Buckeye Partners 10-Q 2008
SECURITIES AND EXCHANGE COMMISSION
Washington, DC 20549
x Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2008 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)
Registrants telephone number, including area code: 610-904-4000
(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, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and small reporting company in Rule 12b-2 of the Exchange Act. (Check one):
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 issuers classes of common stock, as of the latest practicable date.
BUCKEYE PARTNERS, L.P.
Buckeye Partners, L.P.
(In thousands, except per unit amounts)
See Notes to condensed consolidated financial statements.
Buckeye Partners, L.P.
See Notes to condensed consolidated financial statements.
Buckeye Partners, L.P.
See Notes to condensed consolidated financial statements.
Buckeye Partners, L.P.
See Notes to condensed consolidated financial statements.
BUCKEYE PARTNERS, L.P.
1. BASIS OF PRESENTATION
Buckeye Partners, L.P. (Buckeye) is a publicly traded (NYSE: BPL) master limited partnership organized in 1986 under the laws of the state of Delaware. Buckeye GP LLC (Buckeye GP) is the general partner of Buckeye. Buckeye GP is a wholly owned subsidiary of Buckeye GP Holdings L.P. (BGH), a Delaware limited partnership that is also publicly traded (NYSE: BGH).
Buckeye, through its subsidiaries, owns and operates one of the largest independent refined petroleum products pipeline systems in the United States in terms of volumes delivered, with approximately 5,400 miles of pipeline serving 17 states, and operates an approximate 2,200 miles of pipeline under agreements with major oil and chemical companies. Buckeye also owns 63 refined petroleum products terminals with aggregate storage capacity of approximately 22.9 million barrels in 13 states.
On January 18, 2008, Buckeye acquired Lodi Gas Storage, L.L.C. (Lodi Gas). Lodi Gas owns and operates two natural gas storage facilities near Lodi, California. Together, these facilities provide approximately 22 billion cubic feet (bcf) of gas capacity and are connected to Pacific Gas and Electrics intrastate gas pipelines that service natural gas demand in the San Francisco and Sacramento areas (see Note 3 for a further discussion).
On February 8, 2008, Buckeye acquired Farm & Home Oil Company LLC (Farm & Home). Farm & Home sells refined petroleum products on a wholesale basis, principally in eastern and central Pennsylvania. When Farm & Home was acquired, it also had retail operations, but Buckeye sold those operations to a wholly owned subsidiary of Inergy, L.P. on April 15, 2008. The assets and liabilities and results of operations of Farm & Homes retail operations were determined to be discontinued operations effective on the Farm & Home acquisition date of February 8, 2008 (see Note 3 for a further discussion).
With the acquisitions of Lodi Gas and Farm & Home, Buckeye determined that it had two additional reportable segments: Natural Gas Storage and Energy Services. Effective in the first quarter of 2008, Buckeye conducts business in five reportable operating segments: Pipeline Operations; Terminalling and Storage; Natural Gas Storage; Energy Services; and Other Operations. See Note 15 for a more detailed discussion of Buckeyes operating segments.
Buckeye Pipe Line Services Company (Services Company) employs approximately 900 employees who provide services to the operating subsidiaries through which Buckeye conducts its operations. These employees represent the majority of the employees who work for Buckeye. Approximately 100 employees are employed directly by Lodi Gas and Farm & Home. Under a services agreement entered into in December 2004 (the Services Agreement), the operating subsidiaries directly reimburse Services Company for the cost of the services provided by the employees employed by Services Company. Under the Services Agreement and an Executive Employment Agreement, certain executive compensation costs and related benefits for Buckeye GPs four highest paid officers are not reimbursed by Buckeye or its subsidiaries, but are reimbursed to Services Company by BGH. At June 30, 2008, Services Company owned an approximate 4.5% limited partner interest in Buckeye.
In the opinion of management, the condensed consolidated financial statements of Buckeye, which are unaudited except that the balance sheet as of December 31, 2007 is derived from audited financial statements, include all adjustments necessary to present fairly Buckeyes financial position as of June 30, 2008 along with the results of Buckeyes operations for the three and six months ended June 30, 2008 and 2007 and Buckeyes cash flows for the six months ended June 30, 2008 and 2007. The results of operations for the three and six months ended June 30, 2008 are not necessarily indicative of the results to be expected for the full year ending December 31, 2008.
Certain prior year amounts for product sales and the cost of product sales have been reclassified in the statement of income to conform to the current-year presentation.
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 of Buckeye and the notes thereto for the year ended December 31, 2007 contained in Buckeyes Annual Report on Form 10-K as filed with the Securities and Exchange Commission on February 28, 2008.
Claims and Proceedings
Buckeye and its subsidiaries in the ordinary course of business are involved in various claims and legal proceedings, some of which are covered by insurance. Buckeye 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, Buckeye has accrued certain amounts relating to such claims and proceedings, none of which are considered material.
In March 2007, Buckeye was named as a defendant in an action entitled Madigan v. Buckeye Partners, L.P. filed in the U.S. District Court for the Central District of Illinois. The action was brought by the State of Illinois Attorney General acting on behalf of the Illinois Environmental Protection Agency. The complaint alleges that Buckeye violated various Illinois state environmental laws in connection with a product release from Buckeyes terminal located in Harristown, Illinois on or about June 11, 2006 and various other product releases from Buckeyes terminals and pipelines in the State of Illinois during the period of 2001 through 2006. The complaint seeks to recover state oversight costs, damages, and civil penalties and seeks injunctive action requiring Buckeye to remediate the environmental contamination resulting from the product releases. Buckeye believes it has meritorious defenses to the allegations set forth in the complaint.
In accordance with its accounting policy, Buckeye recorded operating expenses of $2.7 million and $1.8 million for the three months ended June 30, 2008 and 2007, respectively, and $4.6 million and $4.0 million for the six months ended June 30, 2008 and 2007, respectively, related to environmental contingencies unrelated to claims and proceedings.
3. BUSINESS COMBINATIONS AND DISCONTINUED OPERATIONS
On January 18, 2008, Buckeye acquired all of the member interests in Lodi Gas from Lodi Holdings, L.L.C. The cost of Lodi Gas was approximately $442.3 million in cash and consisted of the following (in thousands):
Of the contractual purchase price, $428.0 million was paid at closing and an additional $12.0 million was paid on March 6, 2008 upon receipt of approval from the California Public Utilities Commission for an expansion project known as Kirby Hills Phase II. Buckeye acquired Lodi Gas because Buckeyes management believes Lodi Gas represents an attractive opportunity to expand and diversify Buckeyes operations into a new geographic area and a new commodity type, and will provide Buckeye a platform for growth in the natural gas storage industry.
Buckeye has determined that the acquisition represented a business combination under the provisions of Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations (SFAS No. 141). The application of SFAS No. 141 requires that the total purchase price be allocated to the fair value of the assets acquired and the liabilities assumed based on their fair values at the acquisition date, with amounts exceeding the fair values being recorded as goodwill. The purchase price has been allocated, on a preliminary basis, to the tangible and intangible assets acquired, including goodwill, as follows (in thousands):
Buckeye is in the process of finalizing the purchase price allocation based on the valuations of plant, property and equipment, and goodwill. The final purchase price allocation will likely adjust the preliminary amounts shown above. Such changes may be material. As discussed above, the activities of Lodi Gas are reported in a new operating segment called Natural Gas Storage.
Farm & Home
On February 8, 2008, Buckeye acquired all of the member interests of Farm & Home for approximately $146.0 million. On April 15, 2008, Buckeye completed the sale of the retail operations of Farm & Home to a wholly owned subsidiary of Inergy, L.P. for approximately $52.6 million. The retail assets sold consisted primarily of property, plant and equipment as well as inventory and receivables. Buckeye recorded no gain or loss on the sale of Farm & Homes retail operations. The retail operations of Farm & Home were not an integral part of Buckeyes core operations and strategy, and the related retail assets and liabilities were determined to be discontinued operations on the date of Buckeyes acquisition of Farm & Home because Buckeye decided to dispose of them as of that date. Revenues from discontinued operations for the period February 8, 2008 to April 15, 2008 were approximately $19.0 million.
Buckeye acquired Farm & Home because Buckeyes management believes that the wholesale distribution operations of Farm & Home represent an attractive opportunity to further Buckeyes strategy of improving overall profitability by increasing the utilization of Buckeyes existing pipeline and terminal system infrastructure by marketing refined petroleum products in areas served by that infrastructure. Buckeye has determined that the acquisition represented a business combination under the provisions of SFAS No. 141. The application of SFAS No. 141 requires that the total purchase price be allocated to the fair value of the assets acquired and the liabilities assumed based on their fair values at the acquisition date, with amounts exceeding the fair values being recorded as goodwill. The purchase price has been allocated, on a preliminary basis, to the tangible and intangible assets acquired, including goodwill, as follows (in thousands):
Buckeye is in the process of finalizing the purchase price allocation and will likely adjust the preliminary amounts shown above. Such changes may be material. The final allocation may include amounts related to identifiable intangible assets such as trade names, customer relationships and covenants not-to-compete. As discussed above, the operations of Farm & Home that were retained by Buckeye are reported in a new operating segment called Energy Services.
Proforma Unaudited Financial Results
The following unaudited summarized pro forma consolidated income statement information for the three months ended June 30, 2007 and the six months ended June 30, 2008 and 2007 assumes that the acquisitions of Lodi Gas and Farm & Home had occurred as of the beginning of the periods presented. The pro forma presentation below assumes that equity offerings by Buckeye that were used in part to fund the acquisition of Lodi Gas occurred effective January 1, 2007. In the 2008 pro forma presentation, approximately $2.6 million of disposition-related expenses incurred by Lodi Gas in the period from January 1, 2008 to January 17, 2008 (prior to Buckeyes ownership) have been excluded because the inclusion of these expenses would have distorted the financial results. For Farm & Home, the results of the retail operations have been excluded from both periods presented. These pro forma unaudited financial results were prepared for comparative purposes only and are not indicative of actual results that would have occurred if Buckeye had completed these acquisitions as of the beginning of the periods presented or the results that will be attained in the future (in thousands, except per unit amounts):
On February 19, 2008, Buckeye acquired a refined petroleum products terminal in Niles, Michigan and a 50% ownership interest in a refined petroleum products terminal in Ferrysburg, Michigan from an affiliate of ExxonMobil Corporation for approximately $13.9 million. Buckeye determined that the acquisition of the Niles, Michigan terminal and the 50% interest in the Ferrysburg, Michigan terminal should be accounted for as acquisitions of assets rather than an acquisition of a business as defined in SFAS No. 141. Accordingly, Buckeye has allocated, on a preliminary basis, the cost of each acquisition to the various tangible assets acquired, principally property, plant and equipment as follows (in thousands):
Buckeye is in the process of finalizing the purchase price allocation and will likely adjust the preliminary amounts shown above. Such changes may be material.
Effective May 1, 2008, Buckeye purchased the remaining 50% member interest in Wespac Pipe Lines - San Diego LLC from Kealine LLC not already owned by Buckeye for $9.3 million. Buckeye is in the process of allocating the cost of the acquisition to the various tangible assets acquired, principally property, plant and equipment.
On June 20, 2008, Buckeye acquired a refined petroleum products terminal in Wethersfield, Connecticut from Hess Corporation for approximately $5.5 million. Buckeye determined that the acquisition of the Wethersfield, Connecticut terminal should be accounted for as an acquisition of assets rather than an acquisition of a business as defined in SFAS No. 141. Accordingly, Buckeye is in the process of allocating the cost of the acquisition to the various tangible assets acquired, principally property, plant and equipment.
4. PREPAIDS AND OTHER CURRENT ASSETS
Prepaids and other current assets consist of the following:
5. ACCRUED AND OTHER CURRENT LIABILITIES
Accrued and other current liabilities consist of the following:
6. DEBT AND CREDIT FACILITIES
Long-term debt consists of the following:
* Buckeye makes semi-annual interest payments on these notes with the principal balances outstanding to be paid on or before the due dates as shown above.
The fair value of Buckeyes aggregate debt was estimated to be $1,346.0 million at June 30, 2008 and $828.7 million at December 31, 2007. The values at June 30, 2008 and December 31, 2007 were based on approximate market value on the respective dates.
On January 11, 2008, Buckeye sold $300.0 million aggregate principal amount of 6.05% Notes due 2018 (the 6.05% Notes) in an underwritten public offering. Proceeds from this offering, after underwriters fees and expenses, were approximately $298.0 million and were used to partially pre-fund the Lodi Gas acquisition. In connection with this debt offering, Buckeye settled the two forward-starting interest rates swaps discussed in Note 7 below, which resulted in a settlement payment by Buckeye of $9.6 million that is being amortized as interest expense over the ten year term of the 6.05% Notes.
Buckeye has a borrowing capacity of $600.0 million under an unsecured revolving credit agreement (the Credit Facility), which may be expanded up to $800.0 million subject to certain conditions and upon the further approval of the lenders. The Credit Facilitys maturity date is August 24, 2012, which may be extended by Buckeye for up to two additional one-year periods. Borrowings under the Credit Facility bear interest under one of two rate options, selected by Buckeye, equal to either (i) the greater of (a) the federal funds rate plus 0.5% and (b) SunTrust Banks prime rate plus an applicable margin, or (ii) the London Interbank Offered Rate (LIBOR) plus an applicable margin. The applicable margin is determined based on the current utilization level of the Credit Facility and ratings assigned by Standard & Poors and Moodys Investor Services for Buckeyes senior unsecured non-credit enhanced long-term debt. At June 30, 2008, Buckeye had $157.0 million in borrowings outstanding under the Credit Facility. At December 31, 2007, Buckeye did not have any amounts outstanding under the Credit Facility. At June 30, 2008 and December 31, 2007, Buckeye had committed $1.3 million and $1.5 million in support of letters of credit, respectively. The obligations for letters of credit are not reflected as debt on Buckeyes consolidated balance sheet.
The Credit Facility requires Buckeye to maintain a specified ratio (the Funded Debt Ratio) of no greater than 5.00 to 1.00 subject to a provision that allows for increases to 5.50 to 1.00 in connection with certain future acquisitions. The Funded Debt Ratio is calculated by dividing consolidated debt by annualized EBITDA, which is defined in the Credit Facility as earnings before interest, taxes, depreciation, depletion and amortization, in each case excluding the income of certain majority-owned subsidiaries of Buckeye and equity investments (but including distributions from those majority-owned subsidiaries and equity investments). As discussed below, the Credit Facility was amended in January 2008 to, among other things, change the definition of consolidated debt. At June 30, 2008, Buckeyes Funded Debt Ratio was 4.28 to 1.00. As provided for in the Credit Facility, the entire balance of Farm & Homes line of credit, or $72.7 million, was excluded from the calculation of consolidated debt and the Funded Debt Ratio.
In addition, the Credit Facility contains other covenants including, but not limited to, covenants limiting Buckeyes ability to incur additional indebtedness, to create or incur liens on its property, to dispose of property material to its operations, and to consolidate, merge or transfer assets. At June 30, 2008, Buckeye was not aware of any instances of noncompliance with the covenants under its Credit Facility.
On January 28, 2008, Buckeye entered into an amendment to the Credit Facility which permits Farm & Home and its wholly owned subsidiary, Buckeye Energy Services LLC (BES), to incur up to $250.0 million of secured indebtedness related to working capital financing. The Credit Facility, as amended, also permits these subsidiaries to (i) issue performance bonds not to exceed $50.0 million, (ii) incur $5.0 million of equipment lease obligations and liens on equipment, (iii) incur up to $5.0 million of indebtedness owing to major oil companies, and (iv) loan or advance up to $5.0 million to retail distributors of transportation fuels. Finally, the amendment states that the lesser of the amount of this debt or the sum of 90% of qualified inventory and 70% of qualified accounts receivable held by Farm & Home at the balance sheet date may be excluded when calculating Buckeyes Funded Debt Ratio as discussed above.
Buckeye Energy Services Credit Agreement
On May 20, 2008, Farm & Home and BES (the Borrowers) entered into a Credit Agreement (the BES Credit Agreement) with BNP Paribas, as Administrative Agent, Collateral Agent, and Lead Arranger and, on July 18, 2008, amended the BES Credit Agreement. The BES Credit Agreement, as amended, provides for borrowings of up to $160.0 million, which amount may be increased to $250.0 million subject to customary conditions, including procurement of the requisite lender commitments. Under the BES Credit Agreement, borrowings accrue interest at the Borrowers election at (i) the Administrative Agents Cost of Funds (as defined in the BES Credit Agreement) plus 1.75%, (ii) the Eurodollar Rate (as defined in the BES Credit Agreement) plus 1.75% or (iii) the Base Rate (as defined in the BES Credit Agreement) plus 0.25%. The BES Credit Agreement also permits Daylight Overdraft Loans (as defined in the BES Credit Agreement), Swingline Loans (as defined in the BES Credit Agreement) and letters of credit. Such alternative extensions of credit are subject to certain conditions as defined in the BES Credit Agreement. The BES Credit Agreement is secured by liens on certain assets of the Borrowers, including their
inventory, cash deposits (other than certain accounts), investments and hedging accounts, receivables and intangibles.
The BES Credit Agreement replaces the credit agreement that Buckeye had assumed upon the acquisition of Farm & Home.
The balance outstanding under the BES Credit Agreement was approximately $72.7 million at June 30, 2008, all of which was classified as a current liability. The BES Credit Agreement requires the Borrowers to meet certain financial covenants, which are summarized below:
At June 30, 2008, the Borrowers Consolidated Tangible Net Worth (as defined in the BES Credit Agreement) and Consolidated Net Working Capital (as defined in the BES Credit Agreement) were $85.9 million and $51.1 million, respectively, and the Maximum Consolidated Leverage Ratio (as defined in the BES Credit Agreement) was 1.53 to 1.0.
In addition, the BES Credit Agreement contains other covenants, including, but not limited to, covenants limiting the Borrowers ability to incur additional indebtedness, to create or incur certain liens on property, to consolidate, merge or transfer assets, to make dividends or distributions, to dispose of property, to make investments, to modify their risk management policy, or to engage in business activities materially different from those presently conducted. At June 30, 2008, the Borrowers were not aware of any instances of noncompliance with the covenants under the BES Credit Agreement.
The Energy Services segment primarily uses exchange-traded petroleum futures contracts to manage the risk of market price volatility on its petroleum product inventories and its fixed price sales contracts. The derivative contracts used to hedge petroleum product inventories are classified as fair value hedges. Changes in the fair value of the inventory hedges are recorded in current period earnings along with the related gain or loss on the hedged asset. Hedge ineffectiveness is measured quarterly based on the correlation of changes in fair value between the derivative contract and the hedged item during the hedge period. The Energy Services segment has elected not to use hedge accounting with respect to its fixed price sales contracts. Therefore, its fixed price sales contracts and the related futures contracts used to offset those sales contracts are all marked-to-market on the balance sheet with gains and losses being recognized in earnings during the period.
As of June 30, 2008, the Energy Services segment had derivative assets and liabilities as follows:
Substantially all of the liability noted above for unrealized losses of $1.3 million related to inventory hedges will be realized in the third quarter of 2008 as the related inventory is sold. Gains recorded in the second quarter on inventory hedges that were ineffective were approximately $0.2 million. As of June 30, 2008, open petroleum derivative contracts varied in duration, but did not extend beyond August 2009.
In January 2008, Buckeye terminated two forward-starting interest rate swap agreements associated with the 6.05% Notes and made a payment of $9.6 million in connection with the termination. In accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (SFAS No. 133), Buckeye has recorded the amount in other comprehensive income and will amortize the amount of the payment into interest expense over the ten-year term of the 6.05% Notes. Interest expense increased by $0.2 million and $0.4 million for the three and six months ended June 30, 2008, respectively, as a result of the amortization of the termination payment.
8. FAIR VALUE MEASURMENTS
In September 2006, the Financial Accounting Standards Board (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 was effective for fiscal years beginning after November 15, 2007 and interim periods within that year. Buckeye adopted SFAS No. 157 on January 1, 2008.
Pursuant to SFAS No. 157, fair value measurements are characterized in one of three levels based upon the input used to arrive at the measurement. The three levels include:
Level 1: Level 1 inputs are quoted prices in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur with sufficient frequency and volume to provide pricing information on an ongoing basis.
Level 2: Level 2 inputs include the following:
· Quoted prices in active markets for similar assets or liabilities.
· Quoted prices in markets that are not active for identical or similar assets or liabilities.
· Inputs other than quoted prices, that are observable for the asset or liability.
· Inputs that are derived primarily from or corroborated by observable market data by correlation or other means.
Level 3: Level 3 inputs are unobservable inputs for the asset or liability.
The following table sets forth the fair value measurement of Buckeyes assets and liabilities that are subject to SFAS No. 157 as of June 30, 2008:
The value of the Level 1 futures contracts and the inventory hedges noted above were based on quoted market prices obtained from the New York Mercantile Exchange. The value of the Level 1 asset held in trust was obtained from quoted prices from brokers. The value of the Level 2 fixed price sales contract liability was based on observable market data related to the obligation to provide petroleum products.
9. EARNINGS PER LIMITED PARTNERSHIP UNIT
Emerging Issues Task Force (EITF) Issue No. 03-06 (EITF 03-06), Participating Securities and the Two-Class Method Under FASB Statement No. 128, addresses the computation of earnings per share by entities that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the entity. EITF 03-06 provides that Buckeye GPs interest in net income is to be calculated based on the amount that would be allocated to Buckeye GP if all of Buckeyes net income for the period was distributed, and not on the basis of actual cash distributions for the period. The application of EITF 03-06 may have an impact on Buckeyes earnings per limited partnership unit (LP Unit) in future periods if there are material differences between net income and actual cash distributions or if other participating securities are issued. See Note 16 for a discussion of recent accounting pronouncements affecting earnings per LP Unit.
The following table is a reconciliation of the number of LP Units used in the basic and diluted earnings per LP Unit calculations for the three and six months ended June 30, 2008 and 2007:
10. ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The following table displays the components of Accumulated Other Comprehensive (Loss) Income on the Condensed Consolidated Balance Sheet:
11. CASH DISTRIBUTIONS
Buckeye 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 Buckeye GP deems appropriate.
On July 29, 2008, Buckeye declared a cash distribution of $0.8625 per LP Unit payable on August 29, 2008 to unitholders of record on August 8, 2008. The total cash distribution to unitholders will amount to approximately $51.9 million, which includes an incentive distribution of approximately $10.0 million payable to Buckeye GP.
12. RELATED PARTY TRANSACTIONS
Buckeye is managed by Buckeye GP, which is a wholly owned subsidiary of BGH. BGH is in turn controlled by its general partner, MainLine Management LLC (MainLine Management). MainLine Management is a wholly owned subsidiary of BGH GP Holdings, LLC (BGH Holdings). Affiliates of each of ArcLight Capital Partners, LLC (ArcLight), Kelso & Company (Kelso), and Lehman Brothers Holdings, Inc. (Lehman Brothers), along with certain members of Buckeyes senior management, own BGH Holdings. In addition to owning MainLine Management, BGH Holdings owns an approximate 61.9% limited partner interest in BGH.
Under certain partnership agreements, management agreements and a services agreement, Buckeye is obligated to reimburse Services Company and Buckeye GP for substantially all direct and indirect costs related to the business activities of Buckeye and its subsidiaries except for certain executive compensation and related benefits costs that are reimbursed to Services Company by BGH. Costs incurred by Buckeye and its subsidiaries pursuant to these agreements totaled $25.0 million and $20.9 million for the three months ended June 30, 2008 and 2007, respectively, and $49.9 million and $45.8 million for the six months ended June 30, 2008 and 2007, respectively. The reimbursable costs include insurance, general and administrative costs, compensation and benefits payable to employees of Services Company, tax information and reporting costs, legal and audit fees and an allocable portion of overhead expenses.
Services Company, which is beneficially owned by the Buckeye Pipe Line Services Company Employee Stock Ownership Plan (the ESOP), owned 2.2 million LP Units, or approximately 4.5% of the LP Units outstanding, as of June 30, 2008. Distributions received by Services Company from Buckeye on such LP Units are used to fund obligations of the ESOP. Distributions paid to Services Company totaled $1.8 million for the three months ended June 30, 2008 and 2007, and $3.7 million for the six months ended June 30, 2008 and 2007. For the six months ended June 30, 2008 and 2007, ESOP costs were reduced by $0.1 million and $0.4 million, respectively, as estimates of future shortfalls between the distributions that Services Company receives on the LP Units that it owns and amounts currently due under the ESOPs senior notes (for which Buckeye is responsible) were reduced to reflect higher distributions on the LP Units than was previously anticipated. There was no impact on ESOP costs for the three months ended June 30, 2008 and 2007.
Buckeye pays MainLine Management a senior administrative charge for certain management functions performed by affiliates of MainLine Management. Buckeye incurred a senior administrative charge of $0.5 million for the three months ended June 30, 2008 and 2007, respectively, and $0.9 million for the six months ended June 30,
2008 and 2007, respectively. In connection with the Lodi Gas acquisition, MainLine Management agreed to forego payment of the senior administrative charge effective June 25, 2007 through March 31, 2009. This foregone payment has been reflected as a reduction in the purchase price of the Lodi Gas acquisition. The independent directors of Buckeye GP approve the amount of the senior administrative charge on an annual basis.
Buckeye GP receives incentive distributions from Buckeye pursuant to its partnership agreement and an incentive compensation agreement. Incentive distributions are based on the level of quarterly cash distributions paid per LP Unit. Incentive compensation payments totaled $9.7 million and $7.3 million for the three months ended June 30, 2008 and 2007, respectively, and $18.7 million and $14.1 million for the six months ended June 30, 2008 and 2007, respectively.
As discussed in Note 3, on January 18, 2008, Buckeye acquired all the member interests of Lodi Gas. The Lodi Gas acquisition was a related party transaction because Lodi Gas was indirectly owned by affiliates of ArcLight. Due to ArcLights indirect ownership interest in Buckeye GP, the Audit Committee of Buckeye GP, made up of independent directors and represented by independent legal counsel and financial advisors, reviewed and approved the terms of the Lodi Gas acquisition, including the purchase price, as fair and reasonable to Buckeye in accordance with Buckeyes partnership agreement.
Lehman Brothers, which owns an interest in BGH Holdings, and its affiliates have provided, directly or indirectly, investment and commercial banking and financial advisory services to Buckeye for which they received customary fees and commissions. An affiliate of Lehman Brothers is a lender under the Credit Facility and receives its respective share of any repayment by Buckeye of amounts outstanding under the Credit Facility. Lehman Brothers acted as Buckeyes financial advisor in connection with the Lodi Gas and Farm & Home acquisitions. An affiliate of Lehman Brothers also is a customer of Lodi Gas.
13. UNIT OPTION AND DISTRIBUTION EQUIVALENT PLAN
Buckeye sponsors the Unit Option and Distribution Equivalent Plan (the Option Plan), pursuant to which it grants to employees options to purchase LP Units at 100% of the market price of the LP Units on the date of grant. Generally, the options vest three years from the date of grant and expire ten years from the date of grant. As unit options are exercised, Buckeye issues new LP Units. Buckeye has not historically repurchased, and does not expect to repurchase in 2008, any of its LP Units.
Effective January 1, 2006, Buckeye adopted the fair value measurement and recognition provisions of SFAS No. 123 (revised 2004), Share-Based Payment (SFAS No. 123R). Generally, unit-based compensation expense recognized in the three and six months ended June 30, 2008 and 2007 is based on the grant date fair value estimated by using the Black-Scholes option pricing model. Buckeye recognizes compensation expense for awards granted on a straight-line basis over the requisite service period.
For the retirement eligibility provisions of the Option Plan, Buckeye 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 three and six months ended June 30, 2008 and 2007 is based on 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.
The following table summarizes the total unit-based compensation expenses included in Buckeyes Condensed Consolidated Statements of Income (in thousands):
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 six months ended June 30, 2008 and 2007, respectively:
The dividend yield is based on 4.8 years of historic yields of LP Units. The expected volatility is based upon 4.8 years of historical volatility of Buckeyes LP Units. In accordance with SFAS No. 123R, in 2007 Buckeye used the simplified method to calculate the expected life, which was the option vesting period of three years plus the option term of ten years divided by two. In compliance with SFAS No. 123R, effective January 1, 2008, Buckeye now uses historical experience in determining the expected life assumption used to value its options. 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.
The following table summarizes employee unit option activity for the six months ended June 30, 2008:
As of January 1, 2008, there were 234,800 unvested options outstanding. During the first six months of 2008, 56,700 options vested. 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 June 30, 2008. Intrinsic value is determined by calculating the difference between Buckeyes closing price of the LP Units on the last trading day of the second quarter of 2008 and the exercise price, multiplied by the number of LP Units subject to such options. The total intrinsic value of options exercised during the six months ended June 30, 2008 was $89,000.
The total number of in-the-money options exercisable as of June 30, 2008 was 96,200. As of June 30, 2008, total unrecognized compensation cost related to unvested options was $589,000. The cost is expected to be recognized over a weighted average period of 0.7 years. At June 30, 2008, 338,000 LP Units were available for grant under with the Option Plan.
14. PENSIONS AND OTHER POSTRETIREMENT BENEFITS
Services Company, which employs the majority of Buckeyes workforce, sponsors a retirement income guarantee plan (the RIGP), which is a defined benefit plan, that 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 Companys policy is to fund amounts necessary to meet at least the minimum funding requirements of the Employee Retirement Income Security Act of 1974.
Services Company also provides post-retirement health care and life insurance benefits to certain of its retirees (the Retiree Medical Plan). To be eligible for these benefits an employee must have been hired prior to January 1, 1991 and must meet certain service requirements. Services Company does not pre-fund its postretirement benefit obligation.
For the three months ended June 30, 2008 and 2007, the components of the net periodic benefit cost recognized by Buckeye for the RIGP and Retiree Medical Plan were as follows:
For the six months ended June 30, 2008 and 2007, the components of the net periodic benefit cost recognized by Buckeye for the RIGP and Retiree Medical Plan were as follows:
A minimum funding contribution is not required to be made to the RIGP during 2008. However, Buckeye has contributed $0.6 million to the RIGP voluntarily in 2008.
15. SEGMENT INFORMATION
With the acquisitions of Lodi Gas and Farm & Home, Buckeye determined that it has two additional reportable segments: Natural Gas Storage and Energy Services. Effective in the first quarter of 2008, Buckeye conducts business in five reportable operating segments: Pipeline Operations; Terminalling and Storage; Natural Gas Storage; Energy Services; and Other Operations.
The Pipeline Operations segment receives petroleum products from refineries, connecting pipelines, and bulk and marine terminals and transports those products to other locations for a fee. This segment owns and operates approximately 5,400 miles of pipeline systems in 17 states. This segment also has three refined petroleum products terminals with aggregate storage capacity of approximately 0.5 million barrels in three states.
Terminalling and Storage:
The Terminalling and Storage segment provides bulk storage and terminal throughput services. This segment has 55 refined petroleum products terminals with aggregate storage capacity of approximately 21.4 million barrels in ten states.
Natural Gas Storage:
The Natural Gas Storage segment provides natural gas storage services through the two natural gas storage facilities near Lodi, California that are owned and operated by Lodi Gas. Together, these facilities provide approximately 22 bcf of gas capacity and are connected to Pacific Gas and Electrics intrastate gas pipelines that service natural gas demand in the San Francisco and Sacramento areas. The segment has approximately twenty-five customers.
The Natural Gas Storage segments revenues consist of lease revenues and hub services revenues. Lease revenues consist of demand charges for the reservation of storage space under firm storage agreements. The demand charge entitles the customer to a fixed amount of storage space and certain injection and withdrawal rights. Title to the stored gas remains with the customer. Lease revenues are recognized as revenue over the term of the related storage agreement. Hub service revenues consist of a variety of other storage services under interruptible storage agreements. These principally include park and loan transactions. Parks occur when gas from a customer is injected and stored for a specified period. The customer then has the right to withdraw its stored gas at a future date. Title to the gas remains with the customer. Park revenues are recognized ratably over the term of the agreement. Loans occur when gas is delivered to a customer in a specified period. The customer then has the obligation to redeliver gas at a future date. Loan revenues are recognized ratably over the term of the agreement.
The Natural Gas Storage segment does not trade or market natural gas.
The Energy Services segment sells refined petroleum products on a wholesale basis principally in eastern and central Pennsylvania. The segment records revenues after products are delivered. The segments products include gasoline, propane and petroleum distillates such as heating oil, diesel fuel, and kerosene. The segment also has five terminals with aggregate storage capacity of approximately 1.0 million barrels. The segment has approximately one thousand customers which consist principally of product wholesalers as well as major commercial users of these products.
The Other Operations segment consists primarily of Buckeyes contract operation of approximately 2,200 miles of third-party pipeline systems, which are owned primarily by major oil and chemical companies and are located primarily in Texas and Louisiana. 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 Buckeyes ownership and operation of an ammonia pipeline and its majority ownership of the Sabina Pipeline in Texas.
Financial information about each segment is presented below. Each segment uses the same accounting policies as those used in the preparation of Buckeyes condensed consolidated financial statements. All inter-segment revenues, operating income and assets have been eliminated. All periods are presented on a consistent basis.