MARKWEST HYDROCARBON, INC.
Notes to Condensed Consolidated Financial Statements
(unaudited)
1. Organization
MarkWest Hydrocarbon, Inc. ("MarkWest Hydrocarbon" or the "Company") is an energy company primarily focused on marketing natural gas liquids and increasing
shareholder value by growing MarkWest Energy Partners, L.P. ("MarkWest Energy Partners" or the "Partnership"), a consolidated subsidiary and publicly traded master limited partnership. The Partnership
is engaged in the gathering, processing and transmission of natural gas; the transportation, fractionation and storage of natural gas liquids; and the gathering and transportation of crude oil. The
Company also markets natural gas and Natural Gas Liquids ("NGLs"). The Company and the Partnership provide services primarily in Appalachia, Michigan, Texas, Oklahoma, Gulf Coast and other areas of
the Southwest.
2. Basis of Presentation
The Company's unaudited condensed consolidated financial statements include the accounts of all majority-owned or controlled subsidiaries. The consolidated
financial statements include the accounts of the Partnership, and MarkWest Energy GP, L.L.C. (the "General Partner"). The Company consolidates the Partnership because it acts as the General Partner
and the limited partners do not have substantive kick-out or participating rights. Equity investments in which the Company exercises significant influence but does not control, and is not
the primary beneficiary, are accounted for using the equity method. These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in
the United States of America ("GAAP") for interim financial reporting. Accordingly, certain information and footnote disclosures normally included in financial statements prepared in accordance with
GAAP have been condensed or omitted.
In Management's opinion, the Company has made all adjustments necessary for a fair presentation of its results of operations, financial position and cash flows for the periods shown. These adjustments
are of a normal recurring nature. In addition to reviewing these condensed consolidated financial statements and accompanying notes, you should also consult the audited financial statements and
accompanying notes included in the Company's December 31, 2006, Annual Report on Form 10-K, as amended. Finally, consider that results for the three and nine months
ended September 30, 2007, are not necessarily indicative of results for the full year 2007, or any other future period.
The
Company adopted the Financial Accounting Standards Board ("FASB") Interpretation Number 48,
Accounting for Uncertainty in Income Taxes
("FIN 48"), on January 1, 2007. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements in accordance with Statement of Financial
Accounting Standards ("SFAS") Number 109,
Accounting for Income Taxes
("SFAS 109"). Specifically, the pronouncement prescribes a "more likely
than not" recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation
also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. For the impact of FIN
48 on the Company's financial statements, see Note 11.
On
July 12, 2007, the State of Michigan enacted changes in its taxation scheme. As a result, the Company has made the necessary adjustments to its deferred tax assets (and
liabilities) in the form of a charge (or benefit) to income, as part of its income tax provision in the third quarter of 2007. Michigan's new tax law replaces the single business tax with a
two-prong tax. The two prongs comprise a tax at the rate of 0.8% of a taxpayer's modified gross receipts and a tax at the rate of 4.95% of the
8
taxpayer's
business income. The new tax takes effect on January 1, 2008 and applies to all business activity occurring after December 31, 2007. The current single business tax will
remain in effect through December 31, 2007. Adopted on September 30, 2007, and effective January 1, 2008, Michigan House Bill 5104 creates a deduction from a taxpayer's
pre-apportioned business income tax base equal to the total book-tax difference triggered by the enactment of the Michigan business tax that results in a net deferred tax
liability. The net impact to the Partnership was a $0.2 million charge to income, with the Company recording its proportionate share of less than $0.1 million.
The
Partnership issues common units in various transactions, which results in a dilution of the Company's percentage ownership in the Partnership. The Company accounts for the sale of
the Partnership common units in accordance with the Securities and Exchange Commission Staff Accounting Bulletin Number 51,
"Accounting for Sales of Stock by a
Subsidiary"
("SAB 51"). SAB 51 allows for the election of an accounting policy of recording such increase or decreases in a parent's investment (SAB 51 gains or losses,
respectively) either in income or in equity. The Company adopted a policy of recording such SAB 51 gains or losses directly to additional paid in capital. Due to the
preference nature of the Partnership's common units, the Company was precluded from recording SAB 51 gains or losses until the subordinated units converted to common units.
On
August 15, 2007, the Partnership converted its remaining 1.2 million subordinated units to common units, in accordance with the provisions of the amended and restated
partnership agreement. As a result, the Company recorded a $48.2 million SAB 51 gain to additional paid in capital, a decrease in non-controlling interest in consolidated subsidiary of
$77.5 million and an increase to deferred tax liability of $29.3 million associated with gains from sales of common units by the Partnership in conjunction with, and subsequent to, the
Partnership's May 24, 2002 initial public offering. The changes to the Company's balance sheet resulting from the subordinated unit conversion had no effect on the Company's net income or cash
flow and did not result in an increase in the number of limited partner units outstanding.
3. Recent Accounting Pronouncements
In September 2006 the FASB issued SFAS 157,
Fair Value Measurements
("SFAS 157").
SFAS 157 clarifies the principle that fair value should be based on the assumptions market participants would use when pricing an asset or liability and establishes a fair value hierarchy that
prioritizes the information used to develop those assumptions. SFAS 157 is effective for the Company's financial statements as of January 1, 2008, and interim periods within those
fiscal years, with early adoption permitted. The Company is currently evaluating the impact of adopting this statement.
In
February 2007 the FASB issued SFAS 159,
The Fair Value Option for Financial Assets and Financial Liabilities
("SFAS 159"), which permits an entity to measure certain financial assets and financial liabilities at fair value. The statement's objective is to improve financial reporting by allowing
entities to mitigate volatility in reported earnings caused by the measurement of related assets and liabilities using different attributes, without having to apply complex hedge accounting
provisions. Under SFAS 159, entities that elect the fair value option will report unrealized gains and losses in earnings at each subsequent reporting date. The fair value option may be elected
on an instrument-by-instrument basis, with a few exceptions, as long as it is applied to the instrument in its entirety. The fair value option election is irrevocable, unless a
new election date occurs. SFAS 159
9
establishes
presentation and disclosure requirements to help financial statement users understand the effect of the entity's election on its earnings, but does not eliminate disclosure requirements of
other accounting standards. Assets and liabilities that are measured at fair value must be displayed on the face of the balance sheet. SFAS 159 is effective for the Company's financial
statements as of January 1, 2008. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity (1) makes that choice in the first 120 days
of that fiscal year, (2) has not yet issued financial statements, and (3) elects to apply the provisions of SFAS 157. The Company is currently evaluating the impact of adopting
this statement.
4. Merger
On September 5, 2007, the Company announced that it had entered into an Agreement and Plan of Redemption and Merger (the "Redemption and Merger Agreement")
by and among the Company, the Partnership and MWEP, L.L.C., a wholly owned subsidiary of the Partnership, pursuant to which the Company will be merged into the Partnership. Under the Redemption and
Merger Agreement, the Company will, subject to pro ration, redeem for cash those shares of Company common stockholders electing to receive cash. Immediately after the redemption, the Partnership will
acquire the Company through a merger of MWEP, L.L.C. with and into the Company, pursuant to which all remaining shares of the Company's common stock will be converted into Partnership common units. As
a result of the merger, the Company will be a wholly owned subsidiary of the Partnership. In connection with the redemption and merger, the incentive distribution rights in the Partnership, the 2%
economic interest of MarkWest Energy GP, L.L.C. (the "General Partner") and the Partnership common units owned by the Company will be exchanged for Partnership Class A units. Contemporaneously
with the closing of the transactions contemplated by the Redemption and Merger Agreement, the Partnership will separately acquire 100% of the Class B membership interests in the General Partner
currently held by current and former management and certain directors of the Company and the General Partner. Pursuant to the Redemption and Merger Agreement, the Company will pay to its stockholders
approximately $240.5 million in cash in the redemption and the Partnership will issue to the Company's stockholders approximately 15.5 million Partnership common units in the merger.
Each stockholder of the Company may elect the form of consideration they receive in the redemption and merger. Specifically, stockholders of the Company may elect to receive all cash, all common
units, the stated consideration consisting of 1.285 common units and $20.00 in cash for each of their shares, or any combination thereof. The Partnership has secured the financing for the cash payment
through a signed letter of commitment discussed further in Note 9.
The
merger is subject to customary closing conditions including, among other things, (1) approval by the affirmative vote or consent of at least a unit majority (as such term is
defined in the agreement of limited partnership of the Partnership) of the holders of the outstanding common units in the Partnership, (2) approval by the affirmative vote or consent of at
least a majority of the holders of outstanding common shares in the Company, (3) receipt of applicable regulatory approvals, including the expiration or termination of the applicable waiting
period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, (4) effectiveness of a registration statement on Form S-4 with respect to the issuance of
the Partnership's common units in connection with the merger, (5) approval for listing the common units of the Partnership to be issued in connection with the merger on the New York Stock
10
Exchange
and (6) closing of the related transactions contemplated by the Redemption and Merger Agreement.
Pursuant
to the Redemption and Merger Agreement, the Partnership agreed to amend and restate its existing partnership agreement. Under the amended and restated partnership agreement, the
incentive distribution rights and the 2% General Partner interest in the Partnership will be eliminated along with the General Partner's right to call all of the limited partner interests in the
Partnership if the General Partner owns more than 80% of the Partnership. In addition, the Partnership common unitholders will have the right under the amended and restated partnership agreement to
elect the members of the General Partner board annually by a plurality of the votes cast at a meeting of unitholders of the Partnership.
The
merger between the Company and the Partnership will be accounted for in accordance with SFAS 141,
Business Combinations
, and
related interpretations. The merger is considered a downstream merger whereby the Company is viewed as the surviving consolidated entity for accounting purposes rather than the Partnership, which is
the surviving consolidated entity for legal purposes. As such, the merger will be accounted for in the Company's consolidated financial statements as an acquisition of non-controlling
interest using the purchase method of accounting. Under this accounting method, the Partnership's accounts, including goodwill, will be adjusted to proportionately step up the book value of certain
assets and liabilities. The total fair value of the non-controlling interest to be acquired will be the number of non-controlling interest units outstanding on the date the
merger is closed valued at the then current per unit market price of the Partnership common units. The cash and the Partnership units distributed to officers and directors of the General Partner for
their Class B membership interests in the General Partner will be recorded as settlement of share-based payment liability as discussed further in Note 12.
5. Marketable Securities
As of September 30, 2007, the Company held short-term equity investments classified as trading securities. Realized and unrealized gains and
losses on trading securities are included in earnings. Dividend and interest income are recognized when earned.
Marketable
securities classified as available-for-sale are stated at market value, based on the closing price of the securities at the balance sheet date.
Accordingly, unrealized gains and losses are reflected in other comprehensive income, net of applicable income taxes. For losses that are other than temporary, the cost basis of the securities is
written down to fair value, and the amount of the write down is reflected in the statement of operations. The Company utilizes a first-in first-out cost basis to compute
realized gains and losses. Realized gains and losses, dividends, interest income, and the amortization of discounts and premiums are reflected in the statement of operations. Purchases and sales of
securities are recognized on a trade-date basis.
11
The
following are the components of marketable securities (in thousands):
|
|
Cost Basis
|
|
Net Unrealized Gains
|
|
Fair Value
|
September 30, 2007
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
Trading securities
|
|
$
|
3,697
|
|
$
|
4
|
|
$
|
3,701
|
|
|
Available for sale securities
|
|
|
5,294
|
|
|
1,484
|
|
|
6,778
|
|
|
|
|
|
|
|
|
|
$
|
8,991
|
|
$
|
1,488
|
|
$
|
10,479
|
|
|
|
|
|
|
|
|
|
Cost Basis
|
|
Net Unrealized Gains
|
|
Fair Value
|
December 31, 2006
|
|
|
|
|
|
|
|
|
|
|
Equity securities:
|
|
|
|
|
|
|
|
|
|
|
|
Available for sale securities
|
|
$
|
5,942
|
|
$
|
1,771
|
|
$
|
7,713
|
|
|
|
|
|
|
|
For
the nine months ended September 30, 2007, the Company recognized net unrealized losses on available-for-sale securities of $0.2 million,
net of the related tax benefit of $0.1 million. These losses are shown as a component of other comprehensive income for 2007.
For
the nine months ended September 30, 2007, the Company recognized net unrealized gains on trading securities of less then $0.1 million, net of the related tax
expense of less than $0.1 million. The gains are included in income for 2007.
6. Equity Investments
The Company applies the equity method of accounting for its 50% non-operating interest in Starfish Pipeline Company, L.L.C. ("Starfish"). Upon the
acquisition of Starfish, there were differences between the purchase price allocated to the investments and the underlying equity of the subsidiary attributable to the Company's interest. The Company
is amortizing these differences based upon the hypothetical purchase price allocation to the assets and liabilities of the subsidiaries as if the Company were consolidating Starfish. The difference
between the carrying amount of the Company's equity method investment and the underlying equity attributable to the Company's interest is being amortized over 17 years. Summarized financial
information for Starfish is as follows (in thousands):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Revenues
|
|
$
|
8,078
|
|
$
|
8,907
|
|
$
|
25,148
|
|
$
|
21,486
|
Operating income
|
|
|
2,962
|
|
|
1,979
|
|
|
10,515
|
|
|
5,083
|
Net income
|
|
|
2,671
|
|
|
2,289
|
|
|
9,801
|
|
|
6,921
|
12
7. Property, Plant and Equipment
Property, plant and equipment consist of (in thousands):
|
|
September 30, 2007
|
|
December 31, 2006
|
|
Gas gathering facilities
|
|
$
|
518,223
|
|
$
|
289,586
|
|
Gas processing plants
|
|
|
218,237
|
|
|
217,080
|
|
Fractionation and storage facilities
|
|
|
23,609
|
|
|
23,470
|
|
Natural gas pipelines
|
|
|
42,337
|
|
|
42,361
|
|
Crude oil pipelines
|
|
|
19,113
|
|
|
19,113
|
|
NGL transportation facilities
|
|
|
5,326
|
|
|
5,326
|
|
Furniture, office equipment and other
|
|
|
2,641
|
|
|
2,641
|
|
Land, building and other equipment
|
|
|
22,989
|
|
|
20,705
|
|
Construction in progress
|
|
|
48,425
|
|
|
42,324
|
|
|
|
|
|
|
|
|
|
|
900,900
|
|
|
662,606
|
|
Less: Accumulated depreciation
|
|
|
(136,479
|
)
|
|
(108,271
|
)
|
|
|
|
|
|
|
|
Total property, plant and equipment
|
|
$
|
764,421
|
|
$
|
554,335
|
|
|
|
|
|
|
|
The
Company capitalizes interest on major projects during construction. For the three and nine months ended September 30, 2007, the Company capitalized interest, including
deferred finance costs, of $0.5 million and $2.8 million, respectively. For the three and nine months ended September 30, 2006, the Company capitalized interest, including
deferred finance costs, of $0.2 million and $0.4 million, respectively.
On
September 27, 2007, the Partnership signed a gas gathering agreement wherein it agreed to acquire gathering assets located in Pittsburg County in Southeast Oklahoma for
$5.0 million no later than November 25, 2007. In conjunction with the gas gathering agreement, the Partnership will invest up to an additional $25.0 million to support the
development of certain coal bed methane initiatives with a new gathering system. The gathering assets are located adjacent to, and will become fully integrated with the Partnership's Woodford
gathering system.
Additionally,
on September 28, 2007, the Partnership announced an approximate $100.0 million expansion of the Javelina plant. This expansion involves the installation of a
steam methane reformer facility for the recovery of high purity hydrogen. Construction of the facility will begin in the fourth quarter of 2007.
8. Impairments of Long-Lived Assets
The Company's policy is to evaluate whether there has been a permanent impairment in the value of long-lived assets when certain events have taken
place that indicate that the remaining balance may not be recoverable. The Partnership evaluates the carrying value of its property and equipment on at least a segment level and at lower levels where
cash flows for specific assets can be identified.
The
analysis determined that a system located in the Partnership's Other Southwest segment had future estimated cash inflows estimated to be near zero because the system was
shut-in for a year, and as such the carrying amounts of the assets exceeded the estimated undiscounted cash flows. It was determined that an impairment of the system had occurred. Fair
value of the long-lived assets was
13
determined
based on Management's opinion that the idle assets had no economic value. Therefore, an impairment of long-lived assets of $0.4 million was recognized during the
three months ended September 30, 2007.
9. Long-Term Debt
Debt is summarized below (in thousands):
|
|
September 30, 2007
|
|
December 31, 2006
|
MarkWest Hydrocarbon Credit Facility
|
|
|
|
|
|
|
|
8.75% interest
|
|
$
|
|
|
$
|
|
Partnership Credit Facility
|
|
|
|
|
|
|
|
7.84% and 8.75% interest at September 30, 2007, and December 31, 2006, respectively, due December 2010
|
|
|
92,500
|
|
|
30,000
|
Partnership Senior Notes
|
|
|
|
|
|
|
|
6.875% interest, due November 2014
|
|
|
225,000
|
|
|
225,000
|
|
8.5% interest, net of original issue discount of $2,888 and $3,135, respectively, due July 2016
|
|
|
272,112
|
|
|
271,865
|
|
|
|
|
|
|
|
Total long-term debt
|
|
$
|
589,612
|
|
$
|
526,865
|
|
|
|
|
|
On August 18, 2006, the Company entered into the second amended and restated credit agreement (the "Company Credit Facility") which provides a maximum
lending limit of $55.0 million, increased from $25.0 million; and extends the term from one to three years. The Company Credit Facility includes a $40.0 million revolving
facility and a $15.0 million unit acquisition facility. The $15.0 million unit acquisition facility may be used to finance the acquisition of the Partnership's common units.
On
February 16, 2007, the Company entered into the first amendment to the second amended and restated Company Credit Facility, increasing the term by one year to August 20,
2010, and providing an additional $50.0 million of credit to enable the Company to meet potential margin requirements associated with its derivative instruments.
On
March 15, 2007, the Company entered into the second amendment to the second amended and restated Company Credit Facility. This amendment clarifies language relating to the swap
contracts between the Company and the lenders or lender's affiliates in several sections of the Company Credit Facility. It provides that the non-borrowing base credit extension, as
defined in the agreement, shall be used solely for the purpose of enabling the Company to meet margin requirements under swap contracts, as defined in the agreement, with counterparties that are not
lenders or affiliates of the lenders.
The
Company Credit Facility bears interest at a variable interest rate, plus basis points. The variable interest rate typically is based on the London Inter Bank Offering Rate; however,
in certain borrowing circumstances the rate would be based on the higher of a) the Federal Funds Rate plus 0.5-1%, and b) a rate set by the Company Credit Facility's
administrative agent, based on the U.S.
14
prime
rate. The basis points correspond to the ratio of the revolver facility usage to the borrowing base, ranging from 0.50% to 1.75% for base rate loans, and 1.50% to 2.75% for Eurodollar rate
loans. The Company pays a quarterly commitment fee on the unused portion of the credit facility at an annual rate ranging from 0.375% to 0.5%.
Under
the provisions of the Company Credit Facility, the Company is subject to a number of restrictions on its business, including its ability to grant liens on assets; make or own
certain investments; enter into any swap contracts other than in the ordinary course of business; merge, consolidate or sell assets; incur indebtedness (other than subordinated indebtedness); make
distributions on equity investments; declare or make, directly or indirectly, any restricted distributions.
The
Company Credit Facility also contains covenants requiring the Company to maintain:
-
-
a
leverage ratio (as defined in the credit agreement) of not greater than 4.0:1.0, or up to 5.5:1.0, in certain circumstances;
-
-
a
minimum net worth of a) $30.0 million plus, b) 50% of consolidated net income (if positive) earned on or after July 1, 2006, plus,
c) 100% of net proceeds of all equity issued by the Company subsequent to August 18, 2006; and
-
-
a
minimum collateral coverage ratio of not less than 2.0:1.0 as of the date of any determination.
The Partnership's wholly owned subsidiary, MarkWest Energy Operating Company, L.L.C., has a $250.0 million revolving credit facility (the "Partnership
Credit Facility"). The Partnership Credit Facility is guaranteed by the Partnership, substantially all of the Partnership's subsidiaries, and is collateralized by substantially all of the
Partnership's assets and those of its subsidiaries. The borrowings under the
Partnership Credit Facility bear interest at a variable interest rate, plus basis points. The basis points vary as defined in the fifth amendment to the Partnership Credit Facility. For the nine
months ended September 30, 2007, the weighted average interest rate on the Credit Facility was 7.51%.
Under
the provisions of the Partnership Credit Facility, the Partnership is subject to a number of restrictions and covenants as defined in the fifth amendment to the Partnership Credit
Facility. These covenants are used to calculate the available borrowing capacity on a quarterly basis. At September 30, 2007, available borrowings under the Partnership Credit Facility were
$139.9 million.
At September 30, 2007, the Partnership and its wholly owned subsidiary, MarkWest Energy Finance Corporation, had two series of senior notes outstanding;
$225.0 million at a fixed rate of 6.875% due in November 2014 and $272.1 million, net of unamortized discount of $2.9 million, at a fixed rate of 8.5% due in
July 2016 (the "2016 Notes"), together (the "Senior Notes"). The estimated fair value of the Senior Notes was approximately $478.3 million and $499.8 million at
September 30, 2007 and December 31, 2006, respectively, based on quoted market prices.
15
The
Partnership has no independent assets or operations, other than investments in subsidiaries and issuances of debt. Each of the Partnership's existing subsidiaries, other than
MarkWest Energy Finance Corporation, has guaranteed the Senior Notes jointly and severally and fully and unconditionally. The notes are senior unsecured obligations equal in right of payment with all
of the Partnership's existing and future senior debt. These notes are effectively junior in right of payment to its secured debt to the extent of the assets securing the debt, including the
Partnership's obligations in respect of the Partnership Credit Facility.
The
indentures governing the Senior Notes limit the activity of the Partnership and its restricted subsidiaries. Subject to compliance with certain covenants, the Partnership may issue
additional notes from time to time under the indenture pursuant to Rule 144A and Regulation S under the Securities Act of 1933.
The
Partnership agreed to file an exchange offer registration statement or, under certain circumstances, a shelf registration statement, pursuant to a registration rights agreement
relating to the 2016 Senior Notes. The Partnership failed to complete the exchange offer in the time provided for in the
subscription agreements and as a consequence incurred penalty interest of 0.5% from January 7, 2007 until February 26, 2007, when the exchange offer was completed.
The Partnership entered into a debt commitment letter, dated September 4, 2007, as amended on October 31, 2007, whereby, subject to the terms and
conditions set forth therein, two new senior secured credit facilities in an aggregate amount of $575.0 million, subject to increase as described therein, consisting of a $225.0 million
senior secured term loan and a $350.0 million senior secured revolving credit facility which under certain circumstances can be increased up to $450.0 million. Up to $25.0 million
of the revolving credit facility will be available as a letter of credit sub-facility. Both the term loan and revolving credit facility will be senior secured obligations of the
Partnership and guaranteed by MarkWest Energy Operating Company, L.L.C., the Company and substantially all of the subsidiaries of both the Partnership and the Company. Also in connection with the
signing of the redemption and merger agreement, the Partnership committed to make an intercompany loan to the Company in the amount of $225.0 million to fund its obligations under the
Redemption and Merger Agreement.
10. Derivative Financial Instruments
The Company's primary risk management objective is to manage volatility in its cash flows. The Company has a committee comprised of the senior management team
that oversees all of the risk management activity and continually monitors the Company's risk management program and expects to continue to adjust its financial positions as conditions warrant. The
Company uses mark-to-market accounting for its non-trading commodity derivative instruments, accordingly, the volatility in any given period related to unrealized
gains or losses can be significant to the overall financial results of the Company; however, management ultimately expects those gains and losses to be offset when they become realized. The Company
does not have any trading derivative financial instruments.
16
The
Company utilizes a combination of fixed-price forward contracts, fixed-for-floating price swaps and options on the over-the-counter
("OTC") market. The Company may also enter into futures contracts traded on the New York Mercantile Exchange ("NYMEX"). Swaps and futures contracts allow the Company to manage volatility in its
margins because corresponding losses or gains on the financial instruments are generally offset by gains or losses in its physical positions.
The
Company enters into OTC swaps with financial institutions and other energy company counterparties. The Company conducts a standard credit review on counterparties and has agreements
containing collateral requirements where deemed necessary. The Company uses standardized swap agreements that allow for offset of positive and negative exposures. The Company may be subject to margin
deposit requirements under OTC agreements (with non-bank counterparties) and NYMEX positions.
Because
of the strong correlation between NGL prices and crude oil prices and limited liquidity in the NGL financial market, the Company uses crude oil derivative instruments to manage
NGL price risk. As a result of these transactions, the Company has mitigated its expected commodity price risk with agreements expiring at various times through the first quarter of 2011. The margins
the Company earns from condensate sales are directly correlated with crude oil prices.
The
use of derivative instruments may expose the Company to the risk of financial loss in certain circumstances, including instances when (i) NGLs do not trade at historical
levels relative to crude oil, (ii) sales volumes are less than expected requiring market purchases to meet commitments, or (iii) the Company's OTC counterparties fail to purchase or
deliver the contracted quantities of natural gas, NGLs or crude oil or otherwise fail to perform. To the extent that the Company enters into derivative instruments, it may be prevented from realizing
the benefits of favorable price changes in the physical market. The Company is similarly insulated, however, against unfavorable changes in such prices.
The
Company may enter into physical and/or financial positions to manage its risks related to commodity price exposure for its Standalone Segment. Due to the timing of purchases and
sales, direct exposure to price volatility may result because there is no longer an offsetting purchase or sale that remains exposed to market pricing. Through marketing and derivative activities,
direct price exposure may occur naturally or the Company may choose direct exposure when it is favorable as compared to the frac spread risk.
The
Partnership's primary risk management objective is to reduce volatility in its cash flows arising from changes in commodity prices related to future sales of natural gas, NGLs and
crude oil. Swaps and futures contracts may allow the Partnership to reduce volatility in its realized margins as realized losses or gains on the derivative instruments generally are offset by
corresponding gains or losses in the Partnership's sales of physical product. While the Partnership largely expects its realized derivative gains and losses to be offset by increases or decreases in
the value of its physical sales, the Partnership
will experience volatility in reported earnings due to the recording of unrealized gains and losses on its derivative positions that will have no offset.
Fair
value is based on available market information for the particular derivative instrument, and incorporates the commodity, period, volume and pricing. Where published market values
are not readily available, the Company uses a third-party service. Due to the use of mark-to-market accounting, the fair value of our commodity derivative instruments is equal
to the carrying value. The impact of the
17
Company's
commodity derivative instruments on consolidated financial position are summarized below (in thousands):
|
|
September 30, 2007
|
|
December 31, 2006
|
|
Fair value of derivative instruments:
|
|
|
|
|
|
|
|
|
Current asset
|
|
$
|
7,409
|
|
$
|
9,938
|
|
|
Noncurrent asset
|
|
|
2,812
|
|
|
2,794
|
|
|
Current liability
|
|
|
(42,004
|
)
|
|
(7,476
|
)
|
|
Noncurrent liability
|
|
|
(32,122
|
)
|
|
(1,460
|
)
|
Risk management premiums:
|
|
|
|
|
|
|
|
|
Current asset
|
|
$
|
380
|
|
$
|
1,009
|
|
|
Noncurrent asset
|
|
|
717
|
|
|
717
|
|
The
Partnership has recorded premium payments relating to certain derivative option contracts as risk management deposits. The premiums allowed the Partnership to secure specific pricing
on those contracts. The payment is recorded as an asset and is amortized through revenue as the puts expire or are exercised. The current and noncurrent risk management premiums have been recorded as
"Other assets" and "Other long-term assets", respectively, in the accompanying Condensed Consolidated Balance Sheets.
The
Company accounts for the impact of its commodity derivative instruments as either a component of revenue or purchased product costs. Sales are recognized as a component of revenue
and purchases as a component of purchased product costs. The Company also has a contract which creates a floor on the frac spread which can be realized on a specific volume purchased. Gains and losses
from this contract are recorded as a component of purchased product costs. The Partnership accounts for the impact of its commodity derivative instruments as a component of revenue. The Partnership
also has a contract allowing it to fix a component of the price of electricity at one of its plant locations. Gains and losses from the contract are recognized as a component of facility expenses. The
consolidated impact of the Company's commodity derivative instruments on revenues are summarized below (in thousands):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized (loss) gain
|
|
$
|
(4,013
|
)
|
$
|
(1,974
|
)
|
$
|
674
|
|
$
|
(1,911
|
)
|
|
Unrealized (loss) gain
|
|
|
(20,373
|
)
|
|
24,695
|
|
|
(52,882
|
)
|
|
10,317
|
|
|
|
|
|
|
|
|
|
|
|
Derivative (loss) gain
|
|
$
|
(24,386
|
)
|
$
|
22,721
|
|
$
|
(52,208
|
)
|
$
|
8,406
|
|
|
|
|
|
|
|
|
|
|
|
18
The
consolidated impact of the Company's commodity derivative instruments included in purchased product costs and facility expenses in the accompanying Condensed Consolidated Statements
of Operations are summarized below (in thousands):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Purchased product costs:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Realized loss
|
|
$
|
(3,490
|
)
|
$
|
|
|
$
|
(4,691
|
)
|
$
|
|
|
Unrealized loss
|
|
|
(10,960
|
)
|
|
|
|
|
(14,468
|
)
|
|
|
Facility expenses:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Unrealized gain (loss)
|
|
$
|
245
|
|
$
|
|
|
$
|
(351
|
)
|
$
|
|
11. Income Taxes
The Company accounts for income taxes under the asset and liability method pursuant to SFAS 109. Under SFAS 109, deferred income taxes are
recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax basis and net
operating loss and credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect of any tax rate change on deferred taxes is recognized in the period that includes the enactment date of the tax rate change.
Realizability of deferred tax assets is assessed and, if not more likely than not, a valuation allowance is recorded to write down the deferred tax assets to their net realizable value.
The
Company bases the effective corporate tax rate for interim periods on the estimated annual effective corporate tax rate. For the nine months ended September 30, 2007 and 2006,
the estimated annual effective corporate tax rate was 42.7% and 35.4%, respectively. The 2007 estimated annual effective income tax rate varies from the statutory rate mostly due to a change in the
valuation allowance in the state Net Operating Losses ("NOL") related to the state NOL utilization. As a result, income tax benefit totaled $7.9 million and $10.3 million for the three
and nine months ended September 30, 2007, respectively. Income tax expense totaled $5.4 million and $5.9 million for the three and nine months ended September 30, 2006,
respectively.
The
Company adopted FIN 48, effective January 1, 2007. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company's financial statements
in accordance with SFAS 109. Specifically, the pronouncement prescribes a "more likely than not" recognition threshold and a measurement attribute for the financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting
for interim periods, disclosure and transition of uncertain tax positions. As a result of the implementation of FIN 48, the Company recognized a liability of $0.4 million for unrecognized
income tax benefits in the first quarter of 2007, none of which would affect the Company's effective tax rate if recognized. Included in the unrecognized income tax benefit is a $0.1 million
reduction of retained earnings.
19
On
July 12, 2007, the State of Michigan enacted changes in its taxation scheme. As a result, the Company has made the necessary adjustments to the deferred tax assets (and
liabilities) in the form of a charge (or benefit) to income, as part of its income tax provision in the third quarter. Michigan's new tax law replaces the single business tax with a
two-prong tax. The two prongs comprise a tax at the rate of 0.8% of a taxpayer's modified gross receipts and a tax at the rate of 4.95% of the taxpayer's business income. The new tax takes
effect on January 1, 2008 and applies to all business activity occurring after December 31, 2007. The current single business tax will remain in effect through
December 31, 2007. The current single business tax will remain in effect through December 31, 2007. Adopted on September 30, 2007, and effective January 1, 2008, Michigan
House Bill 5104 creates a deduction from a taxpayer's pre-apportioned business income tax base equal to the total book-tax difference triggered by the enactment of the Michigan
business tax that results in a net deferred tax liability. The net impact to the Partnership was a $0.2 million charge to income in the third quarter of 2007, with the Company recording its
proportionate share of less than $0.1 million.
The
Texas margin tax law that was signed into law on May 18, 2006, causes the Partnership to be subject to an entity-level tax on the portion of its income that is generated in
Texas beginning with tax year ending in 2007. The Texas margin tax is imposed at a maximum effective rate of 1.0%. Imposition of such a tax on the Partnership by Texas reduces the cash available for
distribution to unitholders. Consistent with the principles of accounting for income taxes, the Partnership adjusted its deferred tax liability and expense by $0.1 million and
$0.2 million for the three and nine months ended September 30, 2007, respectively, related to the Partnership's temporary differences that are expected to reverse in future periods when
the tax will apply. No adjustment was recorded for the three months ended September 30, 2006 and a deferred tax liability of $0.7 million was recorded for the nine months ended
September 30, 2006.
The
Company recognizes interest and penalties related to uncertain tax positions in "Interest expense" and "Selling, general and administrative expenses" in the accompanying Condensed
Consolidated Statements of Operations. As of the date of adoption, the Company has approximately $0.1 million of accrued interest and penalties related to uncertain tax positions.
The
tax years 2002 through 2006 remain open to examination by the major taxing jurisdictions to which the Company is subject.
12. Incentive Compensation Plans
The Company's shareholders have adopted the 2006 Stock Incentive Plan (the "2006 Plan"), the 2006 Plan allows for the grant of a maximum of 1.0 million
restricted shares and stock options. The 2006 Plan is administered by the Compensation Committee of the Company's Board of Directors.
The
Company has also entered into arrangements with certain directors and employees of the Company referred to as the Participation Plan. Under it, the Company is able to sell interests
in the Partnership's General Partner under a purchase and sale agreement. The Company has not sold any interests in the General Partner since the first quarter of 2006.
The
general partner of the Partnership has adopted the Long Term Incentive Plan (the "LTIP") for employees and directors of the general partner, as well as employees of its affiliates
who perform services for the Partnership. The LTIP currently permits the grant of awards covering an aggregate of
20
1.0 million
common units, comprised of 0.4 million restricted units and 0.6 million unit options. The LTIP is administered by the Compensation Committee of the General Partner's
Board of Directors. As of September 30, 2007 the Partnership had not issued any unit options.
Total
compensation cost for share-based pay arrangements was as follows (in thousands):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
|
MarkWest Hydrocarbon
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock options
|
|
$
|
|
|
$
|
10
|
|
$
|
|
|
$
|
45
|
|
|
Restricted stock
|
|
|
217
|
|
|
111
|
|
|
590
|
|
|
315
|
|
|
General partner interests under Participation Plan
|
|
|
(510
|
)
|
|
8,168
|
|
|
13,263
|
|
|
12,141
|
|
|
Subordinated units under Participation Plan
|
|
|
|
|
|
21
|
|
|
|
|
|
(8
|
)
|
MarkWest Energy Partners
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Restricted units
|
|
|
61
|
|
|
532
|
|
|
1,240
|
|
|
1,103
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total compensation cost
|
|
$
|
(232
|
)
|
$
|
8,842
|
|
$
|
15,093
|
|
$
|
13,596
|
|
|
|
|
|
|
|
|
|
|
|
Compensation
expense has been recorded as "Selling, general and administrative expenses" in the accompanying Condensed Consolidated Statements of Operations. The expense not yet
recognized as of September 30, 2007, related to unvested restricted stock and unvested restricted units was $0.9 million and $1.7 million, respectively, with weighted average
remaining vesting periods of 1.8 and 1.7 years, respectively. The actual compensation cost recognized might differ for the restricted units, as they qualify as liability awards, which are
affected by changes in fair value.
The following summarizes the impact of stock option activity under the 2006 Plan (in thousands of shares):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Options exercised, cashless
|
|
|
|
|
|
1
|
|
7
|
Shares issued, cashless
|
|
|
|
|
|
1
|
|
4
|
Options exercised, cash
|
|
|
|
2
|
|
13
|
|
32
|
Shares issued, cash
|
|
|
|
2
|
|
13
|
|
32
|
For
the nine months ended September 30, 2007 and 2006, the Company received exercise proceeds of $0.1 million and $0.3 million, respectively, for the exercise
of stock options. The Company has not granted any stock options since 2004. The fair value of each option granted in 2004 was estimated
21
using
the Black-Scholes option-pricing model. The following assumptions were used to compute the weighted-average fair value of options granted:
|
|
2004
|
|
Expected life of options
|
|
6 years
|
|
Risk free interest rate
|
|
3.62
|
%
|
Estimated volatility
|
|
32
|
%
|
Dividend yield
|
|
4.7
|
%
|
During
the nine months ended September 30, 2007, the Company had not granted any stock options and there were no forfeitures or cancellations of exercisable options. The
following is a summary of stock option activity under the 2006 Plan:
|
|
Number of
Shares
|
|
Weighted-
average
Exercise Price
|
|
Weighted-
average
Remaining
Contractual
Term
|
|
Aggregate
Intrinsic
Value
|
Outstanding and Exercisable at December 31, 2006
|
|
65,635
|
|
$
|
7.48
|
|
|
|
|
|
Exercised
|
|
(13,645
|
)
|
|
8.55
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding and Exercisable at September 30, 2007
|
|
51,990
|
|
|
7.20
|
|
4.3
|
|
$
|
2,647,946
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Total fair value of options vested during the period
|
|
$
|
|
|
$
|
53,746
|
|
$
|
|
|
$
|
120,932
|
Total intrinsic value of options exercised during the period
|
|
|
14,787
|
|
|
46,006
|
|
|
701,892
|
|
|
605,377
|
The
following is a summary of restricted stock granted under the 2006 Plan:
|
|
Number of Shares
|
|
Weighted-average
Grant-date Fair
Value
|
Unvested at December 31, 2006
|
|
41,694
|
|
$
|
26.89
|
Granted
|
|
17,161
|
|
|
47.89
|
Vested
|
|
(7,197
|
)
|
|
20.51
|
Forfeited
|
|
(5,054
|
)
|
|
31.10
|
|
|
|
|
|
|
Unvested at September 30, 2007
|
|
46,604
|
|
|
35.16
|
|
|
|
|
|
|
22
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
Weighted-average grant-date fair value of restricted stock granted during the period
|
|
$
|
821,840
|
|
$
|
375,500
|
Total fair value of restricted stock vested during the period
|
|
|
147,605
|
|
|
44,526
|
During
the nine months ended September 30, 2007 and 2006, the Company received no proceeds for issuing restricted stock, and there were no cash settlements.
Pursuant
to the terms of the amended and restated Class B Membership Interest Contribution Agreement dated October 26, 2007, all outstanding interests in the General
Partner will be exchanged for a combination of the Partnership's common units and cash on the date of the merger as described in Note 4. The exchange will be accounted for as a settlement of a
share based payment liability under SFAS 123R,
Share Based Payment
("SFAS 123R"), and any difference between the carrying value of the
Company's liability and the payment at the time of the redemption and merger will be recorded as additional compensation expense.
The following is a summary of restricted units granted under the LTIP:
|
|
Number of Units
|
|
Weighted-average
Grant-date Fair
Value
|
Unvested at December 31, 2006
|
|
125,200
|
|
$
|
24.14
|
Granted
|
|
52,716
|
|
|
31.55
|
Vested
|
|
(40,912
|
)
|
|
23.50
|
Forfeited
|
|
(12,682
|
)
|
|
25.63
|
|
|
|
|
|
|
Unvested at September 30, 2007
|
|
124,322
|
|
|
27.34
|
|
|
|
|
|
|
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Weighted-average grant-date fair value of restricted units granted during the period
|
|
$
|
177,305
|
|
$
|
|
|
$
|
1,663,379
|
|
$
|
1,412,933
|
Total fair value of restricted units vested during the period
|
|
|
19,296
|
|
|
162,140
|
|
|
1,281,046
|
|
|
612,513
|
During
the nine months ended September 30, 2007, and 2006, the Partnership received no proceeds (other than the contributions by the General Partner to maintain its 2%
ownership interest) for issuing restricted units, and there were no cash settlements. None of the restricted units that vested in 2007 and 2006 were redeemed by the Partnership for cash. For the
nine months ended September 30, 2007 and 2006, the Partnership issued 40,912 and 25,986 common units, respectively.
On
September 5, 2007, the Compensation Committee of the General Partner's Boards of Directors approved a share based payment arrangement that would provide for the grant of up to
795,000 phantom units to senior executives and other key employees. Any grant is contingent upon the closing of the redemption and merger as described in Note 4.
23
13. Dividends Paid to Shareholders
On October 26, 2007, the Company's Board of Directors declared a quarterly cash dividend of $0.36 per share, payable on November 21, 2007, to the
stockholders of record as of the close of business on November 9, 2007. The ex-dividend date will be November 7, 2007.
14. Earnings Per Share
Basic and diluted income (loss) per common share is computed in accordance with SFAS 128,
Earnings per
Share
. Basic income (loss) per common share is computed by dividing net income (loss) attributable to common stockholders by the weighted average number of shares of common
stock outstanding. For the three months ended September 30, 2007 and 2006, there is no difference between basic and diluted income (loss) per share since potential common shares from the
exercises of stock options are anti-dilutive and are, therefore, excluded from the calculation of income (loss) per share.
Options
to purchase 51,990 shares of common stock were outstanding as of September 30, 2007, and were exercisable into 51,990 shares of common stock as of September 30,
2007, but were not included in the calculation of diluted income (loss) per share because the effect of their inclusion would have been anti-dilutive. The following table shows the
computation of basic and diluted earnings
per share and the weighted-average shares used to compute diluted net income per share (in thousands, except per share data):
|
|
Three months ended September 30,
|
|
Nine months ended September 30,
|
|
|
2007
|
|
2006
|
|
2007
|
|
2006
|
Net (loss) income
|
|
$
|
(7,454
|
)
|
$
|
10,004
|
|
$
|
(13,769
|
)
|
$
|
10,704
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding during the period
|
|
|
12,001
|
|
|
11,956
|
|
|
11,995
|
|
|
11,933
|
|
Effect of dilutive instruments(1)
|
|
|
|
|
|
59
|
|
|
|
|
|
88
|
|
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding during the period including the effects of dilutive instruments(1)
|
|
|
12,001
|
|
|
12,015
|
|
|
11,995
|
|
|
12,021
|
|
|
|
|
|
|
|
|
|
Net (loss) income per share:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.62
|
)
|
$
|
0.84
|
|
$
|
(1.15
|
)
|
$
|
0.90
|
|
|
|
|
|
|
|
|
|
|
Diluted(1)
|
|
$
|
(0.62
|
)
|
$
|
0.83
|
|
$
|
(1.15
|
)
|
$
|
0.89
|
|
|
|
|
|
|
|
|
|
-
(1)
-
Due
to the Company's net loss for the three and nine months ended September 30, 2007, 45,793 and 58,153 shares, respectively, were excluded from the calculation of
diluted shares because the common shares were anti-dilutive.
15. Commitments and Contingencies
The Company is subject to a variety of risks and disputes, and is a party to various legal proceedings in the normal course of its business. The Company maintains
insurance policies in amounts and with coverage and deductibles as it believes is reasonable and prudent. However, the Company cannot assure either that the insurance companies will promptly honor
their policy obligations or that the coverage or levels of insurance will be adequate to protect the Partnership from all material expenses related to future claims for property loss or business
interruption to the Company and the Partnership (collectively MarkWest); or for third-party claims of personal and property damage; or that the coverages or levels of insurance it currently has will
be available in the future at economical prices.
24
While
it is not possible to predict the outcome of the legal actions with certainty, Management is of the opinion that appropriate provision and accruals for potential losses associated with all legal
actions have been made in the financial statements.
In
June 2006, the Office of Pipeline Safety ("OPS") issued a Notice of Probable Violation and Proposed Civil Penalty ("NOPV") (CPF No. 2-2006-5001)
to both MarkWest Hydrocarbon and Equitable Production Company. The NOPV is associated with the pipeline leak and an ensuing explosion and fire that occurred on November 8, 2004 in Ivel,
Kentucky on an NGL pipeline owned by Equitable Production Company and leased and operated by our subsidiary, MarkWest Energy Appalachia, LLC. The NOPV sets forth six counts of violations of applicable
regulations, and a proposed civil penalty in the aggregate amount of $1,070,000. An administrative hearing on the matter, previously set for the last week of March, 2007, was postponed to allow the
administrative record to be produced and to allow OPS an opportunity to responds to a motion to dismiss one of the counts of violations, which involves $825,000 of the $1,070,000 proposed penalty.
This count arises out of alleged
activity in 1982 and 1987, which predates MarkWest's leasing and operation of the pipeline. MarkWest believes it has viable defenses to the remaining counts and will vigorously defend all applicable
assertions of violations at the hearing.
Related
to the above referenced 2004 pipeline explosion and fire incident, MarkWest Hydrocarbon and the Partnership have filed an action captioned
MarkWest
Hydrocarbon, Inc., et al. v. Liberty Mutual Ins. Co., et al.
(District Court, Arapahoe County, Colorado, Case No. 05CV3953 filed August 12, 2005), as
removed to the U.S. District Court for the District of Colorado, (Civil Action No. 1:05-CV-1948, on October 7, 2005) against their All-Risks Property
and Business Interruption insurance carriers as a result of the insurance companies' refusal to honor their insurance coverage obligation to pay the Partnership for certain costs related to the
pipeline incident. The costs include internal costs incurred for damage to, and loss of use of the pipeline, equipment and products; extra transportation costs incurred for transporting the liquids
while the pipeline is out of service; reduced volumes of liquids that could be processed; and the costs of complying with the OPS Corrective Action Order (hydrostatic testing, repair/replacement and
other pipeline integrity assurance measures). Following initial discovery, MarkWest was granted leave of the Court to amend its complaint to add a bad faith claim and a claim for punitive damages. The
Partnership has not provided for a receivable for any of the claims in this action because of the uncertainty as to whether and how much it will ultimately recover under the policies. The costs
associated with this claim have been expensed as incurred and any potential recovery from the All-Risks Property and Business Interruption insurance carriers will be recognized if and when
it is received. Trial has been set for three weeks in April 2008. The Defendant insurance companies and MarkWest have each filed separate summary judgment motions in the action and these
motions are pending with the Court. Discovery in the action is also continuing.
With
regard to the Partnership's Javelina facility, MarkWest Javelina is a party with numerous other defendants to several lawsuits brought by various plaintiffs who had residences or
businesses located near the Corpus Christi industrial area, an area which included the Javelina gas processing plant, and several petroleum, petrochemical and metal processing and refining operations.
These suits,
Victor Huff v. ASARCO Incorporated, et al
. (Cause No. 98-01057-F, 214
th
Judicial Dist. Ct.,
County of Nueces, Texas, original petition filed in March 3, 1998);
Jason and Dianne Gutierrez, individually and as representative of the estate of Sarina Galan
Gutierrez
(Cause No. 05-2470-A, 28
TH
Judicial District, severed May 18, 2005, from the
Gonzales
case cited above); and
Esmerejilda G.
Valasquez, et al. v. Occidental Chemical Corp., et al.,
Case No. A-060352-C, 128
th
Judicial District, Orange County, Texas, original petition filed July 10, 2006; as refiled from previously dismissed
petition captioned
Jesus Villarreal v. Koch Refining Co. et al
., Cause No. 05-01977-F, 214
th
Judicial Dist.
Ct., County of Nueces, Texas, originally filed April 27, 2005), set forth claims for wrongful death, personal injury or property
25
damage,
harm to business operations and nuisance type claims, allegedly incurred as a result of operations and emissions from the various industrial operations in the area or from products Defendants
allegedly manufactured, processed, used, or distributed. The actions have been and are being vigorously defended and; based on initial evaluation and consultations; it appears at this time that these
actions should not have a material adverse impact on the Partnership's business.
In
August 2007, an action styled
Marvin Wageman, et al. v. MarkWest Western Oklahoma Gas Company, L.L.C.
, (District Court,
Pittsburg County, Oklahoma, Case # C-2007-924, filed August 14, 2007), was filed against MarkWest Western Oklahoma Gas Company, L.L.C., alleging a breach of certain
special construction provisions attached to a right of way agreement with MarkWest, enabling construction of a gas pipeline across property owned by Plaintiffs. The Partnership has filed an answer
denying the plaintiffs' allegations. No scheduling order has been issued to date, and discovery has not commenced. Due to the very preliminary stage in this matter, the likelihood of success cannot be
predicted at this time, but based on the current evaluations; it appears at this time that this action should not have a material impact on our interests. The Partnership will vigorously defend
against liability.
In
the ordinary course of business, the Company is a party to various other legal actions. In the opinion of Management, none of these actions, either individually or in the aggregate,
will have a material adverse effect on the Company's financial condition, liquidity or results of operations.
16. Segment Reporting
The Company's operations are classified into two reportable segments:
-
1.
-
MarkWest Hydrocarbon Standalone
MarkWest Hydrocarbon Standalone (the "Standalone Segment") sells its equity and third-party
NGLs, purchases third-party natural gas and sells its equity and third-party natural gas. Between February 2004 and June 2006, the Standalone Segment was engaged in the wholesale propane
marketing business through a third-party agency agreement. The Standalone Segment operates the Partnership, a publicly traded limited partnership.
-
2.
-
MarkWest Energy Partners
The Partnership is engaged in the gathering, processing and transmission of natural gas; the
transportation, fractionation and storage of natural gas liquids; and the gathering and transportation of crude oil.
The
Company evaluates the performance of its segments and allocates resources to them based on operating income. The Company conducts its operations in the United States of America.
Selling,
general and administrative expenses are allocated to the segments based on direct expenses incurred by the segments or allocated based on the percent of time that employees
devote to the
segment in accordance with the Partnership's services agreement with the Standalone Segment. The tables below present information about the net income for the reported segments.
26
Three months ended September 30, 2007 (in thousands):
|
|
MarkWest
Hydrocarbon
Standalone
|
|
MarkWest
Energy
Partners
|
|
Consolidating
Entries
|
|
Total
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
45,745
|
|
$
|
174,918
|
|
$
|
(20,729
|
)
|
$
|
199,934
|
|
|
Derivative loss
|
|
|
(16,531
|
)
|
|
(7,855
|
)
|
|
|
|
|
(24,386
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
29,214
|
|
|
167,063
|
|
|
(20,729
|
)
|
|
175,548
|
|
|
Purchased product costs
|
|
|
47,443
|
|
|
89,474
|
|
|
(14,858
|
)
|
|
122,059
|
|
|
Facility expenses
|
|
|
5,199
|
|
|
19,346
|
|
|
(5,921
|
)
|
|
18,624
|
|
|
Selling, general and administrative expenses
|
|
|
1,828
|
|
|
9,565
|
|
|
|
|
|
11,393
|
|
|
Depreciation
|
|
|
240
|
|
|
10,893
|
|
|
|
|
|
11,133
|
|
|
Amortization of intangible assets
|
|
|
|
|
|
4,168
|
|
|
|
|
|
4,168
|
|
|
Accretion of asset retirement and lease obligations
|
|
|
|
|
|
30
|
|
|
|
|
|
30
|
|
|
Impairments
|
|
|
|
|
|
356
|
|
|
|
|
|
356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations
|
|
|
(25,496
|
)
|
|
33,231
|
|
|
50
|
|
|
7,785
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from unconsolidated affiliates
|
|
|
|
|
|
1,264
|
|
|
|
|
|
1,264
|
|
|
Interest income
|
|
|
253
|
|
|
150
|
|
|
|
|
|
403
|
|
|
Interest expense
|
|
|
(130
|
)
|
|
(10,072
|
)
|
|
|
|
|
(10,202
|
)
|
|
Amortization of deferred financing costs (a component of interest expense)
|
|
|
(69
|
)
|
|
(702
|
)
|
|
|
|
|
(771
|
)
|
|
Dividend income
|
|
|
169
|
|
|
1
|
|
|
|
|
|
170
|
|
|
Miscellaneous income
|
|
|
619
|
|
|
593
|
|
|
(63
|
)
|
|
1,149
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before non-controlling interest in net income of consolidated subsidiary and income taxes
|
|
|
(24,654
|
)
|
|
24,465
|
|
|
(13
|
)
|
|
(202
|
)
|
|
Non-controlling interest in net income of consolidated subsidiary
|
|
|
|
|
|
|
|
|
(15,131
|
)
|
|
(15,131
|
)
|
|
Interest in net income of consolidated subsidiary
|
|
|
9,303
|
|
|
|
|
|
(9,303
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before taxes
|
|
|
(15,351
|
)
|
|
24,465
|
|
|
(24,447
|
)
|
|
(15,333
|
)
|
|
Provision for income tax benefit (expense)
|
|
|
7,909
|
|
|
(304
|
)
|
|
274
|
|
|
7,879
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(7,442
|
)
|
$
|
24,161
|
|
$
|
(24,173
|
)
|
$
|
(7,454
|
)
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
191,289
|
|
$
|
1,342,866
|
|
$
|
(97,697
|
)
|
$
|
1,436,458
|
|
|
|
|
|
|
|
|
|
|
|
27
Three months ended September 30, 2006 (in thousands):
|
|
MarkWest
Hydrocarbon
Standalone
|
|
MarkWest
Energy
Partners
|
|
Consolidating
Entries
|
|
Total
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
53,223
|
|
$
|
163,888
|
|
$
|
(19,694
|
)
|
$
|
197,417
|
|
|
Derivative gain
|
|
|
10,051
|
|
|
12,670
|
|
|
|
|
|
22,721
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
63,274
|
|
|
176,558
|
|
|
(19,694
|
)
|
|
220,138
|
|
|
Purchased product costs
|
|
|
40,150
|
|
|
95,533
|
|
|
(13,746
|
)
|
|
121,937
|
|
|
Facility expenses
|
|
|
5,099
|
|
|
15,689
|
|
|
(5,948
|
)
|
|
14,840
|
|
|
Selling, general and administrative expenses
|
|
|
5,991
|
|
|
13,078
|
|
|
|
|
|
19,069
|
|
|
Depreciation
|
|
|
221
|
|
|
7,905
|
|
|
|
|
|
8,126
|
|
|
Amortization of intangible assets
|
|
|
|
|
|
4,029
|
|
|
|
|
|
4,029
|
|
|
Accretion of asset retirement and lease obligations
|
|
|
|
|
|
24
|
|
|
|
|
|
24
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
11,813
|
|
|
40,300
|
|
|
|
|
|
52,113
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from unconsolidated affiliates
|
|
|
|
|
|
1,067
|
|
|
|
|
|
1,067
|
|
|
Interest income
|
|
|
34
|
|
|
230
|
|
|
|
|
|
264
|
|
|
Interest expense
|
|
|
(60
|
)
|
|
(9,523
|
)
|
|
|
|
|
(9,583
|
)
|
|
Amortization of deferred financing costs (a component of interest expense)
|
|
|
(55
|
)
|
|
(6,066
|
)
|
|
|
|
|
(6,121
|
)
|
|
Dividend income
|
|
|
112
|
|
|
|
|
|
|
|
|
112
|
|
|
Miscellaneous income
|
|
|
8
|
|
|
3,970
|
|
|
|
|
|
3,978
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before non-controlling interest in net income of consolidated subsidiary and income taxes
|
|
|
11,852
|
|
|
29,978
|
|
|
|
|
|
41,830
|
|
|
Non-controlling interest in net income of consolidated subsidiary
|
|
|
|
|
|
|
|
|
(26,438
|
)
|
|
(26,438
|
)
|
|
Interest in net income of consolidated subsidiary
|
|
|
3,540
|
|
|
|
|
|
(3,540
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before taxes
|
|
|
15,392
|
|
|
29,978
|
|
|
(29,978
|
)
|
|
15,392
|
|
|
Provision for income tax expense
|
|
|
(5,388
|
)
|
|
|
|
|
|
|
|
(5,388
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
10,004
|
|
$
|
29,978
|
|
$
|
(29,978
|
)
|
$
|
10,004
|
|
|
|
|
|
|
|
|
|
|
|
|
Total assets
|
|
$
|
101,620
|
|
$
|
1,061,974
|
|
$
|
(19,032
|
)
|
$
|
1,144,562
|
|
|
|
|
|
|
|
|
|
|
|
28
Nine months ended September 30, 2007 (in thousands):
|
|
MarkWest
Hydrocarbon
Standalone
|
|
MarkWest
Energy
Partners
|
|
Consolidating
Entries
|
|
Total
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
170,830
|
|
$
|
478,608
|
|
$
|
(59,096
|
)
|
$
|
590,342
|
|
|
Derivative loss
|
|
|
(30,061
|
)
|
|
(22,147
|
)
|
|
|
|
|
(52,208
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
140,769
|
|
|
456,461
|
|
|
(59,096
|
)
|
|
538,134
|
|
|
Purchased product costs
|
|
|
148,963
|
|
|
265,810
|
|
|
(40,882
|
)
|
|
373,891
|
|
|
Facility expenses
|
|
|
14,974
|
|
|
52,605
|
|
|
(18,478
|
)
|
|
49,101
|
|
|
Selling, general and administrative expenses
|
|
|
15,046
|
|
|
35,882
|
|
|
|
|
|
50,928
|
|
|
Depreciation
|
|
|
826
|
|
|
27,806
|
|
|
|
|
|
28,632
|
|
|
Amortization of intangible assets
|
|
|
|
|
|
12,504
|
|
|
|
|
|
12,504
|
|
|
Accretion of asset retirement and lease obligations
|
|
|
|
|
|
85
|
|
|
|
|
|
85
|
|
|
Impairment
|
|
|
|
|
|
356
|
|
|
|
|
|
356
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income from operations
|
|
|
(39,040
|
)
|
|
61,413
|
|
|
264
|
|
|
22,637
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from unconsolidated affiliates
|
|
|
|
|
|
4,687
|
|
|
|
|
|
4,687
|
|
|
Interest income
|
|
|
1,374
|
|
|
2,549
|
|
|
|
|
|
3,923
|
|
|
Interest expense
|
|
|
(252
|
)
|
|
(28,418
|
)
|
|
|
|
|
(28,670
|
)
|
|
Amortization of deferred financing costs (a component of interest expense)
|
|
|
(198
|
)
|
|
(2,024
|
)
|
|
|
|
|
(2,222
|
)
|
|
Dividend income
|
|
|
427
|
|
|
82
|
|
|
|
|
|
509
|
|
|
Miscellaneous income (expense)
|
|
|
474
|
|
|
(668
|
)
|
|
(63
|
)
|
|
(257
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before non-controlling interest in net income of consolidated subsidiary and income taxes
|
|
|
(37,215
|
)
|
|
37,621
|
|
|
201
|
|
|
607
|
|
|
Non-controlling interest in net income of consolidated subsidiary
|
|
|
|
|
|
|
|
|
(24,653
|
)
|
|
(24,653
|
)
|
|
Interest in net income of consolidated subsidiary
|
|
|
12,915
|
|
|
|
|
|
(12,915
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Loss) income before taxes
|
|
|
(24,300
|
)
|
|
37,621
|
|
|
(37,367
|
)
|
|
(24,046
|
)
|
|
Provision for income tax benefit (expense)
|
|
|
10,329
|
|
|
(429
|
)
|
|
377
|
|
|
10,277
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net (loss) income
|
|
$
|
(13,971
|
)
|
$
|
37,192
|
|
$
|
(36,990
|
)
|
$
|
(13,769
|
)
|
|
|
|
|
|
|
|
|
|
|
29
Nine months ended September 30, 2006 (in thousands):
|
|
MarkWest
Hydrocarbon
Standalone
|
|
MarkWest
Energy
Partners
|
|
Consolidating
Entries
|
|
Total
|
|
Revenue:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
|
$
|
217,503
|
|
$
|
486,301
|
|
$
|
(55,288
|
)
|
$
|
648,516
|
|
|
Derivative gain
|
|
|
2,397
|
|
|
6,009
|
|
|
|
|
|
8,406
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total revenue
|
|
|
219,900
|
|
|
492,310
|
|
|
(55,288
|
)
|
|
656,922
|
|
|
Purchased product costs
|
|
|
184,677
|
|
|
296,368
|
|
|
(37,327
|
)
|
|
443,718
|
|
|
Facility expenses
|
|
|
15,678
|
|
|
44,918
|
|
|
(17,961
|
)
|
|
42,635
|
|
|
Selling, general and administrative expenses
|
|
|
13,102
|
|
|
30,404
|
|
|
|
|
|
43,506
|
|
|
Depreciation
|
|
|
820
|
|
|
22,462
|
|
|
|
|
|
23,282
|
|
|
Amortization of intangible assets
|
|
|
|
|
|
12,072
|
|
|
|
|
|
12,072
|
|
|
Accretion of asset retirement and lease obligations
|
|
|
|
|
|
75
|
|
|
|
|
|
75
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations
|
|
|
5,623
|
|
|
86,011
|
|
|
|
|
|
91,634
|
|
Other income (expense):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Earnings from unconsolidated affiliates
|
|
|
|
|
|
3,240
|
|
|
|
|
|
3,240
|
|
|
Interest income
|
|
|
397
|
|
|
709
|
|
|
|
|
|
1,106
|
|
|
Interest expense
|
|
|
(212
|
)
|
|
(31,213
|
)
|
|
|
|
|
(31,425
|
)
|
|
Amortization of deferred financing costs (a component of interest expense)
|
|
|
(105
|
)
|
|
(7,700
|
)
|
|
|
|
|
(7,805
|
)
|
|
Dividend income
|
|
|
327
|
|
|
|
|
|
|
|
|
327
|
|
|
Miscellaneous income
|
|
|
160
|
|
|
7,577
|
|
|
|
|
|
7,737
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income before non-controlling interest in net income of consolidated subsidiary and income taxes
|
|
|
6,190
|
|
|
58,624
|
|
|
|
|
|
64,814
|
|
|
Non-controlling interest in net income of consolidated subsidiary
|
|
|
|
|
|
|
|
|
(48,255
|
)
|
|
(48,255
|
)
|
|
Interest in net income of consolidated subsidiary
|
|
|
10,233
|
|
|
|
|
|
(10,233
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income (loss) before taxes
|
|
|
16,423
|
|
|
58,624
|
|
|
(58,488
|
)
|
|
16,559
|
|
|
Provision for income tax (expense) benefit
|
|
|
(5,719
|
)
|
|
(679
|
)
|
|
543
|
|
|
(5,855
|
)
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income
|
|
$
|
10,704
|
|
$
|
57,945
|
|
$
|
(57,945
|
)
|
$
|
10,704
|
|
|
|
|
|
|
|
|
|
|
|
17. Restatement of Condensed Consolidated Financial Statements
Subsequent to the issuance of the Company's condensed consolidated financial statements for the quarter ended September 30, 2006, the Company determined
that certain revenue transactions in the MarkWest Energy Partners segment were reported net and should be accounted for gross as a principal, pursuant to EITF Issue No. 99-19,
Reporting Revenue Gross as a Principal versus
Net as an Agent
("EITF 99-19"). EITF 99-19 requires the Company to record revenue
gross when its acts as the principal in a transaction and net when it acts as an agent. As a result, the Company has restated its condensed consolidated financial statements for the three and
nine months periods ended September 30, 2006.
30
The
following tables present the impact of the restatement on the affected line items of the Condensed Consolidated Statements of Operations for the periods presented (in thousands):
|
|
Three Months Ended September 30, 2006
|
|
Nine Months Ended September 30, 2006
|
|
|
As Previously
Reported
|
|
Adjustment
|
|
Restated
|
|
As Previously
Reported
|
|
Adjustment
|
|
Restated
|
Revenue
|
|
|
183,516
|
|
|
13,901
|
|
|
197,417
|
|
|
610,985
|
|
|
37,531
|
|
|
648,516
|
Total revenue
|
|
$
|
206,237
|
|
$
|
13,901
|
|
$
|
220,138
|
|
$
|
619,391
|
|
$
|
37,531
|
|
$
|
656,922
|
Purchased product costs(1)
|
|
|
108,220
|
|
|
13,717
|
|
|
121,937
|
|
|
406,245
|
|
|
37,473
|
|
|
443,718
|
Facility expenses(1)
|
|
|
14,656
|
|
|
184
|
|
|
14,840
|
|
|
42,577
|
|
|
58
|
|
|
42,635
|
Total operating expenses
|
|
|
154,124
|
|
|
13,901
|
|
|
168,025
|
|
|
527,757
|
|
|
37,531
|
|
|
565,288
|
Income from operations
|
|
|
52,113
|
|
|
|
|
|
52,113
|
|
|
91,634
|
|
|
|
|
|
91,634
|
-
(1)
-
In
addition, we corrected a misclassification between facilities expense and purchase product costs, which totaled $184 and $58 for the three and nine months ended
September 30, 2006, respectively.
The
restatement of revenue and expenses does not affect net income, earnings per unit, the Condensed Consolidated Statements of Partners' Capital or the Condensed Consolidated Balance
Sheets.
31