General

We are a leading provider of marine transportation, distribution and logistics services for refined petroleum products in the United States. We currently operate a fleet of 74 tank barges and 66 tugboats that serves a wide range of customers, including major oil companies, oil traders and refiners. With approximately 4.4 million barrels of capacity, we believe we operate the largest coastwise tank barge fleet in the United States.

Demand for our services is driven primarily by demand for refined petroleum products in the areas in which we operate. We generate revenue by charging customers for the transportation and distribution of their products utilizing our tank vessels and tugboats. For the fiscal year ended June 30, 2008, our fleet transported approximately 160 million barrels of refined petroleum products for our customers, including BP, Chevron, ConocoPhillips, ExxonMobil and Tesoro. We do not assume ownership of any of the products we transport. During fiscal 2008, we derived approximately 81% of our revenue from longer-term contracts that are generally for periods of one year or more.

We believe we have a high-quality, well-maintained fleet. As of September 30, 2008, approximately 76% of our barrel-carrying capacity is double-hulled, and we are permitted to continue to operate our single-hull tank vessels until January 1, 2015 in compliance with the Oil Pollution Act of 1990, or OPA 90, which mandates the phase-out of all single-hull tank vessels transporting petroleum and petroleum products in U.S. waters. All of our tank vessels except three operate under the U.S. flag, and all but four are qualified to transport cargo between U.S. ports under the Jones Act, the federal statutes that restrict foreign owners from operating in the U.S. maritime transportation industry.

We operate our tank vessels in markets that exhibit 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 cash flows. Our West Coast operations provide seasonal diversification primarily as a result of its services to our Alaskan markets, which experience the greatest demand for petroleum products in the summer months, due to weather conditions. Considering the above, we believe seasonal demand for our services is lowest during our third fiscal quarter. We do not see any significant seasonality in the Hawaiian market.

Significant Events

Common Unit Offering

On August 20, 2008, we closed a public offering of 2,000,000 common units representing limited partner interests. The price to the public was $25.80 per unit. The net proceeds of $49.8 million from the offering, after payment of underwriting discounts and commissions and other transaction costs, were used to repay borrowings under the credit agreements and to make construction progress payments in connection with our vessel new-building program.

Change in Accounting Estimates

In assessing the appropriateness of the useful lives and salvage values of our vessels, we considered the recent growth in the fleet and changes in its composition. We concluded, based on our accumulated data on useful lives and the planned future use of our vessels, as well as a review of industry data, that our assets are fully operative and economic for periods greater than those previously used for book depreciation purposes. Accordingly, effective July 1, 2008, we prospectively increased the estimated useful lives of double-hulled tank barges and tugboats to a range of ten to thirty years, from the previous ranges of ten to twenty five years and ten to twenty years, respectively, and increased salvage values for double-hulled tank barges. These changes in accounting estimates increased both operating income and net income by $1.6 million and net income per fully diluted limited partner unit by $0.11, each for the three months ended September 30, 2008.

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. 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.

† 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.

Please refer to "-Management's Discussion and Analysis of Financial Condition and Results of Operations - Definitions" included in our Annual Report on Form 10-K for the fiscal year ended June 30, 2008 for definitions of certain other terms used in our discussion of results of operations.

Results of Operations



The following table summarizes our results of operations for the periods
presented (dollars in thousands, except average daily rates).



                                                                Three Months Ended
                                                                  September 30,
                                                                 2008         2007

Voyage revenue                                                $    84,640   $ 68,945
Bareboat charter and other revenue                                  6,854      2,816
Total revenues                                                     91,494     71,761
Voyage expenses                                                    23,505     15,743
Vessel operating expenses                                          37,066     27,517
% of voyage and vessel operating expenses to total revenues          66.2 %     60.3 %
General and administrative expenses                                 7,961      6,344
% of total revenues                                                   8.7 %      8.8 %
Depreciation and amortization                                      12,775     10,329
Net loss (gain) on disposal of vessels                                294       (221 )
Operating income                                                    9,893     12,049
% of total revenues                                                  10.8 %     16.8 %
Interest expense, net                                               5,905      5,820
Other expense (income), net                                            (2 )       (5 )
Income before provision for income taxes                            3,990      6,234
Provision for income taxes                                            136        228
Net income                                                    $     3,854   $  6,006

Net voyage revenue by trade
Coastwise
Total tank vessel days                                              4,117      3,290
Days worked                                                         3,676      2,991
Scheduled drydocking days                                             107        144
Net utilization                                                        89 %       91 %
Average daily rate                                            $    13,027   $ 13,427
Total coastwise net voyage revenue (a)                        $    47,888   $ 40,160
Local
Total tank vessel days                                              2,252      2,484
Days worked                                                         1,835      1,889
Scheduled drydocking days                                              69         39
Net utilization                                                        81 %       76 %
Average daily rate                                            $     7,219   $  6,904
Total local net voyage revenue (a)                            $    13,247   $ 13,042
Tank vessel fleet
Total tank vessel days                                              6,369      5,774
Days worked                                                         5,511      4,880
Scheduled drydocking days                                             176        183
Net utilization                                                        87 %       85 %
Average daily rate                                            $    11,093   $ 10,902
Total fleet net voyage revenue (a)                            $    61,135   $ 53,202

Three Months Ended September 30, 2008 Compared to Three Months Ended September 30, 2007

Voyage Revenue and Voyage Expenses

Voyage revenue was $84.6 million for the three months ended September 30, 2008, an increase of $15.7 million, or 23%, as compared to voyage revenue of $68.9 million for the three months ended September 30, 2007. Voyage expenses were $23.5 million for the three months ended September 30, 2008, an increase of $7.8 million, or 50%, as compared to voyage expenses of $15.7 million for the three months ended September 30, 2007.

Net voyage revenue

Net voyage revenue was $61.1 million for the three months ended September 30, 2008, which exceeded net voyage revenue of $53.2 million for the three months ended September 30, 2007 by $7.9 million, or 15%. In our coastwise trade, net voyage revenue was $47.9 million, an increase of $7.7 million, or 19%, as compared to $40.2 million for the three months ended September 30, 2007, $5.8 million of which was due to the inclusion of the Smith Maritime Group for a full quarter. Net utilization in our coastwise trade was 89% and 91% for the three-month periods ended September 30, 2008 and 2007, respectively. Net voyage revenue in our coastwise trade for the three months ended September 30, 2008 increased by $1.3 million due to the DBL 77, which began operations in July 2008. Coastwise average daily rates decreased 3% to $13,027 for the three months ended September 30, 2008 from $13,427 for the three months ended September 30, 2007. The decrease in coastwise average daily rates is primarily due to lower average rates of certain vessels operated in the Gulf of Mexico as a result of Hurricanes Gustav and Ike.

Net voyage revenue in our local trade for the three months ended September 30, 2008 increased by $0.2 million, or 2%, to $13.2 million from $13.0 million for the three months ended September 30, 2007. Local net voyage revenue increased by $1.7 million during the three months ended September 30, 2008 due to the increased number of working days for the new-build barges DBL 23, DBL 24 and DBL 25, which were delivered in September 2007, December 2007, and March 2008, respectively. This increase was offset by a decrease in local net voyage revenue of $1.7 million due to the retiring of three single-hull vessels. Net utilization in our local trade was 81% for the three months ended September 30, 2008, compared to 76% for the three months ended September 30, 2007. Average daily rates in our local trade increased 5% to $7,219 for the three months ended September 30, 2008 from $6,904 for the comparative prior year period.

Bareboat Charter and Other Revenue

Bareboat charter and other revenue was $6.9 million for the three months ended September 30, 2008, compared to $2.8 million for the three months ended September 30, 2007. Of this $4.1 million increase, $1.2 million was a result of the Smith Maritime Group acquisition, and $3.1 million was attributable to increased revenue from the purchase of eight tugboats in June 2008. This was partially offset by a $0.3 million decrease relating to our water treatment plant in Norfolk.

Vessel Operating Expenses

Vessel operating expenses were $37.1 million for the three months ended September 30, 2008 compared to $27.5 million for the three months ended September 30, 2007, an increase of $9.6 million. Vessel labor and related costs for the three months ended September 30, 2008 increased $7.0 million as a result of a contractual labor rate increase reflected in our new two year labor contract with certain of our vessel employees and a higher average number of employees due to the operation of the additional barges and tugboats described under "-Net voyage revenue" and "-Bareboat Charter and Other Revenue" above. Other vessel operating costs increased $2.6 million for the three months ended September 30, 2008. This increase is primarily comprised of a $1.6 million increase in repairs and maintenance, supplies and parts which is due to the inclusion of the Smith Maritime Group for a full quarter, a $0.9 million increase in fuel and other costs associated with the purchase of eight additional tug boats in June 2008 and a $0.8 million increase in vessel insurance premiums due to both rate increases and the increased number of vessels under the policies relating to the aforementioned acquisitions. Such increases were partially offset by a decrease of $1.5 million in outside towing expenses as a result of the purchase of eight additional tug boats in June 2008.

Due to the factors described above, voyage and vessel operating expenses as a percentage of total revenues increased to 66.2% for the three months ended September 30, 2008 from 60.3% for the three months ended September 30, 2007.

Depreciation and Amortization

Depreciation and amortization was $12.8 million for the three months ended September 30, 2008, an increase of $2.5 million, or 24%, compared to $10.3 million for the three months ended September 30, 2007. Depreciation and drydocking amortization on our newbuild and purchased vessels increased by $4.1 million, which was partially offset by $1.6 million due to the change in estimated useful lives of our vessels and salvage values as described under "-Significant Events" above.

General and Administrative Expenses

General and administrative expenses were $8.0 million for the three months ended September 30, 2008, an increase of $1.7 million, or 27%, as compared to general and administrative expenses of $6.3 million for the three months ended September 30, 2007. As a percentage of total revenues, general and administrative expenses were 8.7% and 8.8% for the three month periods ended September 30, 2008 and 2007, respectively. The $1.7 million increase for the three months ended September 30, 2008 is primarily the result of increased personnel costs resulting from increased headcount to support our growth and the additional facilities costs of our new offices in Philadelphia, Hawaii, and Seattle.

Interest Expense, Net

Net interest expense was $5.9 million for the three months ended September 30, 2008, or $0.1 million higher than the $5.8 million incurred in the three months ended September 30, 2007. The increase resulted from higher average debt balances resulting from increased credit line and term loan borrowings in connection with our acquisitions and newbuild vessels, offset by lower average interest rates.

Provision for Income Taxes

Our interim provisions for income taxes are based on our estimated annual effective tax rate. For the three months ended September 30, 2008, this rate was 3.4% as compared to a rate of 3.7% for the three months ended September 30, 2007. 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 our operating partnership's corporate subsidiaries. Our effective tax rate for the quarter ended September 30, 2008 was lower than the comparable prior year period primarily due to a smaller portion of our pre-tax income for the three months ended September 30, 2008 being attributable to our foreign subsidiaries, which are taxed at a higher rate than our effective tax rate.

Net income

Net income was $3.9 million for the three months ended September 30, 2008, a decrease of $2.1 million, or 35%, compared to net income of $6.0 million for the three months ended September 30, 2007. This decrease resulted from the $2.1 million decrease in operating income.

Liquidity and Capital Resources

Operating Cash Flows

Net cash provided by operating activities was $16.0 million for the three months ended September 30, 2008, an increase of $4.5 million compared to $11.5 million for the three months ended September 30, 2007. The increase resulted from a $6.4 million positive impact from working capital changes and $0.7 million of improved operating results, after adjusting for non-cash expenses such as depreciation and amortization, which was partially offset by increased drydocking payments of $2.6 million. During the three-month period ended September 30, 2008, our working capital decreased, thereby increasing cash flow, due primarily to a decrease in accounts receivable as a result of improved collections and a decrease in prepaid expenses and other current assets mainly due to the lower cost of the fuel inventory used to power our tugboats. This was offset by a decrease in accounts payable as a result of the timing of payments

Investing Cash Flows

Net cash used in investing activities totaled $32.4 million for the three months ended September 30, 2008, compared to $189.1 million used during the three months ended September 30, 2007. The three months ended September 30, 2007 included the $168.7 million cash portion of the purchase price for the Smith Maritime Group. Vessel acquisitions for the three months ended September 30, 2007 included a $3.0 million cash payment in connection with an acquired barge; the seller also issued a $3.0 million note which was paid in November 2007.
Tank vessel construction in the three months ended September 30, 2008 aggregated $31.1 million and included progress payments on construction of one 185,000 articulated tug barge unit, one 100,000-barrel tank barge and one 80,000-barrel tank barge. Tank vessel construction of $12.1 million in the comparative prior year period included progress payments on construction of three new 80,000-barrel tank barges, three new 28,000-barrel tank barges and a new 50,000-barrel tank barge. Other capital expenditures, relating primarily to coupling tugboats to our newbuild tank barges, totaled $1.9 million in the three months ended September 30, 2008 and $4.2 million in the three months ended September 30, 2007.

Financing Cash Flows

Net cash provided by financing activities was $18.4 million for the three months ended September 30, 2008 compared to $178.2 million of net cash provided by financing activities for the three months ended September 30, 2007. The primary financing activities for the three month period ended September 30, 2008 were $51.6 million in gross proceeds ($49.8 million net proceeds after payment of underwriting discounts and commissions and other transactions costs) from the issuance of 2.0 million of new common units in August 2008, the repayment of $37.5 million of credit agreement borrowings with a portion of the equity offering proceeds, partially offset by $26.3 million of additional credit agreement borrowings. We also made $11.7 million in distributions to partners as described under "-Payment of Distributions" below. The primary financing activities for the three month period ended September 30, 2007 were $138.3 million in gross proceeds from the issuance of 3.5 million of new common units in September 2007, and $105.0 million of borrowings related to the Smith Maritime Group acquisition, which were repaid with the equity offering proceeds. During the three month period ended September 30, 2007, we also increased our credit line borrowings by $57.9 million relating to the Smith Maritime Group acquisition, for progress payments on barges under construction, and made $7.5 million in distributions to partners as described under "-Payment of Distributions" below.

Payment of Distributions

The board of directors of K-Sea General Partner GP LLC declared a quarterly distribution to unitholders of $0.77 per unit in respect of the quarter ended June 30, 2008, which was paid on August 14, 2008 to unitholders of record on August 6, 2008. Additionally, the board declared a quarterly distribution to unitholders of $0.77 per unit in respect of the quarter ended September 30, 2008, payable on November 14, 2008 to unitholders of record on November 7, 2008.

Oil Pollution Act of 1990

Tank vessels are subject to the requirements of OPA 90, which mandates that all single-hull tank vessels operating in U.S. waters be removed from 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 September 30, 2008, approximately 76% of the barrel-carrying capacity of our tank vessel fleet was double-hulled in compliance with OPA 90, and the remainder 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 $23.0 million per year to drydock and maintain our fleet. We expect such expenditures to approximate $22.0 million in fiscal 2009. In addition, we anticipate that we will spend $1.0 million annually for other general maintenance capital expenditures. Periodically, we also make expenditures to acquire or construct additional tank vessel capacity and/or to upgrade our overall fleet efficiency.

We define maintenance capital expenditures as capital expenditures required to maintain, over the long term, the operating capacity of our fleet, and expansion capital expenditures as those capital expenditures that increase, over the long term, the operating capacity of our fleet. Examples of maintenance capital expenditures include costs related to drydocking a vessel, retrofitting an existing vessel or acquiring a new vessel to the extent such expenditures maintain the operating capacity of our fleet. Drydocking expenditures are more extensive in nature than normal routine maintenance and, therefore, are capitalized and amortized over three years. Capital expenditures associated with retrofitting an existing vessel, or acquiring a new vessel, which increase the operating capacity of our fleet over the long term, whether through increasing our aggregate barrel-carrying capacity, improving the operational performance of a vessel or otherwise, are classified as expansion capital expenditures. Generally, expenditures for construction in progress are not included as capital expenditures.

The following table summarizes total maintenance capital expenditures, including drydocking expenditures, and expansion capital expenditures for the periods presented (in thousands):

                                                              Three months ended
                                                                September 30,
                                                               2008        2007
  Maintenance capital expenditures                          $    7,388   $   4,548
  Expansion capital expenditures (including acquisitions)        1,707     175,955
  Total capital expenditures                                $    9,095   $ 180,503
  Construction of tank vessels                              $   31,136   $  12,147

During fiscal 2008, we took delivery of the following newbuild vessels: in June 2008, an 80,000-barrel tank barge, the DBL 77; in March 2008, a 28,000-barrel tank barge, the DBL 25; in December 2007, a 28,000-barrel tank barge, the DBL 24; and in September 2007, a 28,000-barrel tank barge, the DBL
23. In total, we have agreements with shipyards for the construction of seven additional new tank barges and one articulated tug barge unit as follows:

 Vessels                                             Expected Delivery

     Two 80,000-barrel tank barges                2nd Quarter fiscal 2009

    One 185,000-barrel articulated               2nd Quarter of fiscal 2010
            tug-barge unit

     One 100,000-barrel tank barge                2nd Quarter fiscal 2010

    Four 50,000-barrel tank barges         2nd Q fiscal 2010 - 2nd Q fiscal 2011

The above tank barges are expected to cost, in the aggregate and after the addition of certain special equipment, approximately $165.0 million, of which $63.0 million has been spent as of September 30, 2008. We expect to spend approximately $45.0 million during the last three quarters of fiscal 2009 on these contracts. We have an agreement for a long-term charter for the 185,000-barrel unit with a major customer that is expected to commence upon delivery. Additionally, we have agreements to lease two 50,000-barrel tank barges from a shipyard when they are delivered in the third quarter of fiscal 2010.

Additionally, we intend to retire, retrofit or replace 25 (including four . . .