UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2006

or

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT Of 1934

 

For the transition period from                       to                         

Commission file number 1-9356

BUCKEYE PARTNERS, L.P.

(Exact name of registrant as specified in its charter)

Delaware

 

23-2432497

(State or other jurisdiction of

 

(IRS Employer

incorporation or organization)

 

Identification No.)

 

 

 

5002 Buckeye Road

 

 

P. O. Box 368

 

 

Emmaus, PA

 

18049

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: 484-232-4000

Not Applicable
(Former name, former address and former fiscal year, if changed since last report).

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large Accelerated Filer x

 

Accelerated Filer o

 

Non-Accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

 

Outstanding at October 17, 2006

Limited Partnership Units

 

39,431,746 Units

 

 




 

BUCKEYE PARTNERS, L.P.

INDEX

 

 

 

Page No.

 

Part I.

 

Financial Information

 

 

 

 

 

 

 

 

 

Item 1.

 

Financial Statements

 

 

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2006 and 2005

 

1

 

 

 

 

 

 

 

 

 

Condensed Consolidated Balance Sheets (unaudited) September 30, 2006 and December 31, 2005

 

2

 

 

 

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2006 and 2005

 

3

 

 

 

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

 

4-19

 

 

 

 

 

 

 

Item 2.

 

Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

20-37

 

 

 

 

 

 

 

Item 3.

 

Quantitative and Qualitative Disclosures About Market Risk

 

37-38

 

 

 

 

 

 

 

Item 4.

 

Controls and Procedures

 

38

 

 

 

 

 

 

 

Part II.

 

Other Information

 

 

 

 

 

 

 

 

 

Item 1.

 

Legal Proceedings

 

38-39

 

 

 

 

 

 

 

Item 6.

 

Exhibits

 

39

 

 

i




Part I. Financial Information

Item 1.                          Condensed Consolidated Financial Statements

Buckeye Partners, L.P.
Condensed Consolidated Statements of Income
(In thousands, except per Unit amounts)
(Unaudited)

 

Three Months Ended
September 30,

 

 

 

Nine Months Ended
September 30,

 

2006

 

2005

 

 

 

2006

 

2005

 

$

116,519

 

$

102,366

 

Revenue

 

$

333,759

 

$

300,171

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Costs and expenses:

 

 

 

 

 

54,345

 

47,733

 

Operating expenses

 

157,149

 

141,941

 

11,419

 

9,338

 

Depreciation and amortization

 

32,758

 

27,014

 

4,709

 

4,585

 

General and administrative expenses

 

14,261

 

13,471

 

70,473

 

61,656

 

Total costs and expenses

 

204,168

 

182,426

 

 

 

 

 

 

 

 

 

 

 

46,046

 

40,710

 

Operating income

 

129,591

 

117,745

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expenses):

 

 

 

 

 

2,040

 

1,626

 

Investment and equity income

 

5,236

 

4,354

 

(13,319)

 

(11,256

)

Interest and debt expense

 

(38,679

)

(32,213

)

 (6,381)

 

(5,323

)

General Partner incentive compensation

 

(18,277

)

(14,658

)

(1,089)

 

(1,023

)

Minority interests and other

 

(3,430

)

(2,906

)

(18,749)

 

(15,976

)

Total other income (expenses)

 

(55,150

)

(45,423

)

 

 

 

 

 

 

 

 

 

 

$

27,297

 

$

24,734

 

Net income

 

$

74,441

 

$

72,322

 

 

 

 

 

 

 

 

 

 

 

$

168

 

$

171

 

Net income allocated to General Partner

 

$

461

 

$

492

 

 

 

 

 

 

 

 

 

 

 

$

27,129

 

$

24,563

 

Net income allocated to Limited Partners

 

$

73,980

 

$

71,830

 

 

 

 

 

 

 

 

 

 

 

39,676

 

38,158

 

Weighted average units outstanding: Basic

 

39,315

 

36,749

 

 

 

 

 

 

 

 

 

 

 

39,700

 

38,202

 

Assuming dilution

 

39,340

 

36,794

 

 

 

 

 

 

 

 

 

 

 

$

0.69

 

$

0.65

 

Earnings per Parnership Unit- basic: Net income allocated to General and Limited Partners per Partnership Unit

 

$

1.89

 

$

1.97

 

 

 

 

 

 

 

 

 

 

 

$

0.69

 

$

0.65

 

Earnings per Parnership Unit — assuming dilution: Net income allocated to General and Limited Partners per Partnership Unit

 

$

1.89

 

$

1.97

 

 

See Notes to condensed consolidated financial statements.

1




 

Buckeye Partners, L.P.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)

 

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

Assets

 

 

 

 

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

29,228

 

$

24,862

 

Trade receivables

 

40,690

 

38,864

 

Construction and pipeline relocation receivables

 

11,796

 

10,571

 

Inventories

 

13,985

 

12,997

 

Prepaid and other current assets

 

21,554

 

11,074

 

Total current assets

 

117,253

 

98,368

 

 

 

 

 

 

 

Property, plant and equipment, net

 

1,711,062

 

1,576,652

 

Goodwill

 

11,355

 

11,355

 

Other non-current assets

 

119,044

 

130,492

 

Total assets

 

$

1,958,714

 

$

1,816,867

 

 

 

 

 

 

 

Liabilities and partners’ capital

 

 

 

 

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Accounts payable

 

$

16,389

 

$

16,925

 

Accrued and other current liabilities

 

53,123

 

45,228

 

Total current liabilities

 

69,512

 

62,153

 

 

 

 

 

 

 

Long-term debt

 

981,115

 

899,077

 

Minority interests

 

20,511

 

19,516

 

Other non-current liabilities

 

77,769

 

77,544

 

Total liabilities

 

1,148,907

 

1,058,290

 

 

 

 

 

 

 

Commitments and contingent liabilities

 

 

 

 

 

 

 

 

 

Partners’ capital:

 

 

 

 

 

General Partner

 

2,441

 

2,529

 

Limited partners

 

807,757

 

756,531

 

Receivable from exercise of options

 

(391

)

(483

)

Total partners’ capital

 

809,807

 

758,577

 

 

 

 

 

 

 

Total liabilities and partners’ capital

 

$

1,958,714

 

$

1,816,867

 

 

See Notes to condensed consolidated financial statements.

2




 

Buckeye Partners, L.P.
Condensed Consolidated Statements of Cash Flows
 (In thousands)
(Unaudited)

 

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

74,441

 

$

72,322

 

 

 

 

 

 

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

32,758

 

27,014

 

Minority interests

 

3,430

 

2,906

 

 Equity earnings

 

(4,598

)

(3,678

)

 Distributions from equity investments

 

4,460

 

2,428

 

Amortization of debt discount

 

38

 

28

 

 Amortization of option grants

 

294

 

 

Change in assets and liabilities, net of amounts related to acquisitions:

 

 

 

 

 

Trade receivables

 

(1,826

)

(403

)

Construction and pipeline relocation receivables

 

(1,225

)

1,729

 

Inventories

 

(317

)

25

 

Prepaid and other current assets

 

(11,363

)

6,245

 

Accounts payable

 

(536

)

(6,017

)

Accrued and other current liabilities

 

7,861

 

(953

)

Other non-current assets

 

82

 

(521

)

Other non-current liabilities

 

225

 

1,184

 

Total adjustments from operating activities

 

29,283

 

29,987

 

 

 

 

 

 

 

Net cash provided by operating activities

 

103,724

 

102,309

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(62,218

)

(51,906

)

Acquisitions

 

(93,330

)

(178,854

)

Net proceeds from disposal of property, plant and equipment

 

130

 

61

 

Net cash used in investing activities

 

(155,418

)

(230,699

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net proceeds from issuance of Partnership units

 

64,092

 

156,101

 

Debt issuance costs

 

 

(1,282

)

Proceeds from exercise of unit options

 

559

 

1,289

 

Distributions to minority interests

 

(2,435

)

(1,611

)

Proceeds from issuance of long-term debt

 

147,000

 

324,767

 

Payment of long-term debt

 

(65,000

)

(273,000

)

Distributions to Unitholders

 

(88,156

)

(76,640

)

Net cash provided by financing activities

 

56,060

 

129,624

 

 

 

 

 

 

 

Net increase in cash and cash equivalents

 

4,366

 

1,234

 

Cash and cash equivalents at beginning of period

 

24,862

 

19,017

 

 

 

 

 

 

 

Cash and cash equivalents at end of period

 

$

29,228

 

$

20,251

 

 

 

 

 

 

 

Supplemental cash flow information:

 

 

 

 

 

Cash paid for interest(net of amount capitalized)

 

$

40,964

 

$

33,283

 

Capitalized interest

 

$

1,271

 

$

1,860

 

Cash paid for income taxes

 

$

7

 

$

1,083

 

 

 

 

 

 

 

Non cash change in assets and liabilities:

 

 

 

 

 

Fair value hedge accounting

 

$

(176

)

$

(176

)

Environmental obligations related to acquisition of Northeastern Pipelines and Terminals

 

$

 

$

(2,332

)

 

See Notes to condensed consolidated financial statements.

3




 

BUCKEYE PARTNERS, L.P.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

In the opinion of management, the accompanying condensed consolidated financial statements of Buckeye Partners, L.P. (the “Partnership”), which are unaudited except that the Balance Sheet as of December 31, 2005 is derived from audited financial statements, include all adjustments necessary to present fairly the Partnership’s financial position as of September 30, 2006, along with the results of the Partnership’s operations for the three and nine months ended September 30, 2006 and 2005 and its cash flows for the nine months ended September 30, 2006 and 2005.  The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year ending December 31, 2006.

Pursuant to the rules and regulations of the Securities and Exchange Commission, the condensed consolidated financial statements do not include all of the information and notes normally included with financial statements prepared in accordance with accounting principles generally accepted in the United States of America.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2005.

The Partnership is a master limited partnership organized in 1986 under the laws of the state of Delaware.  The Partnership conducts all of its operations through subsidiary entities.  These operating subsidiaries are Buckeye Pipe Line Company, L.P. (“Buckeye”), Laurel Pipe Line Company, L.P. (“Laurel”), Everglades Pipe Line Company, L.P. (“Everglades”), Buckeye Pipe Line Holdings, L.P. (“BPH”), Wood River Pipe Lines LLC  (“Wood River”), Buckeye Pipe Line Transportation LLC (“BPL Transportation”) and Buckeye NGL Pipe Lines LLC (“Buckeye NGL”).  Buckeye NGL commenced operations on January 31, 2006 with the acquisition of a natural gas liquids pipeline located in Colorado and Kansas (see Note 3).  Each of these entities is referred to hereinafter as an “Operating Subsidiary” or collectively as the “Operating Subsidiaries.” The Partnership owns an approximate 99% limited partner interest in each Operating Subsidiary except Wood River, BPL Transportation and Buckeye NGL, in each of which it owns a 100% interest.

Buckeye GP LLC (the “General Partner”) is the general partner of the Partnership.  As of September 30, 2006, the General Partner owned an approximate 0.6% general partner interest in the Partnership.  The General Partner also owns and indirectly controls MainLine L.P. (the “Operating Subsidiary GP”), which is the general partner of and owns a 1% interest in, each of Buckeye, Laurel and Everglades and an approximate 0.6% interest in BPH.

The General Partner is a wholly-owned subsidiary of Buckeye GP Holdings L.P. (“BGH”), a Delaware limited partnership that is owned by an affiliate of  Carlyle/Riverstone Global Energy and Power Fund II, L.P. (“Carlyle/Riverstone”), certain members of the Partnership’s senior management and the public and is separately traded on the New York Stock Exchange (NYSE: BGH).  See Note 14 to these condensed consolidated financial statements for an explanation of the restructuring of the General Partner and the Operating

4




 

Subsidiary GP that occurred in connection with the initial public offering of BGH common units on August 9, 2006.

The General Partner has historically received incentive compensation payments under an Incentive Compensation Agreement, which are based on cash distributions to the limited partners of the Partnership.  As described in Note 14, as part of the reorganization of the General Partner and the Operating Subsidiary GP on August 9, 2006, the Incentive Compensation Agreement and the Partnership Agreement were amended to recharacterize the payments received by the General Partner under the Incentive Compensation Agreement and the Partnership Agreement are distribution payments with respect to the general partner interest rather than compensation payments.  The General Partner also receives distributions based on the percentage ownership of the Partnership and the Operating Subsidiaries that its general partner interests represent. Finally, the General Partner receives distributions on 80,000 limited partnership units that it owns.

The method used to compute cash payments to the General Partner and the Partnership’s limited partners is unchanged by the foregoing amendments.  Accordingly, the timing and amounts of cash received by each of the general and limited partners are likewise unchanged.  However, commencing in the fourth quarter of 2006, the foregoing amendments will affect both the way the incentive compensation is reported and the allocation of the Partnership’s income between the general and limited partners for financial reporting purposes.  See Note 14 for a discussion of these changes.

At September 30, 2006, Buckeye Pipe Line Services Company (“Services Company”) employed all of the employees who work for the Operating Subsidiaries.  Under a services agreement entered into in December 2004 (the “Services Agreement”), the Operating Subsidiaries and their subsidiaries directly reimburse Services Company for the cost of the services provided by the employees.  Under the Services Agreement and an Executive Employment Agreement, certain executive compensation costs and related benefits for the General Partner’s four highest salaried officers are not reimbursed by the Partnership or the Operating Subsidiaries, but are reimbursed to Services Company by BGH. Prior to August 9, 2006, these executive compensation costs and related benefits were reimbursed to Services Company by MainLine Sub LLC (See Note 14). At September 30, 2006, Services Company owned an approximate 5.9% limited partner interest in the Partnership.

2. CONTINGENCIES

Claims and Proceedings

The Partnership and the Operating Subsidiaries in the ordinary course of business are involved in various claims and legal proceedings, some of which are covered by insurance.  The General Partner is generally unable to predict the timing or outcome of these claims and proceedings. Based upon its evaluation of existing claims and proceedings and the probability of losses relating to such contingencies, the Partnership has accrued certain amounts relating to such claims and proceedings.

The Partnership has received penalty assessments from the Internal Revenue Service (“IRS”) in the aggregate amount of $4.3 million based on a failure to file excise tax information returns relating to its terminal operations from January 2005 through February 2006.  The Partnership filed the information returns with the IRS on May 10, 2006.  The Partnership believes it had reasonable cause for the failure to file the information returns on a timely basis, and intends to seek the elimination of the asserted penalties.  The asserted penalties are for the failure to file information returns rather than any failure to pay taxes due, as no taxes were owed by the Partnership in

5




 

connection with such information. The timing or outcome of this claim, and the total costs to be incurred by the Partnership in connection therewith, cannot be reasonably estimated at this time.

Environmental Expenditures

In accordance with its accounting policy on environmental expenditures, the Partnership recorded operating expenses, net of insurance recoveries, of $1.5 million and $0.7 million for the three months ended September 30, 2006 and 2005, respectively, and $5.4 million and $6.3 million for the nine months ended September 30, 2006 and 2005, respectively, which were related to environmental expenditures unrelated to claims and proceedings.  Expenditures, both capital and operating, relating to environmental matters are expected to continue due to the Partnership’s commitment to maintaining high environmental standards and to increasingly strict environmental laws and government enforcement policies.

3.  ACQUISITIONS

On January 1, 2006, the Partnership acquired a refined petroleum products terminal located in Niles, Michigan from affiliates of Shell Oil Products, U.S. (“Shell”) for $13.0 million.  On January 31, 2006, the Partnership completed the acquisition of a natural gas liquids pipeline, which extends generally from Wattenberg, Colorado to Bushton, Kansas, from BP Pipelines (North America) Inc. for approximately $87.0 million, which includes a deposit of $7.7 million paid in December 2005.  Buckeye NGL acquired the natural gas liquids pipeline and Buckeye Terminals, LLC, a subsidiary of BPH, acquired the refined petroleum products terminal.  The Partnership also completed certain miscellaneous asset acquisitions during the first nine months of 2006 which approximated $1.0 million.

In connection with each of these acquisitions, the Partnership determined that the transaction represented the acquisition of various assets, and not the acquisition of a business, as that term is defined in Statement of Financial Accounting Standards No. 141 — “Business Combinations”.  Accordingly, Buckeye has allocated, on a preliminary basis, the cost of each acquisition to the various tangible assets acquired, principally property, plant and equipment.  Buckeye is in the process of determining the final allocation.

In December 2005, the Partnership acquired a refined petroleum products terminal and related assets (including certain railroad offloading facilities) located in Taylor, Michigan for $20.0 million.  The Partnership allocated, on a preliminary basis, the cost of the assets to the tangible terminal assets acquired, and is in the process of determining the final allocation.

6




 

4. LONG-TERM DEBT AND CREDIT FACILITY

Long-term debt consists of the following:

 

September 30,
2006

 

December 31,
2005

 

 

 

(In thousands)

 

4.625% Notes due June 15, 2013

 

$

300,000

 

$

300,000

 

6.75% Notes due August 15, 2033

 

150,000

 

150,000

 

5.30% Notes due October 15, 2014

 

275,000

 

275,000

 

5.125% Notes due July 1, 2017

 

125,000

 

125,000

 

Borrowings under Revolving Credit Facility

 

132,000

 

50,000

 

Less: Unamortized discount

 

(2,474

)

(2,688

)

Adjustment to fair value associated with hedge of fair value

 

1,589

 

1,765

 

Total

 

$

981,115

 

$

899,077

 

 

The fair value of the Partnership’s debt was estimated to be $950 million as of September 30, 2006 and $908 million at December 31, 2005.  The values at September 30, 2006 and December 31, 2005 were based on approximate market value on the respective dates.

The Partnership has a $400 million 5-year revolving credit facility (the “Credit Facility”) with a syndicate of banks led by SunTrust Bank.  The Credit Facility contains a one-time expansion feature to $550 million subject to certain conditions.  Borrowings under the Credit Facility are guaranteed by certain of the Partnership’s subsidiaries.  The Credit Facility matures on August 6, 2009.  The weighted average interest rate on amounts outstanding under the Credit Facility at September 30, 2006 was 5.9%.

Borrowings under the Credit Facility bear interest under one of two rate options, selected by the Partnership, equal to either (i) the greater of (a) the federal funds rate plus one half of one percent and (b) SunTrust Bank’s prime rate or (ii) the London Interbank Offered Rate (“LIBOR”) plus an applicable margin. The applicable margin is determined based upon ratings assigned by Standard & Poor’s and Moody’s Investor Services for the Partnership’s senior unsecured non-credit enhanced long-term debt. The applicable margin will increase during any period in which the Partnership’s Funded Debt Ratio (described below) exceeds 5.25 to 1.0.  At September 30, 2006 and December 31, 2005, the Partnership had $132.0 million and $50.0 million outstanding under the Credit Facility, respectively, and had committed $1.7 million and $1.3 million in support of letters of credit, respectively.

The Credit Facility contains covenants and provisions that:

·                  Restrict the Partnership and certain of its subsidiaries’ ability to incur additional indebtedness based on certain ratios described below;

·                  Prohibit the Partnership and certain of its subsidiaries from creating or incurring certain liens on their property;

·                  Prohibit the Partnership and certain of its subsidiaries from disposing of property material to their operations;

·                  Limit consolidations, mergers and asset transfers by the Partnership and certain of its subsidiaries.

The Credit Facility requires that the Partnership and certain of its subsidiaries maintain a maximum “Funded Debt Ratio” and a minimum “Fixed Charge Coverage Ratio,” both of which are calculated using  “Adjusted EBITDA.” Prior to the restructuring of the General

7




 

Partner and Operating Subsidiary GP on August 9, 2006, the Credit Facility defined Adjusted EBITDA as earnings before interest, taxes, depreciation, depletion, amortization and incentive compensation payments to the General Partner, for the four preceding fiscal quarters. Incentive compensation payments were historically included in this definition because the Partnership accounted for them as an expense. Because the Partnership will no longer account for incentive compensation as an expense, it amended its Credit Facility effective as of the restructuring to define Adjusted EBITDA as earnings before interest, taxes, depreciation, depletion and amortization, for the four preceding fiscal quarters. Accordingly, calculations of the Partnership’s Funded Debt Ratio and Fixed Charge Coverage Ratio that include incentive compensation payments that are accounted for as an expense (i.e., those that became payable prior to August 9, 2006) were made using the prior definition of Adjusted EBITDA, and calculations of such ratios beginning in the fourth quarter of 2006 will be made using the current definition. Please read Note 14 to these condensed consolidated financial statements for a description of the General Partner and Operating Subsidiary GP restructuring.

The Partnership’s Funded Debt Ratio equals the ratio of the long-term debt of the Partnership and certain of its subsidiaries (including the current portion, if any) to Adjusted EBITDA. As of the end of any fiscal quarter, the Funded Debt Ratio may not exceed 4.75 to 1.00, subject to a provision for increases to 5.25 to 1.00 in connection with future acquisitions.  At September 30, 2006 the Partnership’s Funded Debt Ratio was 4.50 to 1.00.

The Partnership’s Fixed Charge Coverage Ratio is defined as the ratio of Adjusted EBITDA for the four preceding fiscal quarters to the sum of payments for interest and principal on debt plus certain capital expenditures required for the ongoing maintenance and operation of the Partnership’s assets.  The Partnership is required to maintain a Fixed Charge Coverage Ratio of greater than 1.25 to 1.00 as of the end of any fiscal quarter.  As of September 30, 2006, the Partnership’s Fixed Charge Coverage Ratio was 2.65 to 1.00.

At September 30, 2006 the Partnership was in compliance with all of the covenants under the Credit Facility.

In December 2004, the Partnership terminated an interest rate swap agreement associated with the 4.625% Notes due June 15, 2013 and received proceeds of $2.0 million.  In accordance with FASB Statement No. 133 — “Accounting for Derivative Instruments and Hedging Activities”, the Partnership has deferred the $2.0 million gain as an adjustment to the fair value of the hedged portion of the Partnership’s debt and is amortizing the gain as a reduction of interest expense over the remaining term of the hedged debt.  Interest expense was reduced by $59 thousand during each of the three months ended September 30, 2006 and 2005 and $176 thousand during each of the nine months ended September 30, 2006 and 2005, related to the amortization of the gain on the interest rate swap.

5.  PREPAID AND OTHER CURRENT ASSETS

Prepaid and other current assets consist of the following:

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

Prepaid insurance

 

$

1,195

 

$

4,684

 

Insurance receivables

 

8,532

 

3,513

 

Ammonia receivable

 

5,877

 

 

Other

 

5,950

 

2,877

 

Total

 

$

21,554

 

$

11,074

 

 

8




 

6.  ACCRUED AND OTHER CURRENT LIABILITIES

Accrued and other current liabilities consist of the following:

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

Taxes—other than income

 

$

5,345

 

$

5,811

 

Accrued charges due General Partner

 

98

 

3,821

 

Accrued charges due Services Company

 

2,744

 

450

 

Environmental liabilities

 

8,438

 

6,996

 

Interest

 

13,673

 

16,634

 

Accrued top-up reserve

 

156

 

1,059

 

Retainage

 

744

 

639

 

Payable for ammonia purchase

 

5,650

 

 

Other

 

16,275

 

9,818

 

Total

 

$

53,123

 

$

45,228

 

 

7. PARTNERS’ CAPITAL AND EARNINGS PER PARTNERSHIP UNIT

Partners’ capital consists of the following:

 

 

 

 

 

 

Receivable

 

 

 

 

 

General

 

Limited

 

from Exercise

 

 

 

 

 

Partner

 

Partners

 

of Options

 

Total

 

 

 

(In thousands)

 

Partners’ Capital—1/1/06

 

$

2,529

 

$

756,531

 

$

(483

)

$

758,577

 

Net income

 

461

 

73,980

 

 

74,441

 

Distributions

 

(549

)

(87,607

)

 

(88,156

)

Net proceeds from issuance of Partnership units

 

 

64,092

 

 

64,092

 

Amortization of unit options

 

 

294

 

 

294

 

Decrease in receivable from exercise of unit options

 

 

 

92

 

92

 

Exercise of unit options

 

 

467

 

 

467

 

 

 

 

 

 

 

 

 

 

 

Partners’ Capital — 9/30/06

 

$

2,441

 

$

807,757

 

$

(391

)

$

809,807

 

 

During the nine months ended September 30, 2006, Partnership net income equaled comprehensive income.

The following is a reconciliation of basic and diluted net income per Partnership Unit for the three month and nine month periods ended September 30:

 

 

Three Months Ended September 30,

 

 

 

2006

 

2005

 

 

 

Income
(Numerator)

 

Units
(Denominator)

 


Per Unit Amount

 

Income
(Numerator)

 

Units
(Denominator)

 


Per Unit Amount

 

 

 

(In thousands, except per unit amounts)

 

Net income

 

$

27,297

 

 

 

 

 

$

24,734

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per Partnership Unit

 

27,297

 

39,676

 

$

0.69

 

24,734

 

38,158

 

$

0.65

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities—options

 

 

24

 

 

 

44

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per Partnership Unit

 

$

27,297

 

39,700

 

$

0.69

 

$

24,734

 

38,202

 

$

0.65

 

 

9




 

 

 

Nine Months Ended September 30,

 

 

 

2006

 

2005

 

 

 

Income
(Numerator)

 

Units
(Denominator)

 


Per Unit
Amount

 

Income
(Numerator)

 

Units
(Denominator)

 


Per Unit
Amount

 

 

 

(In thousands, except per unit amounts)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

74,441

 

 

 

 

 

$

72,322

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic earnings per Partnership Unit

 

74,441

 

39,315

 

$

1.89

 

72,322

 

36,749

 

$

1.97

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Effect of dilutive securities — options

 

 

25

 

 

 

45

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted earnings per Partnership Unit

 

$

74,441

 

39,340

 

$

1.89

 

$

72,322

 

36,794

 

$

1.97

 

 

8. CASH DISTRIBUTIONS

The Partnership generally makes quarterly cash distributions of substan­tially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated cash expenditures and contingencies as the General Part­ner deems appropriate.

On October 26, 2006, the Partnership declared a cash distribution of $0.775 per unit payable on November 30, 2006 to Unitholders of record on November 6, 2006. The total cash distribution to Unitholders will amount to approximately $36,841,000.  As a result of the cash distribution, the Partnership will also pay to the General Partner an incentive compensation payment of approximately $6,588,000.

9. RELATED PARTY TRANSACTIONS

Accrued and other current liabilities include $98,000 and $3,821,000 due to the General Partner and affiliates for direct and indirect costs related to the business activities of the Partnership and Operating Subsidiaries at September 30, 2006 and December 31, 2005.  Accrued and other current liabilities included a payable to Services Company of $2,744,000 and $450,000 at September 30, 2006 and December 31, 2005, respectively.

Other Related Party Transactions

The General Partner is partially owned by Carlyle/Riverstone.  Three members of the eight-member board of directors of the General Partner are nominees of Carlyle/Riverstone.  On January 25, 2005, affiliates of Carlyle/Riverstone acquired general and limited partner interests in SemGroup, L.P. (“SemGroup”).  Carlyle/Riverstone’s total combined interest in SemGroup is approximately 30%.  One of the members of the seven-member board of directors of SemGroup’s general partner is a nominee of Carlyle/Riverstone, with three votes on that board.

The Partnership provides terminal and pipeline transportation services to an affiliate of SemGroup.  The Partnership received approximately $460,000 in revenue from the affiliate of SemGroup in the third quarter of 2006.

During the second quarter of 2006, an affiliate of Carlyle/Riverstone announced that it, along with a group of other investors, made an offer to acquire Kinder Morgan, Inc.  Among other assets, Kinder Morgan, Inc. owns the general partner interest of Kinder Morgan Energy Partners, L.P. (“Kinder Morgan”), a publicly traded partnership engaged in the transportation and distribution of petroleum products and natural gas that is a Partnership

10




customer and competes with the Partnership to a limited extent in the Midwestern United States.  If this acquisition is completed, all transactions between the Partnership and Kinder Morgan, Inc. and its affiliates will become related party transactions.

Carlyle/Riverstone also has an ownership interest in the general partner of Magellan Midstream Partners, L.P. (“Magellan”).  The Partnership does not have a significant relationship with Magellan and does not have extensive operations in the geographic areas primarily served by Magellan.

The Partnership does compete directly with Kinder Morgan and Magellan for acquisition opportunities throughout the United States and potentially will compete with these entities for new business or extensions of the existing services provided by our Operating Subsidiaries.

The board of directors of the General Partner has adopted a policy to address board of director conflicts of interests.  In compliance with this policy, Carlyle/Riverstone has adopted procedures internally to ensure that the Partnership’s confidential information is protected from disclosure to competing companies in which Carlyle/Riverstone owns an interest.  As part of these procedures, none of the nominees of Carlyle/Riverstone who serve on the board of directors of the General Partner will also serve on the board of directors of the general partners of Magellan or SemGroup or on the boards of directors of competing companies in which Carlyle/Riverstone owns an interest.

10. UNIT OPTION AND DISTRIBUTION EQUIVALENT PLAN

The Partnership sponsors a Unit Option and Distribution Equivalent Plan (the “Option Plan”), pursuant to which it grants options to purchase limited partner units (“LP units”) at 100% of the market price of the LP units on the date of grant. The options vest three years from the date of grant and expire ten years from date of grant. As unit options are exercised, the Partnership issues new LP units. The Partnership has not historically repurchased, and does not expect to repurchase, any of its LP units in 2006.

Effective January 1, 2006, the Partnership adopted the fair value measurement and recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), using the modified prospective basis transition method. Under this method, unit-based compensation expense recognized in the first nine months of fiscal year 2006 includes: (a) compensation expense for all grants made prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation expense for all grants made on or after January 1, 2006, based on the grant date fair value estimated using the Black-Scholes option pricing model.  The Partnership will recognize compensation expense for awards granted on or after January 1, 2006 on a straight-line basis over the requisite service period.

For the retirement eligibility provisions of the Option Plan, the Partnership follows the non-substantive vesting method and recognizes compensation expense immediately for options granted to retirement-eligible employees, or over the period from the grant date to the date retirement eligibility is achieved. Unit-based compensation expense recognized in the Condensed Consolidated Statements of Income for the first nine months of 2006 is based upon options ultimately expected to vest. In accordance with SFAS No. 123R, forfeitures have been estimated at the time of grant and will be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based upon historical experience.

11




 

As a result of adopting SFAS No. 123R on January 1, 2006, the Partnership’s net income for the three month and nine month periods ended September 30, 2006 was $0.1 million and $0.3 million, respectively, lower than it would have been if the Partnership had continued to account for unit-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  Basic and diluted earnings per unit would not have changed for the three months ended September 30, 2006. The reported basic and diluted earnings per unit for the three months ended September 30, 2006 were $0.69 each. Basic and diluted earnings per unit would have been $0.01 greater for the nine months ended September 30, 2006. The reported basic and diluted earnings per unit for the nine months ended September 30, 2006 were $1.89 each.  The following table summarizes the total unit-based compensation expense included in the Partnership’s Condensed Consolidated Statements of Income:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30, 2006

 

September 30, 2006

 

 

 

(in thousands)

 

 

 

 

 

 

 

Unit-based operating expenses

 

$

42

 

$

226

 

Unit-based general and administrative expenses

 

13

 

68

 

Total unit-based compensation

 

$

55

 

$

294

 

 

Prior to January 1, 2006, the Partnership accounted for the Option Plan under the recognition and measurement provisions of APB No. 25, and related Interpretations, as permitted by Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS No. 148”).  No unit-based employee compensation cost was recognized in the Condensed Consolidated Statements of Income for the three-month and nine-month periods ended September 30, 2005, as all unit options granted under the Option Plan had an exercise price equal to the market value of the underlying units on the date of grant.

12




 

The following table illustrates the effect on net income for the three and nine months ended September 30, 2005 as if the Partnership had applied the fair value recognition provisions of SFAS No. 123 to options granted under the Option Plan.  For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option pricing model and amortized to expense over the units’ vesting periods:

 

 

 

 

Three Months Ended
September 30, 2005

 

Nine Months Ended
September 30, 2005

 

 

 

 

 

(in thousands, except per unit amounts)

 

 

 

 

 

 

 

 

 

Net income as reported

 

 

 

$

24,734

 

$

72,322

 

Stock-based employeecompensation cost includedin net income

 

 

 

 

 

Stock-based employeecompensation cost thatwould have been includedin net income under thefair value method

 

 

 

(61

)

(180

)

Pro forma net income as if the fair value method had been applied to all awards

 

 

 

$

24,673

 

$

72,142

 

 

 

 

 

 

 

 

 

Basic earnings per unit

 

As reported

 

$

0.65

 

$

1.97

 

 

 

Pro forma

 

$

0.65

 

$

1.96

 

 

 

 

 

 

 

 

 

Diluted earnings per unit

 

As reported

 

$

0.65

 

$

1.97

 

 

 

Pro forma

 

$

0.65

 

$

1.96

 

 

The fair value of unit options granted to employees was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions for the three and nine months ended September 30, 2006 and 2005, respectively: 

 

2006

 

2005

 

Expected dividend yield

 

6.9

%

6.0

%

Expected unit price volatility

 

20.7

%

16.2

%

Risk-free interest rate

 

4.6

%

4.0

%

Expected life (in years)

 

6.5

 

4.0

 

Weighted-average fair value at grant date

 

$

4.52

 

$

3.56

 

 

The expected volatility is based on historic volatility of the Partnership’s market-traded LP units. Effective January 1, 2006, the Partnership has elected to use the simplified method for the expected life which is the option vesting period of three years plus the option term of ten years divided by two. The risk-free interest rate is calculated using the U.S. Treasury yield curves in effect at the time of grant, for the periods within the expected life of the options.

13




 

The following table summarizes employee unit option activity for the nine month period ended September 30, 2006:

 

 

Number of
Options

 

Weighted
Average
Exercise
Price

 

Weighted
Average
Remaining
Contractual
Life

 

Aggregate
Intrinsic
Value

 

 

 

 

 

 

 

 

 

 

 

Outstanding, January 1, 2006

 

246,900

 

$

39.44

 

 

 

 

 

Granted

 

82,900

 

44.72

 

 

 

 

 

Exercised

 

(13,400

)

34.86

 

 

 

 

 

Forfeited, cancelled or expired

 

 

 

 

 

 

 

Outstanding, September 30, 2006

 

316,400

 

$

41.02

 

7.3

 

$

816,700

 

Exercisable, September 30, 2006

 

114,700

 

$

34.34

 

5.2

 

$

965,400

 

 

The aggregate intrinsic value in the preceding table represents the total intrinsic value that would have been received by the option holders had all option holders exercised their options on September 30, 2006. Intrinsic value is determined by calculating the difference between the Partnerships’s closing LP unit price on the last trading day of the third quarter of 2006 and the exercise price, multiplied by the number of units. The total intrinsic value of options exercised during the nine month period ended September 30, 2006 was $122,000. The total number of in-the-money options exercisable as of September 30, 2006 was 114,700. As of September 30, 2006, total unrecognized compensation cost related to unvested options was $324,600.  The cost is expected to be recognized over a weighted average period of 1.0 years.  At September 30, 2006, 575,000 LP units were available for grant in connection with the Option Plan.

11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Services Company sponsors a retirement income guaranty plan (the “Defined Benefit Plan”), which is a defined benefit plan and generally guarantees employees hired before January 1, 1986 a retirement benefit at least equal to the benefit they would have received under a previously terminated defined benefit plan.  Services Company’s policy is to fund the Defined Benefit Plan with amounts necessary to at least meet the minimum funding requirements under ERISA.

Services Company also provides postretirement health care and life insurance benefits to certain of its retirees (“Postretirement Benefit”).  To be eligible for these benefits, an employee must have been hired prior to January 1, 1991 with respect to health care benefits and January 1, 2002 with respect to life insurance benefits, and the employee must satisfy certain age and service requirements.  Services Company does not pre-fund this postretirement benefit obligation.

14




 

In the three months ended September 30, 2006 and 2005, the components of the net periodic benefit cost recognized by the Partnership for the Defined Benefit Plan and postretirement health care and life insurance plan were as follows:

 

Pension Benefits

 

Postretirement 
Benefits

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(In thousands)

 

Components of net periodic benefit cost

 

 

 

 

 

 

 

 

 

Service cost

 

$

231

 

$

258

 

$

193

 

$

203

 

Interest cost

 

250

 

264

 

709

 

689

 

Expected return on plan assets

 

(211

)

(195

)

 

 

Amortization of prior service benefit

 

(113

)

(120

)

(208

)

(86

)

Amortization of unrecognized losses

 

152

 

213

 

469

 

144

 

Net periodic benefit cost

 

$

309

 

$

420

 

$

1,163

 

$

950

 

 

In the nine months ended September 30, 2006 and 2005, the components of the net periodic benefit cost recognized by the Partnership for the Defined Benefit Plan and postretirement health care and life insurance plan were as follows:

 

Pension Benefits

 

Postretirement
Benefits

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(In thousands)

 

Components of net periodic benefit cost

 

 

 

 

 

 

 

 

 

Service cost

 

$

692

 

$

718

 

$

643

 

$

612

 

Interest cost

 

750

 

734

 

2,159

 

2,066

 

Expected return on plan assets

 

(634

)

(543

)

 

 

Amortization of prior service benefit

 

(340

)

(334

)

(458

)

(259

)

Amortization of unrecognized losses

 

458

 

591

 

1,019

 

431

 

Net periodic benefit cost

 

$

926

 

$

1,166

 

$

3,363

 

$

2,850

 

 

The Partnership previously disclosed in its financial statements for the year ended December 31, 2005 that a minimum funding contribution was not required to be made during 2006.  However, the Partnership made a voluntary contribution of approximately $575,000 in September of 2006.

15




12.  SEGMENT INFORMATION

Prior to 2005, the Partnership determined that it had one reportable operating segment, the transportation segment, based on its management and financial reporting structure.  Beginning in the fourth quarter of 2004 and continuing throughout 2005, the Partnership substantially expanded its business, including a significant increase in its terminalling operations.   In the fourth quarter of 2005, the Partnership determined that its operations are appropriately presented in three reportable operating segments: Pipeline Operations, Terminalling and Storage and Other Operations.

Pipeline Operations:

The Pipeline Operations segment receives petroleum products including gasoline, jet and diesel fuel and other distillates from refineries, connecting pipelines, bulk and marine terminals and transports these products to other locations for a tariff charge.  This segment owns and operates approximately 5,350 miles of pipelines in the following states: California, Colorado, Connecticut, Florida, Illinois, Indiana, Kansas, Massachusetts, Michigan, Missouri, New Jersey, Nevada, New York, Ohio, Pennsylvania and Tennessee.  This segment also includes the operations of Buckeye NGL.

Terminalling and Storage:

The Terminalling and Storage segment provides bulk storage and terminal throughput services.  This segment owns and operates 45 terminals that have the capacity to store an aggregate of approximately 17.6 million barrels of refined petroleum products.  The terminals are located in Illinois, Indiana, Massachusetts, Michigan, Missouri, New York, Ohio and Pennsylvania.

Other Operations:

The Other Operations segment consists primarily of the Partnership’s contract operation and maintenance of third-party pipelines, which are owned primarily by major petrochemical companies and are located in Texas.  This segment also performs pipeline construction management services, typically for cost plus a fixed fee, for these same customers.  The Other Operations segment also includes the Partnership’s ownership and operation of interests in two petrochemical pipelines.

Financial information about each segment is presented below. Each segment uses the same accounting policies as those used in the preparation of the Partnership’s condensed consolidated financial statements. All inter-segment revenues, operating income and assets have been eliminated.  All periods are presented on a consistent basis.

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in thousands)

 

(in thousands)

 

Revenues:

 

 

 

 

 

 

 

 

 

Pipeline Operations

 

$

91,188

 

$

79,563

 

$

259,592

 

$

226,938

 

Terminalling  and Storage

 

18,661

 

15,774

 

55,271

 

47,921

 

Other Operations

 

6,670

 

7,029

 

18,896

 

25,312

 

Total

 

$

116,519

 

$

102,366

 

$

333,759

 

$

300,171

 

 

16




 

 

Three Months Ended
September 30,

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in thousands)

 

(in thousands)

 

Operating income:

 

 

 

 

 

 

 

 

 

Pipeline Operations

 

$

39,286

 

$

34,009

 

$

106,380

 

$

92,594

 

Terminalling and Storage

 

4,691

 

5,211

 

18,088

 

18,955

 

Other Operations

 

2,069

 

1,490

 

5,123

 

6,196

 

Total

 

$

46,046

 

$

40,710

 

$

129,591

 

$

117,745

 

 

Depreciation and amortization:

 

 

 

 

 

 

 

 

 

Pipeline Operations

 

$

9,462

 

$

8,041

 

$

27,767

 

$

23,069

 

Terminalling and Storage

 

1,528

 

971

 

3,774

 

2,966

 

Other Operations

 

429

 

326

 

1,217

 

979

 

Total

 

$

11,419

 

$

9,338

 

$

32,758

 

$

27,014

 

 

 

Nine Months Ended
September 30,

 

 

 

2006

 

2005

 

 

 

(in thousands)

 

Capital expenditures:

 

 

 

 

 

Pipeline Operations

 

$

48,425

 

$

48,104

 

Terminalling and Storage

 

11,038

 

3,449

 

Other Operations

 

2,755

 

353

 

Total

 

$

62,218

 

$

51,906

 

 

Acquisitions:

 

 

 

 

 

Pipeline Operations

 

$

79,826

 

$

153,633

 

Terminalling and Storage

 

13,504

 

25,221

 

Other Operations

 

 

 

Total

 

$

93,330

 

$

178,854

 

 

 

September 30,

 

December 31,

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

*Assets:

 

 

 

 

 

Pipeline Operations

 

$

1,580,669

 

$

1,466,512

 

Terminalling and Storage

 

310,130

 

288,972

 

Other Operations

 

67,915

 

61,383

 

Total

 

$

1,958,714

 

$

1,816,867

 


*                    All equity investments are included in the assets of Pipeline Operations.

13.  RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (“FASB”) adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 sets forth a recognition threshold and measurement attribute for financial statement recognition of positions taken or expected to be taken in income tax returns. Only tax positions meeting a “more-likely-than-not” threshold of being sustained should be recognized under FIN 48. FIN 48 also provides guidance on derecognizing, classification of interest and penalties and accounting and disclosures for annual and interim financial statements. FIN 48 is effective for fiscal years beginning after December 15,

17




2006. The cumulative effect of the changes arising from the initial application of FIN 48 is required to be reported as an adjustment to the opening balance of retained earnings in the period of adoption. The Partnership does not expect the adoption of FIN 48 to have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).  This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  The Partnership is still determining the impact, if any, of the adoption of SFAS No. 157 on its financial statements.

In September 2006, the FASB adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 106, and 132(R)” (“SFAS No. 158”).  SFAS No. 158 requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income in connection with reporting on the funded status of defined benefit pension and other postretirement benefit plans. SFAS No. 158 requires prospective application, and the recognition and disclosure requirements are effective for the Partnership’s fiscal year ending December 31, 2006. Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date.  This requirement is effective for fiscal years ending after December 15, 2008.  It is estimated that upon adoption of SFAS No. 158, the Partnership will record an initial increase in liabilities, and an offsetting reduction to accumulated other comprehensive income and equity, in the range of $15.0 to $17.0 million in the fourth quarter of 2006 to record the funded status of its defined benefit pension and post retirement healthcare and life insurance benefit plans (see Note 11).

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB No. 108 becomes effective for fiscal years ending after November 15, 2006. The Partnership does not expect the adoption of SAB No. 108 to have an impact on its financial statements.

14.  OTHER EVENTS

BGH IPO and General Partner Restructuring

On August 9, 2006, BGH consummated its initial public offering (“IPO”) of its common units. Following the IPO, approximately 54% of the limited partnership units are owned by Carlyle/Riverstone, approximately 9% of the limited partnership units are owned by certain members of senior management and the public owns approximately 37% of the limited partnership units of BGH. In connection with the closing of the offering, BGH and the General Partner restructured the ownership of the General Partner.  This restructuring will not have any impact on the amounts or timing of cash distributions paid to the general or limited partners of the Partnership.

MainLine Sub LLC (“MainLine Sub”), which was then a wholly-owned subsidiary of BGH and the owner of the General Partner, assigned all of its rights under the Fourth Amended and Restated Incentive Compensation Agreement, dated as of December 15, 2004, between MainLine Sub and the Partnership to the General Partner.  Thereafter, the Partnership and the General Partner amended and

18




restated that agreement by entering into the Fifth Amended and Restated Incentive Compensation Agreement, dated as of August 9, 2006 (the “Incentive Compensation Agreement”).  On August 9, 2006, the Partnership and the General Partner also entered into the Amended and Restated Agreement of Limited Partnership of Buckeye Partners, L.P. (the “Partnership Agreement”).  The amendments to the Incentive Compensation Agreement and the Partnership Agreement reflect the assignment of the Incentive Compensation Agreement to the General Partner and the recharacterization that payments to the General Partner under the Incentive Compensation Agreement and the Partnership Agreement are distribution payments with respect to the general partner interest rather than compensation payments.  On August 18, 2006, MainLine Sub was merged with and into BGH.

Because the quarterly unit distribution was declared prior to August 9, 2006 and, therefore, the related incentive compensation attributable to the General Partner became payable prior to such date, incentive compensation paid in the third quarter of 2006 was recorded as an expense by the Partnership in the accompanying condensed consolidated financial statements, consistent with the Partnership’s prior practice.  Commencing with the fourth quarter of 2006, the Partnership will cease recording incentive compensation payable to the General Partner as an expense and instead will record such payments as distributions from equity.

The amendments to the Incentive Compensation Agreement and the Partnership Agreement were effective on August 9, 2006.  These amendments will result in certain prospective changes in the financial statements of the Partnership beginning in the fourth quarter of 2006.  Commencing in the fourth quarter of 2006, the incentive compensation will no longer be recorded as an expense, but instead as an equity distribution to the General Partner, and the Partnership will change the attribution of income between the General Partner and the limited partners.   Generally, the Partnership will attribute income to the General Partner and the Limited Partners as if the net income of the Partnership were entirely distributed to its Unitholders.  The Partnership will determine the amount of income allocable to the General Partner, which represents the sum of the incentive compensation that would have been payable to the General Partner if the total distribution equaled net income, plus the General Partner’s proportional share of the remaining income of the Partnership. The recording of incentive payments as equity distributions rather than an expense will likely result in a relative increase in reported net income for the Partnership, however.

As discussed above, none of these changes will affect the amounts or timing of cash distributions to the general or limited partners.  The Partnership’s criteria for determining the amount of cash distributions and its policies regarding the timing of declaring and paying such cash distributions remain unchanged.

Immediately prior to the closing of the BGH IPO, in connection with the restructuring of the ownership of the General Partner, the General Partner transferred its 1% general partner interest in each of Buckeye, Laurel and Everglades and its approximate 0.6% interest in BPH to the Operating Subsidiary GP, which is owned by the General Partner.  In connection with the transfer, the Agreement of Limited Partnership of each Operating Partnership, as well as the Management Agreement between each Operating Partnership and its general partner, now the Operating Subsidiary GP in each case, were amended and restated to reflect the Operating Subsidiary GP as the new general partner.

19




Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

RESULTS OF OPERATIONS

Overview

Buckeye Partners, L.P. (the “Partnership”) is a master limited partnership which operates through subsidiary entities and is principally engaged in the transportation, terminalling and storage of refined petroleum products on a fee basis through facilities owned and operated by the Partnership.  The Partnership also operates pipelines owned by third parties pursuant to contracts with major integrated oil and chemical companies, and performs certain construction activities, generally for the owners of these third-party pipelines.

The Partnership’s direct subsidiaries are Buckeye Pipe Line Company, L.P. (“Buckeye”), Laurel Pipe Line Company, L.P. (“Laurel”), Everglades Pipe Line Company, L.P. (“Everglades”), Buckeye Pipe Line Holdings, L.P. (“BPH”), Wood River Pipe Lines LLC (“Wood River”), Buckeye Pipe Line Transportation LLC (“BPL Transportation”) and Buckeye NGL Pipe Lines LLC (“Buckeye NGL”).  Each of these entities is referred to as an “Operating Subsidiary” and they are collectively referred to as the “Operating Subsidiaries”. The Partnership owns approximately a 99% interest in each Operating Subsidiary except Wood River, BPL Transportation and Buckeye NGL, in each of which it owns a 100% interest.

The following discussion provides an analysis of the results for each of the Partnership’s operating segments, an overview of its liquidity and capital resources and other items related to the Partnership.  The following discussion and analysis should be read in conjunction with (i) the accompanying interim condensed consolidated financial statements and related notes and (ii) the Partnership’s consolidated financial statements, related notes and management’s discussion and analysis of financial condition and results of operations included in the Annual Report on Form 10-K for the year ended December 31, 2005.

In May 2005, the Partnership acquired a refined petroleum products pipeline system comprising approximately 478 miles of pipeline and four refined products terminals with aggregate storage capacity of approximately 1.3 million barrels located in the northeastern United States from affiliates of ExxonMobil Corporation (the “Northeast Pipelines and Terminals”).  In December 2005, the Partnership acquired a refined petroleum products terminal and related assets (including certain railroad offloading facilities) located in Taylor, Michigan for $20 million.  On January 1, 2006, the Partnership acquired a refined petroleum products terminal located in Niles, Michigan, with aggregate storage capacity of 630,000 barrels from affiliates of Shell for $13.0 million.  On January 31, 2006, Buckeye NGL acquired a natural gas liquids pipeline (the “NGL Pipeline”) with aggregate mileage of approximately 350 miles from BP Pipelines (North America) Inc. for approximately $87.0 million, which includes a deposit of $7.7 million paid in December 2005.  The NGL Pipeline extends generally from Wattenberg, Colorado to Bushton, Kansas.  The acquired assets have been included in the Partnership’s operations from their dates of acquisition.  The asset acquisitions completed in 2005 and 2006 added $4.4 million of revenue in the three months ended September 30, 2006 and $18.3 million of revenue in the nine months ended September 30, 2006 since their date of acquisition.

20




 

The Partnership’s three operating segments are:  Pipeline Operations, Terminalling and Storage and Other Operations.

Pipeline Operations:

The Pipeline Operations segment receives petroleum products including gasoline, jet and diesel fuel and other distillates from refineries, connecting pipelines, and bulk and marine terminals and transports those products to other locations for a fee.  As of September 30, 2006, this segment owned and operated approximately 5,350 miles of pipeline systems in the following states: California, Colorado, Connecticut, Florida, Illinois, Indiana, Kansas, Massachusetts, Michigan, Missouri, New Jersey, Nevada, New York, Ohio, Pennsylvania and Tennessee.  This segment also includes the operations of Buckeye NGL.

Terminalling and Storage:

The Terminalling and Storage segment provides bulk storage and terminal throughput services.  This segment owns and operates 45 active terminals with the capacity to store an aggregate of approximately 17.6 million barrels of refined petroleum products.  The terminals are located in Illinois, Indiana, Massachusetts, Michigan, Missouri, New York, Ohio and Pennsylvania.

Other Operations:

The Other Operations segment consists primarily of the Partnership’s contract operation and maintenance of third-party pipelines, which are owned primarily by major petrochemical companies and are located in Texas.  This segment also performs pipeline construction management services, typically for cost plus a fixed fee, for these same customers.  The Other Operations segment also includes the Partnership’s ownership and operation of interests in two petrochemical pipelines.

Results of Operations

Summary operating results for the Partnership were as follows:

 

 

Three Months Ended

 

Nine Months Ended

 

 

 

September 30,

 

September 30,

 

 

 

2006

 

2005

 

2006

 

2005

 

 

 

(in thousands)

 

(in thousands)

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

116,519

 

$

102,366

 

$

333,759

 

$

300,171

 

Costs and expenses

 

70,473

 

61,656

 

204,168

 

182,426

 

Operating income

 

46,046

 

40,710

 

129,591

 

117,745

 

Other income (expenses)

 

(18,749

)

(15,976

)

(55,150

)

(45,423

)

Net income

 

$

27,297

 

$

24,734

 

$

74,441

 

$

72,322

 

Earnings per unit - basic

 

$

0.69

 

$

0.65

 

$

1.89

 

$

1.97

 

Earnings per unit - assuming dilution

 

$

0.69

 

$

0.65

 

$

1.89

 

$

1.97

 

 

21




 

Revenues and operating income by operating segment for the three months ended September 30, 2006 and 2005 were as follows:

 

Three Months Ended
September 30,

 

 

 

2006

 

2005

 

 

 

(in thousands)

 

Revenues:

 

 

 

 

 

Pipeline Operations

 

$

91,188

 

$

79,563

 

Terminalling and Storage

 

18,661

 

15,774

 

Other Operations

 

6,670

 

7,029

 

Total

 

$

116,519

 

$

102,366

 

 

 

 

 

 

 

Operating income:

 

 

 

 

 

Pipeline Operations

 

$

39,286

 

$

34,009

 

Terminalling and Storage

 

4,691

 

5,211

 

Other Operations

 

2,069

 

1,490

 

Total

 

$

46,046

 

$

40,710

 

 

Third Quarter

Total revenues for the quarter ended September 30, 2006 were $116.5 million, $14.1 million or 13.8% greater than revenue of $102.4 million in 2005.

Pipeline Operations:

Revenue from Pipeline Operations was $91.2 million for the quarter ended September 30, 2006 compared to $79.6 million for the quarter ended September 30, 2005. The net increase in revenue from Pipeline Operations of $11.6 million was primarily the result of:

·                  Buckeye NGL revenue of $3.2 million (Buckeye NGL’s assets were acquired on January 31, 2006);

·                  a 4.3%, or $1.9 million, increase in gasoline transportation revenue, even though gasoline volumes delivered declined by 1.1%;

·                  a 14.5%, or $1.9 million, increase in jet fuel transportation revenue on an 8.8% increase in jet fuel volumes delivered;

·                  an 8.6%, or $1.5 million increase in distillate transportation revenue, even though distillate volumes delivered declined by 3.5%;

·                  an increase in liquefied petroleum gas (“LPG”) and other product transportation revenue of $0.6 million as a result of higher tariffs and an increase in volumes delivered;

·                  a $1.0 million increase in incidental revenue and rental revenue primarily from increased revenues under a product supply arrangement in connection with WesPac - Reno;

·                  a $1.1 million increase in other revenues principally resulting from  a pipeline and terminal project serving the Memphis International Airport (the “Memphis terminal”), which was commissioned earlier in 2006;

·                  a $0.4 million increase in operating services revenue due to an increase in reimbursable maintenance and inspection activities under an operating services contract; and

22




 

·                  a $1.5 million decrease in transportation settlement revenue, representing primarily the settlement of overages and shortages on product deliveries.

Product deliveries for each of the quarters ended September 30, 2006 and 2005 were as follows:

 

Barrels per Day

 

 

 

Three Months Ended September 30,

 

Product

 

2006

 

2005

 

Gasoline

 

742,700

 

750,700

 

Distillate

 

295,700

 

306,400

 

Jet Fuel

 

361,500

 

332,400

 

LPGs

 

27,200

 

17,800

 

NGLs

 

21,300

 

 

Other

 

8,700

 

4,200

 

Total

 

1,457,100

 

1,411,500

 

 

In the second and third quarters of 2006, certain of the Partnership’s Operating Subsidiaries filed pipeline tariffs related to its interstate common carrier pipelines reflecting increased rates on average of approximately 6.1%.  These tariff rate increases are expected to generate approximately $17 million in additional revenue on an annual basis.  The Partnership also filed with the Federal Energy Regulatory Commission, effective June 1, 2006, a tariff rate surcharge to recover anticipated capital and operating costs associated with the pipeline transportation of ultra low sulfur diesel fuel.  The tariff rate surcharge is expected to generate approximately $3 million in additional revenue on an annual basis.  The tariff rate surcharge is designed to permit the Partnership to recover, over time, its capital investment (and a reasonable rate of return thereon) and its operating costs related to infrastructure improvements in connection with the transportation of ultra low sulfur diesel fuel.

Terminalling and Storage:

Terminalling and Storage revenues of $18.7 million for the quarter ended September 30, 2006 increased by $2.9 million from the comparable quarter in 2005.

Recent terminal acquisitions increased Terminalling and Storage revenues by $1.1 million for the quarter ended September 30, 2006 compared to the comparable period in 2005.  The increase is related to periods which the acquired terminals were owned compared to the comparable period in 2005 during which the acquired terminals were not owned.

Terminalling and Storage revenues at existing terminals owned by the Partnership were $17.6 million for the quarter ended September 30, 2006, an increase of $1.8 million from the second quarter of 2005, which is principally related to an increase in terminal throughput volumes.

23




 

Average daily throughput for the refined products terminals for quarters ended September 30 was as follows:

 

Quarter Ended September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Refined products throughput (bpd)

 

498,900

 

438,800

 

 

Other Operations:

Revenue from other operations of $6.7 million for the quarter ended September 30, 2006 decreased by $0.4 million from the comparable period in 2005.

Operating Expenses:

Costs and expenses for the three months ended September 30, 2006 and 2005 were as follows:

 

Operating Expenses

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Payroll and payroll benefits

 

$

18,292

 

$

18,747

 

Depreciation and amortization

 

11,419

 

9,338

 

Operating power

 

7,605

 

7,424

 

Outside services

 

10,467

 

6,974

 

Property and other taxes

 

5,128

 

4,087

 

Construction management

 

1,909

 

1,900

 

All other

 

15,653

 

13,186

 

Total

 

$

70,473

 

$

61,656

 

 

Payroll and payroll benefits were $18.3 million in the third quarter of 2006, a decrease of $0.4 million from $18.7 million of payroll and payroll benefits incurred in the third quarter of 2005.  The Partnership experienced a reduction of $1.7 million in payroll and payroll benefits expense as a result of a reduction of the fair value of the Partnership’s liability under the Services Agreement to make cash payments to Services Company in amounts sufficient for Services Company’s Employee Stock Ownership Plan (the “ESOP”) to make all payments due under its Note Agreement due to changes in estimates as a result of increases in distribution expectations.  Payroll and payroll benefits expense in the third quarter of 2006 was also reduced by $0.9 million compared to the third quarter of 2005 as a result of a reversal in the third quarter of 2006 of approximately $0.3 million of the Partnership’s annual accrual for Services Company’s incentive compensation plan for employees.  The Partnership also experienced a decrease in payroll benefits of $0.1 million during the third quarter of 2006.  These decreases were partially offset by an increase of $0.4 million in payroll and payroll benefit expenses due to additional employees hired as a result of acquisitions that occurred during the previous twelve months.  Increases in salaries and wages of $1.8 million resulted from an increase in the number of employees and overtime pay due to the Partnership’s expanded operations and higher wage rates.  The Partnership also capitalized less payroll and benefits in the third quarter of 2006 which resulted in an increase in payroll and payroll benefits expense of $0.5 million over the third quarter of 2005.

Depreciation and amortization expense was $11.4 million in the third quarter of 2006, an increase of $2.1 million from the third quarter of 2005.  Depreciation related to recent acquisitions was $0.9 million.  The Partnership incurred depreciation expense of $0.2 million related to the Memphis Terminal

24




which commenced operations earlier in 2006.  The remaining increase resulted from assets placed into service during 2006.

Operating power costs were $7.6 million in the three months ended September 30, 2006, an increase of $0.2 million from the same period in 2005.  Operating power consists primarily of electricity required to operate pumping facilities.

Outside services costs increased $3.5 million from $7.0 million in the third quarter of 2005 to $10.5 million in the third quarter of 2006.  Outside services costs related to acquisitions that occurred during the previous twelve months added $0.3 million of outside services costs.  The Partnership incurred an additional $0.1 million for pipeline inspection and maintenance costs related to an operating service contract.  The remainder of the increase is due to additional pipeline and tank inspections and maintenance work that occurred during the third quarter of 2006.  Outside services costs consist principally of third-party contract services for maintenance activities.

Property and other taxes increased by $1.0 million from $4.1 million in the third quarter of 2005 to $5.1 million for the same period in 2006.  An increase of $0.5 million of property and other taxes was related to recent acquisitions.  The remaining increase is a result of higher real property assessments over the same period in 2005.

Construction management costs were $1.9 million in the third quarter of 2006, which was consistent with costs incurred in the third quarter of 2005.

All other costs were $15.7 million in the three months ended September 30, 2006, an increase of $2.5 million compared to $13.2 million in the same period in 2005.  The increase reflects $0.5 million of costs associated with fuel purchases by Wes Pac — Reno related to a product supply arrangement, such costs have corresponding revenue included in the Partnership’s incidental revenue.  Other costs related to recent acquisitions were $0.3 million.  The Partnership had an increase in other expenses of $0.2 million which was related to the Memphis Terminal which commenced operations earlier in 2006.  The Partnership experienced an increase in casualty losses of $0.6 million in the third quarter of 2006.  The increase in casualty loss related primarily to emergency response and environmental remediation expenditures in connection with a petroleum products release at a Partnership terminal located in Harristown, Illinois. The remainder of the increase is due to increases in various costs resulting from the Partnership’s expanded operations.

Costs and expenses by segment for the quarters ended September 30, 2006 and 2005 were as follows:

 

Costs and Expenses

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

Total costs and expenses

 

 

 

 

 

Pipeline Operations

 

$

51,904

 

$

45,554

 

Terminalling and Storage

 

13,969

 

10,563

 

Other Operations

 

4,600

 

5,539

 

Total

 

$

70,473

 

$

61,656

 

 

25




 

Other income (expense) for the three months ended September 30, 2006 and 2005 was as follows:

 

Other Income

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Investment and equity income

 

$

2,040

 

$

1,626

 

Interest and debt expense

 

(13,319

)

(11,256

)

General Partner incentive compensation

 

(6,381

)

(5,323

)

Minority interests and other

 

(1,089

)

(1,023

)

 

 

 

 

 

 

Total

 

$

(18,749

)

$

(15,976

)

 

Interest expense was $13.3 million in the three months ended September 30, 2006, an increase of $2.0 million from $11.3 million in the three months ended September 30, 2005.  The increase is due to higher average balances outstanding and higher interest rates on the Partnership’s 5-year revolving credit facility.

General Partner incentive compensation was $6.4 million in the third quarter of 2006, compared to $5.3 million in the third quarter of 2005, an increase of $1.1 million.  The increase is a result of the issuance of 1.5 million limited partnership units (“LP Units”) in March 2006, as well as an increase in the quarterly distribution rate to LP unitholders in the 2006 period compared to the 2005 period.  As described under the “Overview,” in the fourth quarter of 2006, the Partnership will cease recording incentive compensation as an expense.

Nine Months

Revenues for the nine months ended September 30, 2006 and 2005 were as follows:

 

Revenues

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Pipeline Operations

 

$

259,592

 

$

226,938

 

Terminalling and Storage

 

55,271

 

47,921

 

Other Operations

 

18,896

 

25,312

 

Total

 

$

333,759

 

$

300,171

 

 

Total revenue for the nine months ended September 30, 2006 was $333.8 million, $33.6 million, or 11.2%, greater than revenue of $300.2 million for the same period in 2005.

Pipeline Operations:

Revenue from Pipeline Operations was $259.6 million for the nine months ended September 30, 2006 compared to $226.9 million for the nine months ended September 30, 2005. The net increase of $32.7 million in Pipeline Operations revenue was primarily the result of:

·                  BPL Transportation revenue increase of $6.9 million (BPL Transportation’s assets were acquired on May 5, 2005);

·                  Buckeye NGL revenue of $7.8 million (Buckeye NGL’s assets were acquired on January 31, 2006);

26




 

·                  a 0.7% increase, or $0.8 million, net of BPL Transportation, in gasoline transportation revenue, even though gasoline volumes delivered declined by 2.4%;

·                  a 12.2% increase, or $4.5 million, net of BPL Transportation, in jet fuel transportation revenue on a 7.1% increase in jet fuel volumes delivered;

·                  a 6.4% increase, or $3.3 million, net of BPL Transportation, in distillate transportation revenue on comparable distillate volumes delivered;

·                  an increase in LPG transportation revenue of $1.1 million as a result of higher tariffs and an increase in volumes delivered;

·                  a $3.4 million increase in incidental revenue primarily from increased revenues under a product supply arrangement in connection with WesPac—Reno;

·                  a $4.7 million increase in other revenues principally resulting from the Memphis terminal;

·                  a $1.8 million increase in operating services revenue due to an increase in reimbursable maintenance and inspection activities under an operating services contract;

·                  a $1.6 million increase in miscellaneous rental revenue; and

·                  a decrease in transportation settlement revenue, representing the settlement of overages and shortages on product deliveries, of $4.6 million.

Product deliveries for the nine months ended September 30, 2006 and 2005, including Buckeye NGL and BPL Transportation product deliveries were as follows:

 

Barrels per Day

 

 

 

Nine Months Ended September 30,

 

Product

 

2006

 

2005

 

Gasoline

 

722,900

 

717,200

 

Distillate

 

314,600

 

312,100

 

Jet Fuel

 

351,200

 

320,700

 

LPG’s

 

24,900

 

17,900

 

NGL’s

 

19,000

 

 

Other

 

9,900

 

5,600

 

Total

 

1,442,500

 

1,373,500

 

 

Terminalling and Storage:

Terminalling and Storage revenues of $55.3 million for the nine months ended September 30, 2006 increased by $7.4 million from the comparable period in 2005.

Recent terminal acquisitions increased Terminalling and Storage revenues by $5.3 million for the nine months ended September 30, 2006 compared to the comparable period in 2005. The increase is related to periods which the acquired terminals were owned compared to the comparable period in 2005 during which the acquired terminals were not owned.

27




 

Terminalling and Storage revenues at existing terminals owned by the Partnership were $50.0 million for the nine months ended September 30, 2006, an increase of $2.1 million from the first nine months of 2005.

 

Average daily throughput for the refined products terminals for the nine months ended September 30, 2006 and 2005 was as follows:

 

 

Nine Months ended September 30,

 

 

 

2006

 

2005

 

 

 

 

 

 

 

Refined products throughput (bpd)

 

490,800

 

420,000

 

 

Other Operations:

Other Operations revenues of $18.9 million for the nine months ended September 30, 2006 declined by $6.4 million from the comparable period in 2005 primarily as a result of the absence of a large construction project which provided approximately $7.5 million of revenue in the first nine months of 2005.

Operating Expenses:

Costs and expenses for the nine month periods ended September 30, 2006 and 2005 were as follows:

 

 

 

Costs and Expenses

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Payroll and payroll benefits

 

$

57,759

 

$

55,570

 

Depreciation and amortization

 

32,758

 

27,014

 

Operating power

 

21,742

 

19,461

 

Outside services

 

23,631

 

17,385

 

Property and other taxes

 

14,207

 

12,236

 

Construction management

 

3,895

 

7,496

 

All other

 

50,176

 

43,264

 

Total

 

$

204,168

 

$

182,426

 

 

Payroll and payroll benefits were $57.8 million for the nine months ended September 30, 2006, an increase of $2.2 million compared to the comparable period in 2005.  Of this increase, approximately $1.9 million is related to the hiring of additional employees as a result of recent acquisitions.  Increases in salaries and wages of $4.3 million resulted from an increase in the number of employees and overtime pay due to the Partnership’s expanded operations and higher wage rates.  The Partnership also experienced an increase in benefit costs of $0.3 million.  These increases were partially offset by an increase of capitalized payroll of $0.9 million resulting from increased charges to capital projects by internal personnel and a decrease in severance pay.  The Partnership incurred expense of $0.6 million for severance pay in 2005 which did not occur during 2006.  Payroll and benefits expense was also reduced by $1.7 million as a result of a reduction in the fair value of the Partnership’s liability under the Services Agreement to make cash payments to Services Company in amounts sufficient for Services Company’s ESOP to make all payments due under its Note Agreement due to changes in the estimates as a result of increases in distribution expectations.  Payroll and benefits expense was also reduced by $1.0 million in the nine months ended September 30, 2006 compared to the same period in 2005 as a result of lower incentive compensation accruals.  In the first nine months of 2006, the Partnership accrued approximately $0.7 million in annual incentive compensation for employees, compared to approximately $1.7 million in the same period of 2005.

28




 

Depreciation and amortization expense was $32.8 million for the nine months ended September 30, 2006, an increase of $5.7 million from the comparable period of 2005.  Depreciation related to recent acquisitions was $2.8 million.  The Partnership incurred depreciation expense of $0.4 million related to the Memphis Terminal which commenced operations earlier in 2006.  The remaining increase resulted from assets placed into service during the nine months ended September 30, 2006.

Operating power costs of $21.7 million in the first nine months of 2006 were $2.3 million higher than the same period in 2005. Recent acquisitions added $1.8 million to operating power expense. The remainder of the increase is due to additional pipeline volumes in the Partnership’s pipeline operations.  Operating power consists primarily of electricity required to operate pumping facilities.

Outside services costs were $23.6 million in the first nine months of 2006, or $6.2 million greater than the same period in 2005. Outside services costs related to recent acquisitions were $0.7 million.  The Partnership incurred an additional $1.0 million for pipeline inspection and maintenance costs related to an operating service contract.  The Partnership also incurred additional expense of $0.3 million for public awareness programs.  The remainder of the increase is due to additional pipeline and tank inspections and maintenance work that occurred during the first nine months of 2006.

Property and other taxes increased by $2.0 million from $12.2 million in the first nine months of 2005 to $14.2 million for the same period in 2006.  Of this increase, $1.4 million related to recent acquisitions.  This increase was offset by a reimbursement of $0.9 million in 2006 for certain property taxes under an operating service agreement.  The remainder of the increase is due to higher real property assessments over the same period in 2005.

Construction management costs were $3.9 million in the nine months ended September 30, 2006, which is a decrease of $3.6 million from the same period in 2005.  The decrease is a result of the absence of a significant construction contract that was completed in 2005.

All other costs were $50.2 million, an increase of $6.9 million, in the first nine months of 2006 compared to the first nine months of 2005. The increase reflects $3.1 million of costs associated with fuel purchases by WesPac Reno related to a product-supply arrangement, such costs have corresponding revenue included in the Partnership’s incidental revenue.  Other costs related to recent acquisitions were $1.6 million.  The Partnership had an increase in other expenses of $0.8 million which was related to the Memphis Terminal which commenced operations earlier in 2006.  These increases were partially offset by a decrease in casualty losses of $1.1 million.  The remainder of the increases related to various pipeline operating costs resulting from the Partnership’s expanded operations.

Costs and expenses by segment for the nine months ended September 30, 2006 and 2005 were as follows:

 

 

 

Costs and Expenses

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

Total costs and expenses

 

 

 

 

 

Pipeline Operations

 

$

153,212

 

$

134,344

 

Terminalling and Storage

 

37,183

 

28,966

 

Other Operations

 

13,773

 

19,116

 

Total

 

$

204,168

 

$

182,426

 

 

29




 

Other income (expense) for the nine month periods ended September 30, 2006 and 2005 was as follows:

 

 

Other Income (Expenses)

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Investment and equity income

 

$

5,236

 

$

4,354

 

Interest and debt expense

 

(38,679

)

(32,213

)

General Partner incentive compensation

 

(18,277

)

(14,658

)

Minority interests and other

 

(3,430

)

(2,906

)

 

 

 

 

 

 

Total

 

$

(55,150

)

$

(45,423

)

 

Investment and equity income for the nine months ended September 30, 2006 was $5.2 million, which is an increase of $0.9 million from the comparable period in 2005.  The increase is principally a result of equity income earned from the Partnership’s approximate 40% interest in Muskegon Pipeline LLC which was acquired in December 2005.

Interest expense was $38.7 million in the nine months ended September 30, 2006, an increase of $6.5 million from $32.2 million in the nine months ended September 30, 2005.  The Partnership incurred approximately $3.2 million in interest related to the 5.125% Notes due 2017, which were issued in June 2005.  The balance of the increase in interest expense resulted from higher average balances outstanding and interest rates on the Partnership’s 5-year revolving credit facility.

General Partner incentive compensation was $18.3 million in the first nine months of 2006, compared to $14.7 million for the same period in 2005, an increase of $3.6 million.  The increase is a result of the issuance of 2.5 million LP Units in May 2005 and the issuance of 1.5 million LP Units issued in March 2006 and an increase in the quarterly distribution rate to LP unitholders in the 2006 period compared to the 2005 period.  As described under the “Overview,” in the fourth quarter of 2006, the Partnership will cease recording incentive compensation as an expense.

LIQUIDITY AND CAPITAL RESOURCES

The Partnership’s financial condition at September 30, 2006 and December 31, 2005 is highlighted in the following comparative summary:

Liquidity and Capital Indicators

 

 

As of

 

 

 

9/30/06

 

12/31/05

 

Current ratio (1)

 

1.7 to 1

 

1.6 to 1

 

Ratio of cash and cash equivalents, and trade receivables to  current liabilities

 

1.0 to 1

 

1.0 to 1

 

Working capital - in thousands (2)

 

$

47,741

 

$

36,215

 

Ratio of total debt to total capital (3)

 

.55 to 1

 

.54 to 1

 

Book value (per Unit) (4)

 

$

20.41

 

$

19.88

 


(1)          current assets divided by current liabilities

(2)          current assets minus current liabilities

(3)          long-term debt divided by long-term debt plus total partners’ capital

(4)          total partners’ capital divided by Units outstanding at the end of the period.

30




 

During the first nine months of 2006 and 2005, the Partnership’s principal sources of liquidity were cash from operations, borrowings under its revolving credit facility and proceeds from the issuance of the Partnership’s LP Units.  In the first nine months of 2006 and 2005, the Partnership’s principal uses of cash were capital expenditures, distributions to Unitholders, debt payments and acquisitions described in “Cash Flows From Investing Activities” below.

At September 30, 2006, the Partnership had $982 million aggregate amount of long-term debt, which consisted of $300 million of the Partnership’s 4.625% Notes due 2013 (the “4.625% Notes”), $275 million of the Partnership’s 5.30% Notes due 2014 (the “5.30% Notes”), $150 million of the Partnership’s 6.75% Notes due 2033 (the “6.75% Notes”), $125 million of the Partnership’s 5.125% Notes due 2017 (the “5.125% Notes”) and $132 million outstanding under the Partnership’s revolving credit facility.

The Partnership has a $400 million 5-year revolving credit facility (the “Credit Facility”) with a syndicate of banks led by SunTrust Bank.  The Credit Facility contains a one-time expansion feature to $550 million subject to certain conditions.  Borrowings under the Credit Facility are guaranteed by certain of the Partnership’s subsidiaries.  The Credit Facility matures on August 6, 2009.  At September 30, 2006, the weighted average interest rate on amounts outstanding was 5.9%.

Borrowings under the Credit Facility bear interest under one of two rate options, selected by the Partnership, equal to either (i) the greater of (a) the federal funds rate plus one half of one percent and (b) SunTrust Bank’s prime rate or (ii) the London Interbank Offered Rate (“LIBOR”) plus an applicable margin. The applicable margin is determined based upon ratings assigned by Standard & Poor’s and Moody’s Investor Services for the Partnership’s senior unsecured non-credit enhanced long-term debt. The applicable margin will increase during any period in which the Partnership’s Funded Debt Ratio (described below) exceeds 5.25 to 1.0.  At September 30, 2006 and December 31, 2005, the Partnership had $132.0 million and $50.0 million outstanding under the Credit Facility, respectively, and had committed $1.7 million and $1.3 million, respectively, in support of letters of credit.

The Credit Facility contains covenants and provisions that:

·                  Restrict the Partnership and certain of its subsidiaries’ ability to incur additional indebtedness based on certain ratios described below;

·                  Prohibit the Partnership and certain of its subsidiaries from creating or incurring certain liens on their property;

·                  Prohibit the Partnership and certain of its subsidiaries from disposing of property material to their operations;

·                  Limit consolidations, mergers and asset transfers by the Partnership and certain of its subsidiaries.

The Credit Facility requires that the Partnership and certain of its subsidiaries maintain a maximum “Funded Debt Ratio” and a minimum “Fixed Charge Coverage Ratio,” both of which are calculated using “Adjusted EBITDA.” Prior to the restructuring of the General Partner and Operating Subsidiary GP on August 9, 2006, the Credit Facility defined Adjusted EBITDA as earnings before interest, taxes, depreciation, depletion, amortization and incentive compensation payments to the General Partner, for the four preceding fiscal quarters. Incentive compensation payments were historically included in this definition because the Partnership accounted for them as an expense. Because the Partnership will no longer account for incentive compensation as an expense, it amended its Credit Facility effective as of the restructuring to define Adjusted EBITDA as

31




 

earnings before interest, taxes, depreciation, depletion and amortization, for the four preceding fiscal quarters. Accordingly, calculations of the Partnership’s Funded Debt Ratio and Fixed Charge Coverage Ratio that include incentive compensation payments that are accounted for as an expense (i.e., those that became payable prior to August 9, 2006) were made using the prior definition of Adjusted EBITDA, and calculations of such ratios beginning in the fourth quarter of 2006 will be made using the current definition.

The Partnership’s Funded Debt Ratio equals the ratio of the long-term debt of the Partnership and certain of its subsidiaries (including the current portion, if any) to Adjusted EBITDA. As of the end of any fiscal quarter, the Funded Debt Ratio may not exceed 4.75 to 1.00, subject to a provision for increases to 5.25 to 1.00 in connection with future acquisitions.  At September 30, 2006 the Partnership’s Funded Debt Ratio was 4.50 to 1.00.

The Partnership’s Fixed Charge Coverage Ratio is defined as the ratio of Adjusted EBITDA for the four preceding fiscal quarters to the sum of payments for interest and principal on debt plus certain capital expenditures required for the ongoing maintenance and operation of the Partnership’s assets.  The Partnership is required to maintain a Fixed Charge Coverage Ratio of greater than 1.25 to 1.00 as of the end of any fiscal quarter.  As of September 30, 2006, the Partnership’s Fixed Charge Coverage Ratio was 2.65 to 1.00.

At September 30, 2006 the Partnership was in compliance with all of the covenants under the Credit Facility.

The Partnership had no derivative instruments outstanding at September 30, 2006.

Cash Flows from Operations

The components of cash flows from operations for the nine months ended September 30, 2006 and 2005 are as follows:

 

 

 

Cash Flows from Operations

 

 

 

2006

 

2005

 

 

 

(In thousands)

 

 

 

 

 

 

 

Net income

 

$

74,441

 

$

72,322

 

Depreciation and amortization

 

32,758

 

27,014

 

Minority interests

 

3,430