PART I.  FINANCIAL INFORMATION

The accompanying notes are an integral part of these consolidated financial statements.

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The accompanying notes are an integral part of these consolidated financial statements.

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The accompanying notes are an integral part of these consolidated financial statements.

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K-SEA TRANSPORTATION PARTNERS L.P.

agreement.  The partnership agreement does not provide for the distribution of net income; rather, it provides for the distribution of available cash, which is a contractually defined term that generally means all cash on hand at the end of each quarter after provision for reserves.  Unlike available cash, net income is affected by non-cash items, such as depreciation and amortization.

As described in note 1 above, the general partner’s incentive distribution rights also entitle it to receive an increasing percentage of distributions, above its nominal ownership percentage, when the quarterly cash distribution exceeds $0.55 per unit.  Under EITF 03-6, the impact of these increasing percentages is reflected in the calculation of the general partner’s interest in net income when such net income exceeds $0.55 per unit.

3.              Acquisition of the Smith Maritime Group

On August 14, 2007, the Partnership, through certain wholly owned subsidiaries, completed the acquisition of all of the equity interests in Smith Maritime, Ltd. (“Smith Maritime”), Go Big Chartering, LLC (“Go Big”), and Sirius Maritime, LLC (“Sirius Maritime” and together with Smith Maritime and Go Big, “the Smith Maritime Group”).  This transaction is part of the Partnership’s business strategy to expand its fleet through strategic and accretive acquisitions.  The Smith Maritime Group provides marine transportation and logistics services to major oil companies, oil traders and refiners in Hawaii and along the West Coast of the United States.  The aggregate purchase price was $203,352, subject to certain closing balance sheet-related adjustments.  As further described in note 5 below, the Partnership financed the cash portion of the purchase through additional borrowings under its revolving credit agreement and a bridge loan.

Under the purchase method of accounting, the Partnership has included the Smith Maritime Group’s results of operations from August 14, 2007, the acquisition date, through December 31, 2007.  The aggregate recorded purchase price of $203,352 consisted of $169,606 of cash, including $1,467 of direct expenses, $23,511 of assumed debt, and $10,235 representing 250,000 common units valued at their market value on the acquisition date.  The Partnership allocated the purchase price to the tangible assets, intangible assets, and liabilities acquired based on their fair values.  The purchased identifiable intangible assets are being amortized on a straight-line basis over their respective estimated useful lives.  The excess of the purchase price over the fair value of the acquired net assets has been recorded as goodwill, which is not amortized but which will be reviewed annually for impairment.  The Partnership’s preliminary allocation of the purchase price is as follows.  This allocation has been adjusted at December 31, 2007 to reflect certain vessel purchase options acquired as part of the acquisition.

The identifiable intangible assets purchased in the acquisition include customer relationships and covenants not to compete, valued at $17,500, which will be amortized over 20 and 3 years, respectively.  The annual amortization expense for the identifiable intangibles is $903.  A substantial portion of the goodwill is expected to be deductible for tax purposes.  In connection with the acquisition, the Partnership assumed an excise tax liability of $2,705 for which it has been indemnified by the sellers.  This liability was settled by sellers in December 2007 and is no longer reflected in the Partnership’s consolidated balance sheet.

The acquisition also included an option to purchase a 50% interest in a tank barge, at less than fair market value, which resulted in recognition of an intangible asset of $2,615 at the acquisition date.  Upon exercise of the option in October 2007, the Partnership obtained a 50% interest in a joint venture newly-formed to own and charter the tank barge, which joint venture is considered a variable interest entity and is consolidated in the accompanying financial statements.  As a result, the consolidated balance sheet reflects $4,275 for the non-controlling interest in this joint venture at December 31, 2007.  Other income (expense) includes an allocation of $66 for the non-controlling interest’s portion of the joint venture’s net loss.

Pro Forma Financial Information

The unaudited pro forma financial information for the three and six months ended December 31, 2007 and 2006 combines the historical results of the Partnership with the historical results of the Smith Maritime Group for the period preceding the August 14, 2007 acquisition.  The unaudited financial information in the table below

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summarizes the combined results of operations of the Partnership and the Smith Maritime Group, on a pro forma basis, as though the acquisition had been completed as of the beginning of each period presented.  This pro forma financial data is presented for information purposes only and is not necessarily indicative of the results of operations that would have been achieved had the acquisition actually taken place at those dates.

4.              Vessels and Equipment and Construction in Progress

Vessels and equipment and construction in progress comprised the following as of the dates indicated:

Depreciation and amortization of vessels and equipment was $10,381 and $7,618 for the three months ended December 31, 2007 and 2006, respectively. Depreciation and amortization of vessels and equipment was $19,462 and $14,828 for the six months ended December 31, 2007 and 2006, respectively. Such depreciation and amortization includes amortization of drydocking expenditures for the three and six months ended December 31, 2007 of $3,033 and $5,908, respectively, and $2,425 and $4,799 for the three and six months ended December 31, 2006, respectively.

In September 2007, the Partnership took delivery of a 28,000-barrel tank barge, the DBL 23, and in December 2007 took delivery of a 28,000-barrel tank barge, the DBL 24.  In October 2007, the Partnership entered into an agreement with a shipyard to construct an 185,000-barrel articulated tug-barge unit.  In December 2007, the Partnership entered into an agreement with a shipyard to construct a 100,000-barrel tank barge.  The Partnership also has agreements with shipyards for the construction of eight additional new tank barges.  Construction in progress at December 31, 2007 comprises expenditures for three 80,000-barrel tank barges, one 50,000-barrel tank barge, one 28,000-barrel tank barge, and one 185,000-barrel articulated tug-barge unit.

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5.              Financing

The Partnership’s outstanding debt balances were as follows as of the dates indicated:

Credit Agreement

The Partnership maintains a revolving credit agreement with a group of banks, with KeyBank National Association as administrative agent and lead arranger, to provide financing for its operations.  On August 14, 2007, the Partnership amended and restated its revolving credit agreement to provide for (1) an increase in availability to $175,000 under the primary revolving facility, with an increase in the term to seven years, (2) an additional $45,000 364-day senior secured revolving credit facility, (3) amendments to certain financial covenants and (4) a reduction in interest rate margins.  Under certain conditions, the Partnership has the right to increase the primary revolving facility by up to $75,000, to a maximum total facility amount of $250,000.  On November 7, 2007, the Partnership exercised this right and increased the facility by $25,000 to $200,000.  The primary revolving facility is, and the 364-day facility was,  collateralized by a first perfected security interest in vessels having a total fair market value of approximately $275,000 and certain equipment and machinery related to such vessels.  The revolving facility bears interest at the London Interbank Offered Rate, or LIBOR, plus a margin ranging from 0.7% to 1.5% depending on the Partnership’s ratio of total funded debt to EBITDA (as defined in the agreement).  On August 14, 2007, the Partnership borrowed $67,000 under the primary revolving facility and $45,000 under the 364-day facility to fund a portion of the purchase price of the Smith Maritime Group (see note 3).

Also on August 14, 2007, the Partnership entered into a bridge loan facility for up to $60,000 with an affiliate of KeyBank National Association in connection with the Smith Maritime Group acquisition.  While outstanding, the bridge loan facility bore interest at an annual rate of LIBOR plus 1.5%, and was to mature on November 12, 2007.  During an event of default, the bridge loan facility provided for interest at an annual rate of LIBOR plus 7.5%.

Both the $45,000 364-day senior secured facility and the $60,000 bridge loan were repaid on September 26, 2007 upon closing of an offering of common units by the Partnership.  See “—Common Unit Offering” below.  As of December 31, 2007, the Partnership had $180,350 outstanding on the revolving facility.  The Partnership also maintains a separate revolver with a commercial bank to support its daily cash management activities; there was no outstanding balance on this revolver at December 31, 2007.

On August 14, 2007, in connection with the acquisition of the Smith Maritime Group, the Partnership also assumed two term loans totaling $23,511.  The first, in the amount of $19,464, bears interest at LIBOR plus 1.25% and is repayable in equal monthly installments of $147, plus interest, through August 2018.  The second, in the amount of $4,047, bears interest at LIBOR plus 1.0% and is repayable in monthly installments ranging from $59 to $81, plus interest, through May 2012.  These loans are collateralized by three tank barges.  The Partnership also agreed with the related lending institution to assume the two existing interest rate swaps relating to these two loans.  The LIBOR-based, variable rate interest payments on these loans have been swapped for fixed payments at an average rate of 5.44%, plus a margin, over the same terms as the loans.

On November 30, 2007, the Partnership entered into agreements with a financial institution to swap the LIBOR-based, variable rate interest payments on $104,850 of its credit agreement borrowings for fixed rates, for a term of three years.  The fixed rates to be paid by the Partnership average 4.01% plus the applicable margin.

Common Unit Offering

On September 26, 2007, the Partnership closed a public offering of 3,500,000 common units representing limited partner interests. The price to the public was $39.50 per unit.  The net proceeds of $131,918 from the offering, after payment of underwriting discounts and commissions and expenses, were used to repay borrowings under the credit agreement, including the $45,000 364-day facility, and also the $60,000 bridge loan facility described above.

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Restrictive Covenants

The agreements governing the credit agreement and the term loans contain restrictive covenants that, among other things, (a) prohibit distributions under defined events of default, (b) restrict investments and sales of assets, and (c) require the Partnership to adhere to certain financial covenants, including defined ratios of fixed charge coverage and funded debt to EBITDA (earnings before interest, taxes, depreciation and amortization, as defined).

6.              Commitments and Contingencies

As previously reported, in November 2005 one of the Partnership’s tank barges, the DBL 152, struck submerged debris in the U.S. Gulf of Mexico, causing significant damage which resulted in the barge eventually capsizing. At the time of the incident, the barge was carrying approximately 120,000 barrels of No. 6 fuel oil, a heavy oil product.  In January 2006, submerged oil recovery operations were suspended and a monitoring program, which sought to determine if any recoverable oil could be found on the ocean floor, was begun. In February 2007, the Coast Guard agreed to end the cleanup and response phase, including the Partnership’s obligation to conduct any further monitoring of the area around the spill site. The Partnership’s incident response effort is complete. The Partnership is not aware of any further recovery, cleanup or other costs. However, if any such costs are incurred, they are expected to be paid by the Partnership’s insurers.

The Partnership’s insurers responded to the pollution-related costs and environmental damages resulting from the incident, paying approximately $65,000 less $60 in total deductibles, and have been pursuing their own financial recovery efforts.  In December 2007, a court made a final determination of liability in this case, resulting in a financial recovery by the Partnership’s insurers, and also by the Partnership.  As a result of the ruling, the Partnership was awarded a reimbursement of certain expenses totaling $2,073, which has been included in other expense (income) in the Partnership’s consolidated statement of operations and in prepaid expenses and other assets in the December 31, 2007 consolidated balance sheet.  This amount was received in January 2008.

The European Union is currently working toward a new directive for the insurance industry, called “Solvency 2”, that is expected to become law within four to five years and require increases in the level of free, or unallocated, reserves required to be maintained by insurance entities, including protection and indemnity clubs that provide coverage for the maritime industry.  The West of England Ship Owners Insurance Services Ltd. (“WOE”), a mutual insurance association based in Luxembourg, provides the Partnership’s protection and indemnity insurance coverage and would be impacted by the new directive.  In anticipation of these new regulatory requirements, the WOE has assessed its members an additional capital call that it believes will contribute to achievement of the projected required free reserve increases.  The Partnership’s capital call of $1,119 was paid during calendar year 2007.  A further request for capital may be made in the future; however, the amount of such further assessment, if any, cannot be reasonably estimated at this time.  As a shipowner member of the WOE, the Partnership has an interest in the WOE’s free reserves, and therefore has recorded the additional $1,119 capital call as an investment, at cost, subject to periodic review for impairment.  This amount is included in other assets in the December 31, 2007 balance sheet.

EW Transportation Corp., a predecessor to the Partnership, and many other marine transportation companies operating in New York have come under audit with respect to the New York State Petroleum Business Tax (“PBT”), which is a tax on vessel fuel consumed while operating in New York State territorial waters.  An industry group in which EW Transportation Corp. and the Partnership participate has come to a final agreement with the New York taxing authority on a calculation methodology for the PBT.  Effective January 1, 2007, the Partnership and the other marine transportation companies began rebilling this tax to customers.  For applicable periods prior to 2007, the Partnership has accrued an estimated liability using the agreed methodology.  In accordance with the agreements entered into in connection with the Partnership’s initial public offering in January 2004, any liability resulting from the PBT prior to January 14, 2004 (the effective date of the offering) is a retained liability of the Partnership’s predecessor companies.  The New York taxing authority has completed an audit of all open periods and has issued a proposed assessment which has been substantially accepted by the Partnership.  The Partnership’s final liability is not materially different from the accruals previously recorded and will be paid during the quarter ended March 31, 2008.

The Partnership has agreements with shipyards for the construction of one new articulated tug-barge unit and nine additional new tank barges.

The Partnership is the subject of various claims and lawsuits in the ordinary course of business for monetary relief arising principally from personal injuries, collisions and other casualties. Although the outcome of any individual claim or action cannot be predicted with certainty, the Partnership believes that any adverse outcome, individually or in the aggregate, would be substantially mitigated by applicable insurance or indemnification from previous owners of the Partnership’s assets, and would not have a material adverse effect on the Partnership’s

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financial position, results of operations or cash flows.  The Partnership is also subject to deductibles with respect to its insurance coverage that range from $25 to $100 per incident and provides on a current basis for estimated payments thereunder.

7.              New Accounting Pronouncements

On February 16, 2006, the FASB issued FASB Statement No. 155, “Accounting for Certain Hybrid Financial Instruments, an amendment of FASB Statements No. 133 and 140” (“FAS 155”). FAS 155 amends FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” and FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”.  The Partnership adopted FAS 155 as of July 1, 2007, and such adoption did not have any impact on its financial position, results of operations or cash flows.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”).  FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with FASB Statement No. 109, “Accounting for Income Taxes”.  FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.  FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition.  The Partnership adopted FIN 48 as of July 1, 2007, and such adoption had no impact on its financial position, results of operations or cash flows.

At the date of the adoption, there were no unrecognized tax benefits and consequently no related interest and penalties.  The significant jurisdictions in which the Partnership files tax returns and is subject to tax include New York City, Venezuela and Puerto Rico.  The significant jurisdictions in which the Partnership’s corporate subsidiaries file tax returns and are subject to tax include the United States and Canada.  The tax returns filed in the United States and state jurisdictions are subject to examination for the years 2004 through 2007 and in foreign jurisdictions for the years 2005 through 2007.  The Partnership has adopted a policy to record tax related interest and penalties under interest expense and general and administrative expenses, respectively.

In September 2006, the FASB issued FASB Statement No. 157, “Fair Value Measurements” (“FAS 157”).  FAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements.  FAS 157 applies under other accounting pronouncements that require or permit fair value measurements.  FAS 157 is effective for fiscal years beginning after November 15, 2007, and the Partnership is currently analyzing its impact, if any.

In December 2007, the FASB issued Statement of Financial Accounting Standards (“FAS”) No. 141 (revised 2007), “Business Combinations” (“FAS 141(R)”) which replaces FAS No.141, “Business Combinations”.  FAS 141(R) retains the underlying concepts of FAS 141 in that all business combinations are still required to be accounted for at fair value under the purchase method of accounting, but FAS 141(R) changed the method of applying the purchase method in a number of significant aspects.  FAS 141(R) is effective on a prospective basis for all business combinations for which the acquisition date is on or after the beginning of the first fiscal year subsequent to December 15, 2008, with the exception of the accounting for valuation allowances on deferred taxes and acquired tax contingencies.  FAS 141(R) amends FAS 109 such that adjustments made to valuation allowances on deferred taxes and acquired tax contingencies associated with acquisitions that closed prior to the effective date of FAS 141(R) would also apply the provisions of FAS 141(R).  The Partnership is currently analyzing the impact, if any, of this standard.

In December 2007, the FASB issued Statement of Financial Accounting Standards (“FAS”) No. 160, “Non-controlling Interests in Consolidated Financial Statements, an Amendment of ARB 51” (“FAS 160”). FAS 160 amends ARB 51 to establish new standards that will govern the accounting for and reporting of (1) non-controlling interest in partially owned consolidated subsidiaries and (2) the loss of control of subsidiaries.  FAS 160 is effective on a prospective basis for all fiscal years, and interim periods within those fiscal years beginning, on or after December 15, 2008, except for the presentation and disclosure requirements, which will be applied retrospectively.  The Partnership is currently analyzing the impact, if any, of this standard.

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