. (1989 Form 10-K - Exhibit 3.8)
Exhibit Number Description - -------- -------------------------------------------------------------------- 3.11 Certificate of Amendment No. 2 to Certificate of Limited Partnership of the Operating Partnership, dated as of January 30, 1990. (1989 Form 10-K - Exhibit 3.9) 4.1 Form of Deposit Agreement between the Registrant, American Stock Transfer & Trust Company and the General Partner, as attorney-in-fact for holders of units and depositary receipts. (Form S-1 Registration Statement No. 33-24395 - Exhibit 4.1) 4.2 First Mortgage Note Agreement, dated December 8, 1988 (a conformed composite of 54 separate agreements, identical except for signatures). (1988 Form 10-K - Exhibit 4.2) 4.3 Deed of Trust, Security Agreement and Fixture Filing, dated December 8, 1988, between the Operating Partnership, the General Partner, Chicago Title Insurance Company and Security Pacific National Bank. (1988 Form 10-K - Exhibit 4.3) 4.4 Trust Agreement, dated December 19, 1988, between the Operating Partnership, the General Partner and Security Pacific National Bank. (1988 Form 10-K - Exhibit 4.4) 4.5 The Operating Partnership has established a $60 million term credit facility with three banks, dated as of October 14, 1993. As the maximum allowable borrowings under this facility do not exceed 10% of the Registrant's total assets, this instrument is not filed as an exhibit to this Report, however, the Registrant hereby agrees to furnish a copy of such instrument to the Securities and Exchange Commission upon request. 21 Subsidiaries of the Registrant* 24 Powers of attorney* 27 Financial Data Schedule as of and for the year ended December 31, 1995*
* Filed herewith.
(b) Reports on Form 8-K filed during the quarter ended December 31, 1995: None
SIGNATURES
Santa Fe Pacific Pipeline Partners, L.P., pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
SANTA FE PACIFIC PIPELINE PARTNERS, L.P. (Registrant) By: Santa Fe Pacific Pipelines, Inc., as General Partner
Dated: March 20, 1996 By: /s/ IRVIN TOOLE, JR. -------------------------------------- Irvin Toole, Jr. Chairman, President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Registrant and in the capacities with Santa Fe Pacific Pipelines, Inc., as General Partner, and on the date indicated.
REPORT OF INDEPENDENT ACCOUNTANTS
TO THE PARTNERS OF SANTA FE PACIFIC PIPELINE PARTNERS, L.P.
In our opinion, the consolidated financial statements listed in the index appearing under Item 14 (a) (1) on page 25 present fairly, in all material respects, the financial position of Santa Fe Pacific Pipeline Partners, L.P. and its majority-owned operating partnership at December 31, 1995 and 1994, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1995, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Partnership's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Los Angeles, California January 26, 1996
SANTA FE PACIFIC PIPELINE PARTNERS, L.P. CONSOLIDATED BALANCE SHEET
(IN THOUSANDS)
See Notes to Consolidated Financial Statements.
SANTA FE PACIFIC PIPELINE PARTNERS, L.P. CONSOLIDATED STATEMENT OF INCOME
(IN THOUSANDS, EXCEPT PER UNIT AMOUNTS)
See Notes to Consolidated Financial Statements.
SANTA FE PACIFIC PIPELINE PARTNERS, L.P.
CONSOLIDATED STATEMENT OF CASH FLOWS (IN THOUSANDS)
See Notes to Consolidated Financial Statements.
SANTA FE PACIFIC PIPELINE PARTNERS, L.P. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - ---------------------------------------------------
ORGANIZATION AND BASIS OF ACCOUNTING - The accompanying consolidated financial statements include the accounts of Santa Fe Pacific Pipeline Partners, L.P. (the "Trading Partnership") and SFPP, L.P., (the "Operating Partnership"), collectively referred to as the "Partnership", on a consolidated basis. The Trading Partnership is a publicly traded limited partnership organized under the laws of the state of Delaware in 1988 which owns a 99% limited partnership interest in the Operating Partnership, through which the Partnership conducts all its operations. The Operating Partnership was acquired by the Trading Partnership in December 1988 and is engaged in the transportation of refined petroleum products and related services.
The Operating Partnership is managed by its general partner, Santa Fe Pacific Pipelines, Inc. (the "General Partner"), which, by virtue of its 1% general partner interest, represents the minority interest in the Partnership's consolidated financial statements. The General Partner, which is a wholly owned indirect subsidiary of Santa Fe Pacific Corporation ("Santa Fe"), also holds the 1% general partner interest in the Trading Partnership and, therefore, in total, holds a 2% general partner interest in the Partnership on a consolidated basis. In addition, the General Partner owns 8,148,148 Partnership common units, representing an approximate 42% limited partner interest in the Trading Partnership. In September 1995, Santa Fe and Burlington Northern Inc. consummated a business combination pursuant to which Santa Fe became a subsidiary of a new publicly-held company, Burlington Northern Santa Fe Corporation ("BNSF"). The remaining approximate 56% limited partner ownership in the Trading Partnership is represented by 11,000,000 publicly traded common units.
The preparation of financial statements in accordance with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the periods presented. Actual results could differ from those estimates.
REVENUE RECOGNITION - Substantially all revenues are derived from pipeline transportation and storage and terminaling charges and are recognized in income upon delivery. Other revenues, primarily incidental service charges and tank and land rentals, are recognized as earned.
Operating revenues received from ARCO Products Company and Chevron U.S.A. Products Company accounted for 16.3% and 13.3%, respectively, of total 1995 revenues. These two customers accounted for 16.1% and 12.4%, respectively, of total 1994 revenues, and for 16.9% and 12.9%, respectively, of total 1993 revenues. In addition, Texaco Refining and Marketing Inc. accounted for 10.2% of total 1993 revenues.
The Partnership's interstate common carrier pipeline operations are subject to rate regulation by the Federal Energy Regulatory Commission ("FERC") under a rate-making methodology that is subject to clarification and reconsideration in individual cases and leaves many issues for determination on a case-by-case basis. The Partnership's California intrastate common carrier pipeline operations are subject to rate regulation by the California Public Utilities Commission.
PROPERTIES, PLANT AND EQUIPMENT - Properties are stated at cost and include capitalized interest on borrowed funds. Additions and replacements are capitalized. Expenditures for maintenance and repairs are charged to income. Upon sale or retirement of depreciable properties, cost less salvage is charged to accumulated depreciation.
Properties are depreciated on a straight-line basis over the estimated service lives of the related assets. Rates for the Partnership's interstate pipeline properties are prescribed by the FERC. The Partnership's intrastate pipeline properties and its terminal properties are depreciated using similar rates. The following annual rates were used in computing depreciation:
Depreciation expense aggregated $17,680,000 in 1995, $17,445,000 in 1994 and $16,920,000 in 1993.
ENVIRONMENTAL COSTS - Environmental expenditures that relate to current or future revenues are expensed or capitalized, as appropriate. Expenditures that relate to an existing condition caused by past operations, and do not contribute to current or future revenue generation, are expensed. Liabilities are recorded when environmental assessments and/or clean-ups are probable and the costs can be reasonably estimated.
INCOME PER UNIT - Income per unit is computed based upon net income of the Partnership less an allocation of income to the general partner of the Trading Partnership in accordance with the partnership agreement, and is based upon 19,148,148 common units. The quarterly allocation of net income to the general partner of the Trading Partnership (which is always equivalent to the minority interest in net income) is based on its percentage of cash distributions from Available Cash at the end of each quarter (see Note 7). The general partner of the Trading Partnership was allocated 3.23%, 2.07% and 2.07% of net income before minority interest for the years 1995, 1994 and 1993, respectively.
INCOME TAX - For federal and state income tax purposes, the Partnership is not a taxable entity. Accordingly, the taxable income or loss resulting from the operations of the Partnership is ultimately includable in the federal and state income tax returns of the general and limited partners, and may vary substantially from the income or loss reported for financial reporting purposes.
CASH EQUIVALENTS AND SHORT-TERM INVESTMENTS - The Partnership considers all highly liquid investments with a maturity of three months or less when purchased to be cash equivalents.
RECLASSIFICATIONS - Certain comparative prior year amounts have been reclassified to conform with the current year presentation.
NOTE 2 - DETAIL OF SELECTED BALANCE SHEET ACCOUNTS - --------------------------------------------------
NOTE 3 - LONG-TERM DEBT - -----------------------
Long-term debt consists of the following:
The Partnership intends to refinance the Series C Notes on a long-term basis upon their maturity and, therefore, has included them in long-term debt at December 31, 1995. The Series F Notes become payable in annual installments, including $31.5 million in 1999 and $32.5 million in 2000. The Notes may also be prepaid beginning in 1999 in full or in part at a price equal to par plus, in certain circumstances, a premium.
The First Mortgage Notes (the "Notes") are secured by mortgages on substantially all of the properties of the Partnership (the "Mortgaged Property"). The Notes contain covenants specifying certain limitations on the Partnership's operations including the amount of additional debt or equity that may be issued, cash distributions, investments and property dispositions. Management does not believe such limitations will adversely affect the Partnership's ability to fund its operations or planned capital expenditures.
The Partnership has arranged a $60 million multi-year term credit facility and a $20 million working capital facility with three banks. The term facility is available for refinancing a portion of the Partnership's long-term debt and capital projects, and may be utilized on a revolving basis through October 1998, with any outstanding balance at that time converted to a three-year amortizing term loan. Borrowings under the term facility are also secured by the Mortgaged Property and are generally subject to the same terms and conditions as the Notes. In December 1994, the Partnership refinanced the Series A Notes by borrowing $11 million under this facility and, in December 1995, refinanced the Series B Notes by borrowing an additional $17 million under this facility. The Partnership has selected an interest rate on this loan that is presently determined by reference to a short-term Eurodollar rate, and was 6-5/16% at December 31, 1995.
Advances under the $20 million working capital credit facility can be used for general Partnership purposes and would be secured by certain of the Partnership's accounts receivable. This facility may not be utilized for a 45- day period, the designation of such period to be at the Partnership's discretion, during each year. This facility also provides for certain interest rate options, and is subject to annual renewal and other reasonable and customary terms and conditions. To date, the working capital facility has not been utilized.
Interest on the Notes is payable semiannually in June and December. Interest on the bank term loan is generally payable quarterly. Total interest paid was $36,985,000 during 1995 and $37,326,000 during both 1994 and 1993. Interest capitalized during the years 1995, 1994 and 1993 aggregated $405,000, $205,000 and $600,000, respectively.
The fair value of the Partnership's long-term debt was approximately $430 million at December 31, 1995. Such estimate represents the present value of interest and principal payments on the Notes discounted at present market yields, and assumes the Series F Notes will be prepaid in full in 1999 at par plus a premium. The fair market value of the term loan is considered to be equal to its principal amount.
NOTE 4 - COMMITMENTS AND CONTINGENCIES - --------------------------------------
East Line Civil Litigation and FERC Proceeding
Certain of the Partnership's shippers have filed civil suits and initiated Federal Energy Regulatory Commission ("FERC") complaint proceedings alleging, among other things, that the shippers were damaged by the Partnership's failure to fulfill alleged promises to expand the East Line's capacity between El Paso, Texas and Phoenix, Arizona to meet shipper demand. The FERC proceeding also involves claims, among other things, that certain of the Partnership's rates and charges on its East and West Lines are excessive. To date, the complainants have filed testimony in the FERC proceeding seeking reparations for shipments between 1990 and 1994 aggregating approximately $35 million, as well as rate reductions of between 30% and 40% for shipments in 1995 and thereafter. Hearings before a FERC Administrative Law Judge are scheduled to commence in April 1996.
In July 1993, the Partnership reached a settlement with one of these shippers, Navajo Refining Company ("Navajo"), whereby, among other things, Navajo agreed to dismiss its pending civil litigation in New Mexico and the Partnership agreed to make certain cash payments to Navajo over three years. The remaining civil action, brought by El Paso Refinery, L.P. ("El Paso") and its general partner, claims unspecified actual damages, which appear to include the $190 million cost of a refinery expansion completed in 1992, plus punitive and consequential damages.
In June 1995, the FERC issued a decision in an unrelated oil pipeline rate proceeding involving Lakehead Pipe Line Company, Limited Partnership ("Lakehead") ruling that Lakehead, which is also a publicly traded partnership engaged in oil pipeline transportation, may not include an income tax allowance in its cost of service with respect to partnership income attributable to limited partnership interests held by individuals. If this decision is upheld and applied in the Partnership's FERC proceeding, it would reduce the Partnership's allowable cost of service and, possibly, its revenues.
In 1993, the Partnership recorded a $12 million provision for litigation costs, reflecting the terms of the Navajo settlement and management's estimate of other costs related to the resolution of the FERC proceeding and El Paso's civil action, and, during the quarter ended December 31, 1995, recorded a $10 million provision to increase its existing reserves relating to the FERC proceeding, the El Paso action and certain other matters. In the interim, lesser amounts of litigation costs have, from time to time, been recorded as current period expense.
While the Partnership believes it has meritorious defenses in these matters, the complainants and plaintiffs are seeking amounts that, in the aggregate, substantially exceed the Partnership's reserves and, because of the uncertainties associated with litigation and FERC rate-making methodology, management cannot predict with certainty the ultimate outcome of these matters. As additional information becomes available, it may be necessary for the Partnership to record additional charges to earnings to maintain its reserves at a level deemed adequate at that time, and the costs associated with the ultimate resolution of these matters could have a material adverse effect on the Partnership's results of operations, financial condition, or ability to maintain its quarterly cash distribution at the current level.
Environmental
The Partnership's transportation and terminal operations are subject to extensive regulation under federal, state and local environmental laws concerning, among other things, the generation, handling, transportation and disposal of hazardous materials and the Partnership is, from time to time, subject to environmental cleanup and enforcement actions. In particular, the federal Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA" or "Superfund" law) generally imposes joint and several liability for cleanup and enforcement costs, without regard to fault or the legality of the original conduct, on current or predecessor owners and operators of a site.
Along with several other respondents, the Partnership is presently involved in one cleanup ordered by the United States Environmental Protection Agency related to soil and groundwater contamination in the vicinity of the Partnership's storage facilities and truck loading terminal at Sparks, Nevada. In addition, the Partnership is presently involved in eleven groundwater hydrocarbon remediation efforts under administrative orders issued by the California Regional Water Quality Control Board and two other state agencies and, from time to time, may be involved in groundwater investigations or remediations at the direction of other governmental agencies. The Partnership is also involved in soil and groundwater remediation projects, at and adjacent to various other terminal and pipeline locations, that have not been mandated by government agencies but are conducted in the ordinary course of business. In a number of remediation projects, the Partnership is participating with other entities ranging from large integrated petroleum companies to certain less financially sound parties.
The Partnership accrues for environmental costs that relate to existing conditions caused by past operations. Such costs include initial site surveys and environmental studies of potentially contaminated sites, costs for remediation and restoration of sites determined to be contaminated and ongoing monitoring costs, as well as fines, damages and other costs, when estimable. Estimates of the Partnership's ultimate liabilities associated with environmental costs are particularly difficult to make with certainty due to the number of variables involved, including the early stage of investigation at certain sites, the lengthy time frames required to complete remediation at most locations, the number of parties involved, the number of remediation alternatives available, the uncertainty of potential recoveries from third parties and the evolving nature of environmental laws and regulations.
The Partnership's environmental reserves are monitored on a regular basis by management and are adjusted, from time to time, to reflect changing circumstances and estimates. During 1993, the Partnership conducted a comprehensive re-evaluation of its potential liabilities associated with remediation activities at a number of sites and recorded a $15 million provision to increase its reserve for environmental costs. During 1995, the Partnership, as a member of a defendant group, reached agreements in principle settling all of the claims for penalties and damages that had been asserted by several governmental agencies and property owners in lawsuits associated with the soil and
groundwater contamination present in the vicinity of the Sparks, Nevada environmental site. The Partnership recorded provisions for environmental costs aggregating $24 million during 1995 largely to reflect its share of these settlement costs.
The Partnership's balance sheet at December 31, 1995 and 1994 includes reserves for environmental costs aggregating $37.1 million and $22.7 million, respectively, which reflect the estimated cost of completing all remediation projects presently known to be required, either by government mandate or in the ordinary course of business, and the cost of performing preliminary environmental investigations at several locations, as well as estimable environmental damage claims, primarily associated with the Sparks environmental site. With respect to the costs accrued at December 31, 1995, the Partnership estimates that between $12.5 million and $15.0 million will be paid in 1996, approximately $2 million to $4 million will be paid per year over the following four years, and approximately $1 million or less will be paid per year over the subsequent five years.
Based on the information presently available, it is the opinion of management that the Partnership's environmental costs, to the extent they exceed recorded liabilities, will not have a material adverse effect on the Partnership's financial condition; nevertheless, it is possible that the Partnership's results of operations in particular quarterly or annual periods could be materially affected as additional information becomes available.
Other Claims and Litigation
The Partnership is also party to a number of other legal actions arising in the ordinary course of business. While the final outcome of these other matters cannot be predicted with certainty, it is the opinion of management that none of these other legal actions, either individually or in the aggregate, when finally resolved, will have a material adverse effect on the annual results of operations, financial condition or liquidity of the Partnership.
Lease Commitments
The Partnership and the General Partner lease space in office buildings and certain computer equipment. Total lease commitments not subject to cancellation at December 31, 1995 are as follows: $1,680,000 in 1996, $1,125,000 in 1997, $1,090,000 in 1998, $1,215,000 in 1999, $1,225,000 in 2000, and $17,600,000 thereafter.
The Partnership also leases certain rights-of-way and land under agreements that can be canceled at any time should they not be required for operations. The annual payments associated with these leases aggregated approximately $5 million in 1993, however a substantial portion of this amount became subject to renegotiation effective January 1, 1994 and, to date, the Partnership and the lessor have been unable to reach an agreement on the base annual rental payments for the next ten-year period. In a judicial reference proceeding in this matter, the lessor has asserted that the amount of the easement rent should be increased from approximately $3.7 million per year to $18.5 million per year, subject to annual inflation adjustments. The Partnership has accrued for an increase in the annual rental effective January 1, 1994 and does not believe that the evidence provided by the lessor to date supports an annual rental in excess of the amounts accrued; however, it is not presently possible to predict with certainty the annual right-of-way rentals that will ultimately be payable. Rental expense recorded for all operating leases was $8,850,000 in 1995, $8,335,000 in 1994 and $7,130,000 in 1993.
NOTE 5 - RELATED PARTY TRANSACTIONS - -----------------------------------
The Partnership has no employees and is managed by the General Partner. Under certain partnership and management agreements, the General Partner and Santa Fe or its subsidiaries are entitled to reimbursement of all direct and indirect costs related to the business activities of the Partnership. These expenses, which are included in field operating and general and administrative expenses in the Partnership's statement of income, totaled $49.3 million, $44.2 million and $43.0 million for the years 1995, 1994 and 1993, respectively, and include compensation and benefits payable to officers and employees of the General Partner, payroll taxes, corporate office building rentals, general and administrative costs, tax information and reporting costs and legal and other professional services fees.
NOTE 6 - PENSION AND POSTRETIREMENT PLANS - -----------------------------------------
The General Partner is included with certain other affiliates in the trusteed non-contributory Santa Fe Pacific Retirement Plan (the "Plan") which fully complies with ERISA requirements. The Plan covers substantially all officers and employees of Santa Fe and its subsidiaries not covered by collective bargaining agreements. Benefits payable under the Plan are based on years of service and compensation during the sixty highest paid consecutive months of service during the ten years immediately preceding retirement. Santa Fe's funding policy is to contribute annually at a rate not less than the ERISA minimum, and not more than the maximum amount deductible for income tax purposes. Since the General Partner is included with certain other affiliates, detailed Plan information for the General Partner is not available in all cases; however, as of September 30, 1995, the fair value of Plan assets allocated to employees associated with the Partnership's operations was $51.7 million, and the actuarial present value of projected Plan obligations, discounted at 7.5%, was $42.0 million. The expected return on the market value of Plan assets was 9.75% and compensation levels were assumed to increase at 4.0% per year. Primarily as a result of the excess of Plan assets over liabilities, pension income of $470,000, $200,000 and $435,000 was recognized in 1995, 1994 and 1993, respectively.
As of June 1994, salaried employees who have rendered ten years of service after attaining age 45 are eligible for both medical benefits and life insurance coverage during retirement. Prior to June 1994, salaried employees who had attained age 55 and who had rendered ten years of service were eligible. This change in eligibility requirements resulted in a $3.1 million curtailment gain in 1994 relating to employees who are no longer currently eligible for postretirement benefits, and a negative plan amendment due to a reduction in the accumulated postretirement benefit obligation related to remaining eligible active employees. This curtailment gain is included in other income in the Partnership's statement of income. The retiree medical plan is contributory and provides benefits to retirees, their covered dependents and beneficiaries. Retiree contributions are adjusted annually. The plan also contains fixed deductibles, coinsurance and out-of-pocket limitations. The life insurance plan is non-contributory and covers retirees only.
Net periodic postretirement benefit cost was $770,000, $1,500,000 and $1,557,000 in 1995, 1994 and 1993, respectively, and included the following components:
The Partnership's policy is to fund benefits payable under the medical and life insurance plans as they come due. The following table shows the reconciliation of the plans' obligations, using a September 30 measurement date, to amounts accrued at December 31, 1995 and 1994:
The unrecognized prior service credit will be amortized straight-line over the average future service to full eligibility of the active population. For 1996, the assumed health care cost trend rate for managed care medical costs is 11% and is assumed to decrease gradually to 5% by 2006 and remain constant thereafter. For medical costs not in managed care, the assumed health care cost trend is 13% in 1996 and is assumed to decrease gradually to 5% by 2006 and remain constant thereafter. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation for the medical plan by $1.3 million and the combined service and interest components of net periodic postretirement benefit cost recognized in 1995 by $200,000. The weighted-average discount rate assumed in determining the accumulated postretirement benefit obligation was 7.5% in 1995 and 8.5% in 1994. The assumed weighted-average salary increase was 4% in both 1995 and 1994.
NOTE 7 - PARTNERS' CAPITAL AND CASH DISTRIBUTIONS - -------------------------------------------------
Changes in partners' capital were as follows:
The Partnership makes quarterly cash distributions of substantially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated capital expenditures and contingencies as the General Partner deems appropriate or as are required by the terms of the Notes. Distributions are made 98% to the common unitholders and 2% to the General Partner, subject to the payment of incentive distributions to the General Partner which increase as quarterly distributions to unitholders exceed certain specified target levels. The incremental incentive distributions payable to the General Partner are 8%, 18% and 28% of all quarterly distributions of available cash that exceed, respectively, $0.60, $0.65 and $0.70 per unit. Such incentive distributions aggregated $2,351,000 in 1995 and $1,202,000 in 1994 and 1993.
Cash distributions declared aggregated $3.00 per unit in 1995, reflecting an increase from $0.70 to $0.75 per unit in the first quarter, and $2.80 per unit in 1994 and 1993. In January 1996, the Partnership announced a fourth quarter 1995 distribution of $0.75 per unit, payable in February 1996.
Note 8 - SUMMARIZED QUARTERLY OPERATING RESULTS - ----------------------------------------------- AND COMMON UNIT INFORMATION (UNAUDITED) -------------------------------------- Quarterly results of operations are summarized below:
Note: 1995 operating results included provisions for environmental and litigation costs of $9.0 million in the second quarter and $25.0 million in the fourth quarter.
Santa Fe Pacific Pipeline Partners, L.P. common units are traded on the New York Stock Exchange, under the symbol SFL. The quarterly price range per unit and cash distributions declared per unit for 1995 and 1994 are summarized below:
As of January 31, 1996, there were approximately 18,000 unitholders.