Enterprise GP Holdings L.P. 10-Q 2006
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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
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: 1-32610
ENTERPRISE GP HOLDINGS L.P.
(Exact name of Registrant as Specified in Its Charter)
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.
Large accelerated filer o Accelerated filer o Non-accelerated filer x
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
There were 88,884,116 units of Enterprise GP Holdings L.P. outstanding at November 1, 2006. These units trade on the New York Stock Exchange under the ticker symbol EPE.
ENTERPRISE GP HOLDINGS L.P.
TABLE OF CONTENTS
PART I. FINANCIAL INFORMATION.
Item 1. Financial Statements.
ENTERPRISE GP HOLDINGS L.P.
UNAUDITED CONDENSED CONSOLIDATED BALANCE SHEETS
(Dollars in thousands)
See Notes to Unaudited Condensed Consolidated Financial Statements
ENTERPRISE GP HOLDINGS L.P.
UNAUDITED CONDENSED STATEMENTS OF CONSOLIDATED OPERATIONS
AND COMPREHENSIVE INCOME
(Dollars in thousands, except per unit amounts)
See Notes to Unaudited Condensed Consolidated Financial Statements
ENTERPRISE GP HOLDINGS L.P.
UNAUDITED CONDENSED STATEMENTS OF CONSOLIDATED CASH FLOWS
(Dollars in thousands)
See Notes to Unaudited Condensed Consolidated Financial Statements
ENTERPRISE GP HOLDINGS L.P.
UNAUDITED CONDENSED STATEMENTS OF CONSOLIDATED PARTNERS EQUITY
(Dollars in thousands)
See Notes to Unaudited Condensed Consolidated Financial Statements
ENTERPRISE GP HOLDINGS L.P.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Partnership Organization and Basis of Financial Statement Presentation
Significant Relationships referenced in Notes to Consolidated Financial Statements
Unless the context requires otherwise, references to we, us, our or Enterprise GP Holdings L.P. are intended to mean and include the business and operations of Enterprise GP Holdings L.P., the parent company, as well as its consolidated subsidiaries, which include Enterprise Products GP, LLC and Enterprise Products Partners L.P. and its consolidated subsidiaries.
References to the parent company are intended to mean and include Enterprise GP Holdings L.P., individually as the parent company, and not on a consolidated basis.
References to EPE Holdings mean EPE Holdings, LLC, which is the general partner of Enterprise GP Holdings L.P.
References to Enterprise Products Partners mean the business and operations of Enterprise Products Partners L.P. and its consolidated subsidiaries.
References to Enterprise Products GP mean Enterprise Products GP, LLC, which is the general partner of Enterprise Products Partners L.P.
References to EPCO mean EPCO, Inc., which is a related party affiliate to all of the foregoing named entities.
References to TEPPCO mean TEPPCO Partners, L.P., a publicly traded Delaware limited partnership, which is an affiliate of Enterprise GP Holdings L.P. References to TEPPCO GP refer to the general partner of TEPPCO, which is wholly owned by a private company subsidiary of EPCO.
Partnership organization and formation
Enterprise GP Holdings L.P. is a publicly traded Delaware limited partnership, the units of which are listed on the New York Stock Exchange (NYSE) under the ticker symbol EPE. Enterprise GP Holdings L.P. was formed in April 2005 and completed its initial public offering in August 2005.
Enterprise GP Holdings L.P. is the owner of Enterprise Products GP, which is the general partner of Enterprise Products Partners. The primary business purpose of Enterprise Products GP is to manage the affairs and operations of Enterprise Products Partners, which is a North American energy company that provides a wide range of services to producers and consumers of natural gas, natural gas liquids (NGLs), crude oil and certain petrochemicals. Enterprise Products Partners is an industry leader in the development of pipeline and other midstream energy infrastructure in the continental United States and Gulf of Mexico. Enterprise Products Partners conducts substantially all of its business through a wholly owned subsidiary, Enterprise Products Operating L.P. (the Operating Partnership).
On November 2, 2006, a newly formed and wholly owned subsidiary of Enterprise Products Partners, Duncan Energy Partners L.P. (Duncan Energy Partners), filed its initial registration statement for a proposed public offering of its common units. Duncan Energy Partners will own interests in certain of Enterprise Products Partners midstream energy businesses. For additional information regarding this subsequent event, please read Note 19.
Enterprise GP Holdings L.P. is owned 99.99% by its limited partners and 0.01% by EPE Holdings, its general partner. EPE Holdings is a wholly owned subsidiary of Dan Duncan LLC, the membership interests of which are owned by Dan L. Duncan. Enterprise GP Holdings L.P., EPE Holdings, Dan Duncan LLC, Enterprise Products GP and Enterprise Products Partners are affiliates and under common control of Dan L. Duncan, the Chairman and controlling shareholder of EPCO. Enterprise GP Holdings L.P. and Enterprise Products GP have no independent operations outside those of Enterprise Products Partners.
Basis of presentation of consolidated financial statements
Since the parent company owns the general partner of Enterprise Products Partners, it controls the activities of Enterprise Products GP and Enterprise Products Partners. The parent company consolidates the financial information of these subsidiaries with that of its own. We refer to the consolidated group of entities as Enterprise GP Holdings L.P.
Aside from minority interest-related amounts (see Note 2), debt and interest expense recognized in connection with the parent companys borrowings, our consolidated financial statements do not differ materially from those of Enterprise Products Partners.
Our results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of results expected for the full year.
Except per unit amounts, or as noted within the context of each footnote disclosure, dollar amounts presented in the tabular data within these footnote disclosures are stated in thousands of dollars.
In our opinion, the accompanying unaudited condensed consolidated financial statements include all adjustments consisting of normal recurring accruals necessary for fair presentation. Although we believe our disclosures in these financial statements are adequate to make the information presented not misleading, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the United States of America (GAAP) have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (SEC or Commission). These unaudited financial statements should be read in conjunction with our annual report on Form 10-K for the year ended December 31, 2005 (Commission File No. 1-32610).
Parent company financial information
The parent company has no separate operating activities apart from those conducted by the Operating Partnership. The principal sources of cash flow for the parent company are its investments in limited partner and general partner interests of Enterprise Products Partners. The parent companys primary cash requirements are for general and administrative expenses, debt service requirements and distributions to its partners. The parent companys assets and liabilities are not available to satisfy the debts and other obligations of Enterprise Products Partners.
In order to fully understand the financial condition and results of operations of the parent company, we are providing the financial information of Enterprise GP Holdings L.P. apart from that of our consolidated partnership information included within this Item 1.
The following table presents the parent companys balance sheets at the dates indicated:
The following table presents the parent companys income statements for the periods indicated:
The following table shows the parent companys statement of cash flow for the periods indicated:
2. General Accounting Policies and Related Matters
We evaluate our financial interests in business enterprises to determine if they represent variable interest entities requiring consolidation. Our consolidated financial statements include our accounts and those of our majority-owned subsidiaries in which we have a controlling interest, after the elimination of all material intercompany accounts and transactions. We consolidate majority-owned subsidiaries in which we possess a controlling financial interest through a direct or indirect ownership of a majority voting interest in the subsidiary.
Investments in which we own 3% to 50% and exercise significant influence over operating and financial policies are accounted for using the equity method. If the investee is organized as a limited liability company and maintains separate ownership accounts for its members, we account for our investment using the equity method if our ownership interest is between 3% and 50%. For all other types of investees, we apply the equity method of accounting if our ownership interest is between 20% and 50%. Our proportionate share of profits and losses from transactions with equity method unconsolidated affiliates
are eliminated in consolidation to the extent such amounts are material and remain on our balance sheet (or those of our equity method investees) in inventory or similar accounts.
If our ownership interest in an investee does not provide us with either control or significant influence over the investee, we account for the investment using the cost method.
Use of estimates
In accordance with GAAP, we use estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during each reporting period. Our actual results could differ from these estimates.
New accounting pronouncements
Emerging Issues Task Force (EITF) 04-13, Accounting for Purchases and Sale of Inventory With the Same Counterparty. This accounting guidance requires that two or more inventory transactions with the same counterparty should be viewed as a single nonmonetary transaction, if the transactions were entered into in contemplation of one another. Exchanges of inventory between entities in the same line of business should be accounted for at fair value or recorded at carrying amounts, depending on the classification of such inventory. This guidance was effective April 1, 2006, and our adoption of this guidance had no impact on our financial position, results of operations or cash flows.
EITF 06-3, How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation). This accounting guidance requires companies to disclose their policy regarding the presentation of tax receipts on the face of their income statements. This guidance specifically applies to taxes imposed by governmental authorities on revenue-producing transactions between sellers and customers (gross receipts taxes are excluded). This guidance is effective January 1, 2007. As a matter of policy, we report such taxes on a net basis.
Financial Accounting Standards Board Interpretation (FIN) No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of SFAS 109, Accounting for Income Taxes. FIN 48 provides that tax effects of an uncertain tax position should be recognized in a companys financial statements if the position taken by the entity is more likely than not sustainable, if it were to be examined by an appropriate taxing authority, based on technical merit. After determining a tax position meets such criteria, the amount of benefit to be recognized should be the largest amount of benefit that has more than a 50 percent chance of being realized upon settlement. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact, if any, the adoption of FIN 48 will have on our statements of financial position, results of operation and cash flows.
Statement of Financial Accounting Standards (SFAS) 155, Accounting for Certain Hybrid Financial Instruments. This accounting standard amends SFAS 133, Accounting for Derivative Instruments and Hedging Activities, amends SFAS 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and resolves issues addressed in Statement 133 Implementation Issue D1, Application of Statement 133 to Beneficial Interests to Securitized Financial Assets. A hybrid financial instrument is one that embodies both an embedded derivative and a host contract. For certain hybrid financial instruments, SFAS 133 requires an embedded derivative instrument be separated from the host contract and accounted for as a separate derivative instrument. SFAS 155 amends SFAS 133 to provide a fair value measurement alternative for certain hybrid financial instruments that contain an embedded derivative that would otherwise be recognized as a derivative separately from the host contract. For hybrid financial instruments within its scope, SFAS 155 allows the holder of the instrument to make a one-time, irrevocable election to initially and subsequently measure the instrument in its entirety at fair value instead of separately accounting for the embedded derivative and host contract. We are evaluating the effect of this recent guidance, which is effective January 1, 2007 for our partnership.
SFAS 157, Fair Value Measurements. This accounting standard defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 applies only to fair-value measurements that are already required or permitted by other accounting standards and is expected to increase the consistency of those measurements. The statement emphasizes that fair value is a market-based measurement that should be determined based on the assumptions that market participants would use in pricing an asset or liability. Companies will be required to disclose the extent to which fair value is used to measure assets and liabilities, the inputs used to develop the measurements, and the effect of certain of the measurements on earnings (or changes in net assets) for the period. SFAS 157 is effective for fiscal years beginning after December 15, 2007 and we will be required to adopt SFAS 157 as of January 1, 2008. We are currently evaluating the impact of adopting SFAS 157 on our financial position, results of operations, and cash flows.
SFAS 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 88, 106, and 132(R). This accounting standard requires an employer to recognize the over-funded or under-funded status of its defined benefit pension and other postretirement plans as an asset or liability in its statement of financial position and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. In addition, SFAS 158 eliminates the use of a measurement date that is different than the date of the employer's year-end financial statements. SFAS 158 requires an employer to disclose in the notes to financial statements additional information about certain effects on net periodic benefit cost for the next fiscal year that arise from delayed recognition of the gains or losses, prior service costs or credits, and transition asset or obligation. Under SFAS 158, we will be required to recognize the funded status of our defined benefit pension and postretirement plans and to provide the required disclosures commencing as of December 31, 2006. We do not believe the adoption of SFAS 158 will have a material effect on our financial position, results of operations, and cash flows. For additional information regarding our accounting for employee benefit plans, please see Accounting for employee benefit plans in this Note 2.
Staff Accounting Bulletin (SAB) No. 108, Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements. SAB 108 addresses how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in current-year financial statements. The SAB requires registrants to quantify misstatements using both the balance-sheet and income-statement approaches and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. When the effect of initial adoption is determined to be material, SAB 108 allows registrants to record the effect as a cumulative-effect adjustment to beginning-of-year retained earnings. The requirements are effective for annual financial statements covering the first fiscal year ending after November 15, 2006. Additionally, the nature and amount of each individual error being corrected through the cumulative-effect adjustment, when and how each error arose, and the fact that the errors had previously been considered immaterial is required to be disclosed. We are required to adopt SAB 108 for our current fiscal year ending December 31, 2006. We do not expect the adoption of SAB 108 to have a material impact on our financial statements.
Change in accounting principle
In January 2006, we adopted the provisions of SFAS 123(R), Share-Based Payment. Upon adoption of this accounting standard, we recognized, as a benefit, a cumulative effect of change in accounting principle of $1.5 million, of which $1.4 million is included as a component of minority interest expense since the limited partners of Enterprise Products Partners (other than the parent company) were allocated their share of this benefit. For additional information regarding our adoption of SFAS 123(R), see Note 3.
Accounting for employee benefit plans
Dixie Pipeline Company (Dixie), a consolidated subsidiary, directly employs the personnel operating its pipeline system. Certain of these employees are eligible to participate in Dixies defined contribution plan and pension and postretirement benefit plans. Due to the immaterial nature of Dixie's
employee benefit plans to our consolidated financial position, results of operations and cash flows, our discussion is limited to the following:
Defined contribution plan. Dixie contributed $0.1 million to its company-sponsored defined contribution plan during each of the three month periods ended September 30, 2006 and 2005. During each of the nine month periods ended September 30, 2006 and 2005, Dixie contributed $0.2 million to its company-sponsored defined contribution plan.
Pension and postretirement benefit plans. Dixie's net pension benefit costs were $0.2 million for each of the three month periods ended September 30, 2006 and 2005. For the nine months ended September 30, 2006 and 2005, Dixies net pension benefit costs were $0.5 million and $0.4 million, respectively. Dixies net postretirement benefit costs were $0.1 million for each of the three month periods ended September 30, 2006 and 2005. For the nine months ended September 30, 2006 and 2005, Dixies net postretirement benefit costs were $0.2 million and $0.1 million, respectively. During the remainder of 2006, Dixie expects to contribute approximately $0.1 million to its postretirement benefit plan and approximately $1 million to its pension plan.
Minority interest represents third-party and related party ownership interests in the net assets of certain of our subsidiaries. For financial reporting purposes, the assets and liabilities of our majority owned subsidiaries are consolidated with those of the parent company, with any third-party investors ownership in our consolidated balance sheet amounts shown as minority interest. The following table presents the components of minority interest at the dates indicated:
The following table presents the components of minority interest expense for the periods indicated:
The following table presents distributions paid to and contributions received from the major classes of minority interest holders during the periods indicated:
Distributions paid to the limited partners of Enterprise Products Partners primarily represent the quarterly cash distributions paid by Enterprise Products Partners (excluding limited partner interests owned by the parent company). Contributions from the limited partners of Enterprise Products Partners primarily represent proceeds Enterprise Products Partners received from its common unit offerings (other than related cash receipts from the parent company).
Provision for income taxes
Prior to the second quarter of 2006, our provision for income taxes related to federal income tax and state franchise and income tax obligations of Seminole and Dixie, which are both corporations and represented our only consolidated subsidiaries that were historically subject to such income taxes. In May 2006, the State of Texas enacted a new business tax (the Texas Margin Tax) that replaced the existing state franchise tax. In general, legal entities that conduct business in Texas are subject to the Texas Margin Tax. Limited partnerships, limited liability companies, corporations and limited liability partnerships are examples of the types of entities that are subject to the Texas Margin Tax. As a result of the change in tax law, our tax status in the State of Texas will change from non-taxable to taxable. The tax is considered an income tax for purposes of adjustments to deferred tax liability as the tax is determined by applying a tax rate to a base that considers both revenues and expenses. The Texas Margin Tax becomes effective for margin tax reports due on or after January 1, 2008. The Texas Margin Tax due in 2008 will be based on revenues earned during the 2007 fiscal year.
The Texas Margin Tax is assessed at 1% of Texas-sourced taxable margin. The taxable margin is the lesser of (i) 70% of total revenue or (ii) total revenue less (a) cost of goods sold or (b) compensation and benefits. Our deferred tax liability, which is a component of other long-term liabilities on our consolidated balance sheets, reflects the net tax effects of temporary differences related to items such as property, plant and equipment; therefore, the deferred tax liability is noncurrent. We recorded an estimated net deferred tax liability of approximately $6.6 million for the Texas Margin Tax. The offsetting net charge of $6.6 million is shown on our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income as a component of provision for income taxes for the nine months ended September 30, 2006.
3. Accounting for Equity Awards
Effective January 1, 2006, we adopted SFAS 123(R) to account for equity awards. Prior to our adoption of SFAS 123(R), we accounted for our equity awards using the intrinsic value method described in Accounting Principles Board Opinion (APB) 25, Accounting for Stock Issued to Employees. SFAS 123(R) requires us to recognize compensation expense related to our equity awards based on the fair value of the award at the grant date. The fair value of an equity award is estimated using the Black-Scholes option pricing model. Under SFAS 123(R), the fair value of an award is amortized to earnings on a straight-line basis over the requisite service or vesting period.
Upon our adoption of SFAS 123(R), we recognized, as a benefit, a cumulative effect of change in accounting principle of $1.5 million, of which $1.4 million is included as a component of minority interest expense since the limited partners of Enterprise Products Partners (other than the parent company) were allocated their share of this benefit. The cumulative effect adjustment is based on SFAS 123(R)s requirement to recognize compensation expense based upon the grant date fair value of an equity award and the application of an estimated forfeiture rate to unvested awards. In addition, previously recognized deferred compensation expense of $14.6 million related to Enterprise Products Partners nonvested (or restricted) common units was reversed on January 1, 2006. At September 30, 2006, our equity awards primarily related to those issued by Enterprise Products Partners.
Prior to our adoption of SFAS 123(R), we did not recognize any compensation expense related to unit options of Enterprise Products Partners; however, compensation expense was recognized in connection with awards granted by EPE Unit L.P. (the Employee Partnership) and the issuance of nonvested units of Enterprise Products Partners. The effects of applying SFAS 123(R) during the three and nine months ended September 30, 2006 did not have a material effect on our net income or basic and diluted earnings per unit.
Since we adopted SFAS 123(R) using the modified prospective method, we have not restated the financial statements of prior periods to reflect this new standard. The following table shows the pro forma effects on our earnings for the three and nine months ended September 30, 2005 as if the fair value method of SFAS 123, Accounting for Stock-Based Compensation had been used instead of the intrinsic-value method of APB 25. The only equity awards outstanding during the three and nine months ended September 30, 2005 were unit options and nonvested units.
Under EPCOs 1998 Long-Term Incentive Plan (the 1998 Plan), non-qualified incentive options to purchase a fixed number of Enterprise Products Partners common units may be granted to EPCOs key employees who perform management, administrative or operational functions for us. When issued, the exercise price of each option grant is equivalent to the market price of the underlying equity on the date of grant. In general, options granted under the 1998 Plan have a vesting period of four years and remain exercisable for ten years from the date of grant.
In order to fund its obligations under the 1998 Plan, EPCO purchases common units at fair value either in the open market or directly from Enterprise Products Partners. When employees exercise unit options, we reimburse EPCO for our allocable share of the cash difference between the strike price paid by the employee and the actual purchase price paid by EPCO for the units issued to the employee.
The fair value of each option to purchase Enterprise Products Partners common units is estimated on the date of grant using the Black-Scholes option pricing model, which incorporates various assumptions including (i) an expected life of the options of seven years, (ii) risk-free interest rates ranging from 3.1% to 6.4%, (iii) an expected distribution yield on common units of Enterprise Products Partners ranging from 5.3% to 10%, and (iv) expected unit price volatility on Enterprise Products Partners common units ranging from 20% to 30%. In general, our assumption of expected life represents the period of time that options are expected to be outstanding based on an analysis of historical option activity. Our selection of the risk-free
interest rate is based on published yields for U.S. government securities with comparable terms. The expected distribution yield and unit price volatility for Enterprise Products Partners units is estimated based on several factors, which include an analysis of our historical unit price volatility and distribution yield over a period equal to the expected life of the option.
The information in the following table shows unit option activity under the 1998 Plan.
The total intrinsic value of Enterprise Products Partners unit options exercised during the three and nine months ended September 30, 2006 was $1.1 million and $1.7 million, respectively. We recognized $0.2 million and $0.5 million of compensation expense associated with unit options during the three and nine months ended September 30, 2006, respectively.
As of September 30, 2006, there was an estimated $1.7 million of total unrecognized compensation cost related to nonvested unit options granted under the 1998 Plan to EPCO employees who work on our behalf. That cost is expected to be recognized over a weighted-average period of 2.6 years.
During the nine months ended September 30, 2006, we received cash of $4 million from the exercise of unit options, and our option-related reimbursements to EPCO were $1.7 million.
Under the 1998 Plan, Enterprise Products Partners may issue nonvested (or restricted) common units to key employees of EPCO and directors of Enterprise Products GP. The 1998 Plan provides for the issuance of 3,000,000 restricted common units of Enterprise Products Partners, of which 1,956,433 remain authorized for issuance at September 30, 2006.
In general, Enterprise Products Partners restricted unit awards allow recipients to acquire the underlying common units (at no cost to the recipient) once a defined vesting period expires, subject to certain forfeiture provisions. The restrictions on such nonvested units generally lapse four years from the date of grant. Compensation expense is recognized on a straight-line basis over the vesting period. The fair value of such restricted units is based on (i) the market price of the underlying common units on the date of grant and (ii) an allowance for forfeitures.
The following table summarizes information regarding Enterprise Products Partners restricted units for the nine months ended September 30, 2006.
The total fair value of Enterprise Products Partners restricted units that vested during the nine months ended September 30, 2006 was $1 million. During the three and nine months ended September 30, 2006, we recognized $0.8 million and $3.1 million of compensation expense, respectively, associated with Enterprise Products Partners nonvested units.
As of September 30, 2006, there was $11.7 million of total unrecognized compensation cost related to nonvested units issued to EPCO employees that work on our behalf. That cost is expected to be recognized over a weighted-average period of 2.9 years.
In connection with the initial public offering of the parent company in August 2005, the Employee Partnership was formed to serve as an incentive arrangement for certain employees of EPCO through a profits interest in the Employee Partnership. At inception, the Employee Partnership used $51 million in contributions it received from an affiliate of EPCO (which was admitted as the Class A limited partner of the Employee Partnership as a result of such contribution) to purchase 1,821,428 units of the parent company in August 2005. Certain EPCO employees, including substantially all of EPE Holdings and Enterprise Products GPs executive officers other than Dan L. Duncan, were issued Class B limited partner interests without any capital contribution and admitted as Class B limited partners of the Employee Partnership.
As described in its partnership agreement, the Employee Partnership will be liquidated upon the earlier of (i) August 2010 or (ii) a change in control of the parent company or its general partner, EPE Holdings. Upon liquidation of the Employee Partnership, units having a fair market value equal to the Class A limited partners capital base will be distributed to the Class A limited partner, plus any Class A preferred return for the quarter in which liquidation occurs. Any remaining units will be distributed to the Class B limited partners as a residual profits interest in the Employee Partnership as an award.
Prior to our adoption of SFAS 123(R), the estimated value of the profits interest was accounted for in a manner similar to a stock appreciation right. Upon our adoption of SFAS 123(R), we began recognizing compensation expense based upon the estimated grant date fair value of the Class B partnership equity awards.
The fair value of the Class B partnership equity awards is estimated on the date of grant using the Black-Scholes option pricing model, which incorporates various assumptions including (i) an expected life of the awards ranging from five to four years, (ii) risk-free interest rates ranging from 4.1% to 4.8%, (iii) an expected distribution yield on units of Enterprise GP Holdings ranging from 3.0% to 3.7%, and (iv) an expected Enterprise GP Holdings unit price volatility ranging from 21.1% to 30.0%. In general, the methodology we followed to estimate the fair value of the Class B partnership equity awards is similar to that used to estimate the fair value of Enterprise Products Partners unit options.
During the three and nine months ended September 30, 2006, we recognized $0.5 million and $1.6 million of compensation expense, respectively, associated with such profits interests. As of September 30,
2006, there was $9.9 million of total unrecognized compensation cost related to the profits interests, of which we estimate our allocable share to be $8.9 million. That cost is expected to be recognized on a straight-line basis through the third quarter of 2010.
Parent companys long-term incentive plan
The parent company can issue 250,000 of its units in connection with a long-term incentive plan of EPCO (the 2005 Plan). In August 2006, the six independent directors of Enterprise Products GP and EPE Holdings were granted 10,000 unit appreciation rights each, for a total of 60,000 unit appreciation rights. A unit appreciation right entitles the holder to receive an amount equal to the excess, if any, of the fair market value of the parent companys units (as of the future vesting date) over the grant date price per unit, in units or cash (at the discretion of EPE Holdings). The grant date price per unit was $35.71 on August 3, 2006. Each unit appreciation right has a vesting period of five years.
We will account for these awards as liabilities due to managements current intent to settle these awards in cash. For the three and nine months ended September 30, 2006, we recorded a nominal amount of expense associated with these awards. Since the average market price of the parent companys units for the period in which these awards were outstanding during the three months ended September 30, 2006 was less than the grant date price of $35.71, there was no dilutive effect on our earnings per unit.
4. Financial Instruments
We are exposed to financial market risks, including changes in commodity prices and interest rates. We may use financial instruments (i.e., futures, forwards, swaps, options and other financial instruments with similar characteristics) to mitigate the risks of certain identifiable and anticipated transactions. In general, the type of risks we attempt to hedge are those related to (i) the variability of future earnings, (ii) fair values of certain debt instruments and (iii) cash flows resulting from changes in certain interest rates or commodity prices. As a matter of policy, we do not use financial instruments for speculative (or trading) purposes.
Interest Rate Risk Hedging Program
Our interest rate exposure results from variable and fixed interest rate borrowings under various debt agreements. We manage a portion of our interest rate exposures by utilizing interest rate swaps and similar arrangements, which allow us to convert a portion of fixed rate debt into variable rate debt or a portion of variable rate debt into fixed rate debt.
Fair value hedges Interest rate swaps. As summarized in the following table, we had eleven interest rate swap agreements outstanding at September 30, 2006 that were accounted for as fair value hedges.
The total fair value of these eleven interest rate swaps at September 30, 2006 and December 31, 2005, was a liability of $30.4 million and $19.2 million, respectively, with an offsetting decrease in the fair value of the underlying debt. Interest expense for the three months ended September 30, 2006 and 2005 reflects a $1.9 million expense and a $2.3 million benefit from these swap agreements, respectively. For the nine months ended September 30, 2006 and 2005, interest expense reflects a $2.8 million expense and a $9.8 million benefit, respectively, from these swap agreements.
Cash flow hedges Treasury Locks. During the second quarter of 2006, the Operating Partnership entered into a treasury lock transaction having a notional amount of $250 million. In addition, in July 2006, the Operating Partnership entered into an additional treasury lock transaction having a notional amount of $50 million. A treasury lock is a specialized agreement that fixes the price (or yield) on a specific treasury security for an established period of time. A treasury lock purchaser is protected from a rise in the yield of the underlying treasury security during the lock period. The Operating Partnerships purpose of entering into these transactions was to hedge the underlying U.S. treasury rate related to its anticipated issuance of subordinated debt during the second quarter of 2006. In July 2006, the Operating Partnership issued $300 million in principal amount of its Junior Notes A (see Note 10). Each of the treasury lock transactions was designated as a cash flow hedge under SFAS 133. In July 2006, the Operating Partnership elected to terminate these treasury lock transactions and recognized a minimal gain.
Commodity Risk Hedging Program
The prices of natural gas, NGLs and petrochemical products are subject to fluctuations in response to changes in supply, market uncertainty and a variety of additional factors that are beyond our control. In order to manage the price risks associated with such products, we may enter into commodity financial instruments. The primary purpose of our commodity risk management activities is to hedge our exposure to price risks associated with (i) natural gas purchases, (ii) the value of NGL production and inventories, (iii) related firm commitments, (iv) fluctuations in transportation revenues where the underlying fees are based on natural gas index prices and (v) certain anticipated transactions involving either natural gas, NGLs or certain petrochemical products.
The fair value of our commodity financial instrument portfolio at September 30, 2006 and December 31, 2005 was a benefit of $4.8 million and a liability of $0.1 million, respectively. During the three and nine months ended September 30, 2006, we recorded $7.8 million and $2.4 million of income related to our commodity financial instruments, respectively, which is included in operating costs and expenses on our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income. We recorded nominal amounts of earnings from our commodity financial instruments during the three and nine months ended September 30, 2005.
Our regular trade (or working) inventory is comprised of inventories of natural gas, NGLs, and certain petrochemical products that are available for sale or used by us in the provision of services. Our forward sales inventory consists of segregated NGL and natural gas volumes dedicated to the fulfillment of forward-sales contracts. Both inventories are valued at the lower of average cost or market.
Costs and expenses, as shown on our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income, include cost of sales related to the sale of inventories. For the three months ended September 30, 2006 and 2005, such consolidated cost of sales amounts were $3.2 billion and $2.7 billion, respectively. We recorded $9 billion and $7.1 billion of such consolidated cost of sales amounts for the nine months ended September 30, 2006 and 2005, respectively.
Due to fluctuating commodity prices in the NGL, natural gas and petrochemical industry, we recognize lower of cost or market adjustments when the carrying values of our inventories exceed their net realizable value. These non-cash charges are a component of cost of sales in the period they are
recognized. For the three months ended September 30, 2006 and 2005, we recognized $5.7 million and $0.5 million, respectively, of lower of cost or market adjustments. We recorded $17.7 million and $17.5 million of such adjustments for the nine months ended September 30, 2006 and 2005, respectively.
6. Property, Plant and Equipment
The following table shows our property, plant and equipment and accumulated depreciation at the dates indicated:
Depreciation expense for the three months ended September 30, 2006 and 2005 was $88.9 million and $81.8 million, respectively. We recorded $259.4 million and $239.9 million of depreciation expense for the nine months ended September 30, 2006 and 2005, respectively. Capitalized interest on our construction projects for the three months ended September 30, 2006 and 2005 was $15 million and $4.6 million, respectively. We recorded $36.6 million and $12.2 million of capitalized interest on our construction projects for the nine months ended September 30, 2006 and 2005, respectively. The increase in capitalized interest period-to-period is due to our capital spending program.
In March 2006, we paid $38.2 million to TEPPCO for its Pioneer natural gas processing plant located in Opal, Wyoming and certain natural gas processing rights related to production from the Jonah and Pinedale fields located in the Greater Green River Basin in Wyoming. After completing this asset purchase, we increased the capacity of the Pioneer natural gas processing plant at an additional cost of $21 million. This expansion was completed in July 2006 and enables us to process natural gas production from the Jonah and Pinedale fields that will be transported to our Wyoming facilities as a result of the contract rights we acquired from TEPPCO. Of the $38.2 million we paid TEPPCO to acquire the Pioneer facility, $37.8 million was allocated to the contract rights we acquired. See Note 9 for information regarding the intangible assets recorded in connection with this asset purchase.
In August 2006, we acquired a 223-mile pipeline from ExxonMobil Pipeline Company for $97.7 million in cash. This pipeline originates in Corpus Christi, Texas and extends to Pasadena, Texas. This pipeline segment will be expanded (the Phase I expansion) to (i) connect with our Armstrong and Shoup NGL fractionation facilities through the construction of 45 miles of pipeline laterals; (ii) lease from TEPPCO a 10-mile interconnecting pipeline extending from Pasadena, Texas to Baytown, Texas; and (iii) purchase an additional 10-mile pipeline from TEPPCO that will connect the leased TEPPCO pipeline to Mont Belvieu, Texas. The purchase of the 10-mile segment from TEPPCO is estimated to cost $8 million and be completed during the fourth quarter of 2006. The primary term of the TEPPCO pipeline lease will expire in July 2007, and will continue on a month-to-month basis subject to customary termination provisions. Collectively, this 288-mile pipeline will be termed the South Texas NGL pipeline system. The South Texas NGL pipeline system is not in operation, but it is currently undergoing modifications, extensions and interconnections as described above to allow it to transport NGLs beginning in January 2007.
During 2007, we will construct an additional 21 miles of pipeline (the Phase II upgrade) to replace (i) the 10-mile pipeline we will lease from TEPPCO and (ii) certain segments of the pipeline we acquired in August 2006 from ExxonMobil Pipeline Company. The Phase II upgrade is expected to provide a significant increase in pipeline capacity and be operational during the third quarter of 2007.
We estimate the cost of the Phase I expansion to be $37.7 million, which includes the $8 million we will pay TEPPCO to acquire its 10-mile Baytown to Mont Belvieu pipeline. We expect the Phase II upgrade to cost an additional $30.9 million.
The South Texas NGL pipeline system will be owned by our new subsidiary, South Texas NGL Pipelines, LLC. Please see Note 19 for a subsequent event involving this subsidiary.
7. Investments in and Advances to Unconsolidated Affiliates
We own interests in a number of related businesses that are accounted for using the equity method. Our investments in and advances to unconsolidated affiliates are grouped according to the business segment to which they relate. For a general discussion of our business segments, see Note 12. The following table shows our investments in and advances to unconsolidated affiliates at the dates indicated.
Equity method investments are evaluated for impairment when events or changes in circumstances indicate there is a loss in value of the investment which is an other than temporary decline. In the event we determine that the loss in value of an investment is other than a temporary decline, we would record a charge to earnings to adjust the carrying value to fair value.
Neptune owns the Manta Ray Offshore Gathering System (Manta Ray) and Nautilus Pipeline System (Nautilus). Manta Ray gathers natural gas originating from producing fields located in the Green Canyon, Southern Green Canyon, Ship Shoal, South Timbalier and Ewing Bank areas of the Gulf of Mexico to numerous downstream pipelines, including the Nautilus pipeline. Nautilus connects our Manta Ray pipeline to our Neptune natural gas processing plant located in South Louisiana. Due to a recent decrease in throughput volumes on the Manta Ray and Nautilus pipelines, we evaluated our 25.7% investment in Neptune for impairment during the third quarter of 2006. The decrease in throughput volumes is primarily due to underperformance of certain fields, natural depletion and hurricane-related
delays in starting new production. These factors contributed to significant delays in throughput volumes Neptune expects to receive. As a result, Neptune has experienced operating losses in recent periods.
At December 31, 2005, the carrying value of our investment in Neptune was $68.1 million, which included $10.9 million of excess cost related to its original acquisition in 2001. Our review of Neptunes estimated cash flows during the third quarter of 2006 indicated that the carrying value of our investment exceeded its fair value, which resulted in a non-cash impairment charge of $7.4 million. This loss is recorded as a component of Equity in income of unconsolidated affiliates in our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income for the three and nine months ended September 30, 2006. Equity earnings from our investment in Neptune are classified under our Offshore Pipelines & Services business segment. After recording this impairment charge, the carrying value of our investment in Neptune at September 30, 2006 was $59.9 million, which reflects $0.7 million in losses and $0.1 million of distributions we recorded during the first nine months of 2006.
Our investment in Neptune was written down to fair value, which management prepared using recognized business valuation techniques. The fair value analysis is based upon managements expectation of future cash flows. Such expectation of future cash flows incorporates industry information and assumptions made by management. For example, the review of Neptune included management estimates regarding natural gas reserves of producers served by the Neptune pipelines. If the assumptions underlying our fair value analysis change and expected cash flows are reduced, additional impairment charges may result.
On occasion, the price we pay to purchase an equity interest in a company exceeds the underlying book capital account we acquire. Such excess cost amounts are included within our investments in and advances to unconsolidated affiliates. At September 30, 2006, our investments in Promix, La Porte, Neptune, Poseidon, Cameron Highway and Nemo included excess cost amounts totaling $39.1 million, all of which was attributed to fair values in excess of the underlying carrying values of tangible assets at the time of our acquisition of interests in these entities. Amortization of such excess cost amounts was $0.5 million during each of the three month periods ended September 30, 2006 and 2005. For the nine months ended September 30, 2006 and 2005, amortization of such amounts was $1.6 million and $1.7 million, respectively.
The following table shows our equity in income of unconsolidated affiliates by business segment for the periods indicated:
Summarized financial information of unconsolidated affiliates
The following table presents unaudited income statement data for our current unconsolidated affiliates, aggregated by business segment, for the periods indicated (on a 100% basis):
8. Business Combination
Effective July 1, 2006, we acquired the Encinal and Canales natural gas gathering systems and related gathering and processing contracts and other amounts that comprised the South Texas natural gas transportation and processing business of an affiliate of Lewis Energy Group, L.P. (Lewis). The aggregate value of total consideration we paid or issued to complete this business combination (referred to as the Encinal acquisition) was $326.1 million, consisting of $145 million in cash and 7,115,844 of Enterprise Products Partners common units.
Our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income for the three and nine months ended September 30, 2006 includes three months of results of operations from the Encinal business.
The Encinal and Canales gathering systems are located in South Texas and are connected to over 1,450 natural gas production wells tapped into the Olmos and Wilcox formations. The Encinal system consists of 452 miles of pipeline, which is comprised of 280 miles of pipeline we acquired from Lewis in this transaction and 172 miles of pipeline that we own and had previously leased to Lewis. The Canales gathering system is comprised of 32 miles of pipeline. Currently, volumes gathered by the Encinal and Canales systems are transported by our existing South Texas pipeline system and are processed by our South Texas natural gas processing plants.
As part of this transaction, we acquired long-term natural gas processing and gathering dedications from Lewis. First, these gathering systems will be supported by a life of reserves gathering and processing dedication of Lewis natural gas production from the Olmos formation. Second, Lewis entered into a 10-year agreement with us for the transportation of natural gas treated at its Big Reef facility. This facility processes natural gas production from the southern portion of the Edwards Trend in South Texas. Third, Lewis entered into a 10-year gathering and processing agreement with Enterprise Products Partners for rich gas developed below the Olmos formation.
The total consideration paid or granted for the Encinal acquisition is summarized in the following table:
In accordance with purchase accounting, the value of Enterprise Products Partners common units issued to Lewis is based on the average closing price of such units immediately prior to and after the transaction was announced on July 12, 2006. The average closing price used was $25.45 per unit.
The value of equity consideration granted to Lewis, an unrelated third party, is reflected as a component of minority interest on our Unaudited Condensed Consolidated Balance Sheet at September 30, 2006.
Purchase price allocation
This acquisition was accounted for under the purchase method of accounting and, accordingly, its cost has been allocated to the assets acquired and liabilities assumed based on estimated preliminary fair values. Such preliminary values have been developed using recognized business valuation techniques and are subject to change pending a final valuation report. We expect to finalize the purchase price allocation for this transaction during the third quarter of 2007.
As a result of our preliminary purchase price allocation, we recorded $132.9 million of amortizable intangible assets. The remaining preliminary amount represents goodwill of $94.9 million, which management attributes to potential future benefits we may realize from our other South Texas processing and NGL businesses as a result of the Encinal acquisition. Specifically, the long-term dedication rights acquired in connection with the Encinal acquisition are expected to add value to our South Texas processing facilities and related NGL businesses due to increased volumes. For additional information regarding our intangible assets and goodwill, see Note 9.
Pro forma financial information
The following table presents selected unaudited pro forma financial information incorporating the historical results of the Encinal and Canales operations. The effective closing date of our purchase of the Encinal business was July 1, 2006. As a result, our Unaudited Condensed Statements of Consolidated Operations and Comprehensive Income for the three and nine months ended September 30, 2006 include three months of results of operations of this acquired business.
Our unaudited pro forma financial information reflects adjustments that are factually supportable and exclude amounts that may or may not be realized from operating synergies or potential future business opportunities resulting from the business combination.
The following pro forma information has been prepared as if the acquisition had been completed on January 1, 2005 rather than the actual closing date. The pro forma information is based upon data currently available and includes certain estimates and assumptions made by management. As a result, this pro forma information is not necessarily indicative of our financial results had the transaction actually occurred on this date. Likewise, the following unaudited pro forma financial information is not necessarily indicative of our future financial results.
9. Intangible Assets and Goodwill
Identifiable intangible assets
As a result of asset purchases and business combinations during the nine months ended September 30, 2006, we recorded an additional $170.7 million of intangible assets. The following table summarizes our intangible assets by business segment at the dates indicated. Our intangible assets primarily consist of values we assigned to contracts and customer relationships.
The $37.8 million of intangible assets we acquired in connection with our purchase of the Pioneer natural gas processing plant (see Note 6) represent our contractual rights to process natural gas produced from the Jonah and Pinedale fields located in the Greater Green River Basin in Wyoming. The value we assigned to these processing rights is recorded in our NGL Pipelines & Services segment and will be amortized to earnings using methods that closely resemble the pattern in which we estimate the depletion of the underlying natural gas resource basins. Our estimate of the remaining useful life of each resource basin is predicated on a number of factors, including third-party reserve estimates, the economic viability of production and exploration activities in the basin and other industry-related factors.
The $132.9 million of intangible assets we acquired in connection with the Encinal acquisition (see Note 8) represent the value we assigned to customer relationships, particularly the long-term relationship we now have with Lewis through natural gas processing and gathering arrangements. We recorded $127.1 million in our NGL Pipelines & Services segment associated with processing arrangements and $5.8 million in our Onshore Natural Gas Pipelines & Services segment associated with gathering arrangements. Customer relationships, as used in this context, represent the estimated economic value attributable to (i) contractual arrangements in existence at the time of the acquisition plus (ii) projected cash flows from the anticipated future renewal of such arrangements due to the relationship we have with such customer. These intangible assets will be amortized to earnings in a manner similar to that described in the previous paragraph.
The following table shows amortization expense by segment associated with our intangible assets for the periods indicated:
For the remainder of 2006, amortization expense associated with our intangible assets is currently estimated at $23.2 million. Based on information available, we estimate that the additional amortization expense associated with the intangible assets we acquired during the first nine months of 2006 will be $12.7 million in 2007, $13.9 million in 2008, $13 million in 2009, $12.1 million in 2010 and $11.3 million in 2011.
The following table summarizes our goodwill amounts by segment at the dates indicated:
In August 2006, we recorded $94.9 million of goodwill in connection with our preliminary purchase price allocation for the Encinal acquisition. Management attributes this goodwill amount to potential future benefits we may realize from our other South Texas processing and NGL businesses as a result of acquiring the Encinal business. Specifically, our acquisition of the long-term dedication rights associated with the Encinal business is expected to add value to our South Texas processing facilities and related NGL businesses due to increased volumes. The Encinal goodwill is recorded as part of the NGL Pipelines & Services business segment due to managements belief that such future benefits will accrue to businesses classified within this segment.
The remainder of our goodwill is associated with previous acquisitions, principally the $387.1 million recorded in connection with the merger of GulfTerra Energy Partners, L.P. with a wholly owned subsidiary of ours in September 2004.
10. Debt Obligations
Our consolidated debt consisted of the following at the dates indicated:
Parent company debt obligation
$200 Million Credit Facility. In January 2006, the parent company amended and restated its $525 Million Credit Facility to reflect a new borrowing capacity of $200 million, which includes a sublimit of $25 million for letters of credit. Amounts borrowed under the new $200 Million Credit Facility are due in January 2009. The parent company has secured its borrowings under this credit agreement by a pledge of its limited and general partner ownership interests in Enterprise Products Partners.
Amounts borrowed under this credit agreement bear interest at a variable interest rate selected by the parent company at the time of each borrowing equal to (i) the greater of (a) the prime rate publicly announced by Citibank N.A. or (b) the Federal Funds Effective Rate plus 0.5% or (ii) a Eurodollar rate. Variable interest rates based on either the prime rate or Federal Funds Effective Rate will be increased by an applicable margin ranging from 0% to 0.75%. Variable interest rates based on Eurodollar rates will be increased by an applicable margin ranging from 1% to 1.75%.
The $200 Million Credit Facility contains various covenants related to the parent companys ability, and the ability of certain of its subsidiaries (excluding Enterprise Products GP and Enterprise Products Partners), to incur certain indebtedness, grant certain liens, make fundamental structural changes, make distributions following an event of default and enter into certain restricted agreements. The credit agreement also requires the parent company to satisfy certain quarterly financial covenants including (i) its leverage ratio must not exceed 4.5 to 1, except under certain circumstances, and (ii) its minimum net worth must exceed $525 million.
Enterprise Products Partners-Subsidiary guarantor relationships
Enterprise Products Partners guarantees the debt obligations of its Operating Partnership, with the exception of the Dixie revolving credit facility and the senior subordinated notes assumed from GulfTerra. If the Operating Partnership were to default on any debt guaranteed by Enterprise Products Partners, Enterprise Products Partners would be responsible for full repayment of that obligation.
Operating Partnership debt obligations
Apart from that discussed below, there have been no significant changes in the terms of the Operating Partnerships debt obligations since those reported in our annual report on Form 10-K for the year ended December 31, 2005.
Multi-Year Revolving Credit Facility. At September 30, 2006, we did not have any amounts outstanding under this facility. In June 2006, the Operating Partnership executed a second amendment (the Second Amendment) to the credit agreement governing its Multi-Year Revolving Credit Facility. The Second Amendment, among other things, extends the maturity date of the Multi-Year Revolving Credit Facility from October 2010 to October 2011 with respect to $1.2 billion of the commitments. Borrowings with respect to $48 million in commitments mature in October 2010. The Second Amendment also modifies the Operating Partnerships financial covenants to, among other things, allow the Operating Partnership to include in the calculation of its Consolidated EBITDA (as defined in the credit agreement) pro forma adjustments for material capital projects. In addition, the Second Amendment allows for the issuance of hybrid debt, such as the $550 million in principal amount of Junior Notes A issued by the Operating Partnership during the third quarter of 2006 (see below).
In March 2006, Enterprise Products Partners generated net proceeds of $430 million in connection with the sale of 18,400,000 of its common units in an underwritten equity offering. In addition, in September 2006, Enterprise Products Partners generated net proceeds of $320.8 million in connection with the sale of 12,650,000 of its common units in an underwritten equity offering. Subsequently, these amounts were contributed to the Operating Partnership, which, in turn, primarily used the amounts to temporarily reduce debt outstanding under its Multi-Year Revolving Credit Facility.
Junior Notes A. The Operating Partnership sold $550 million in principal amount of fixed/floating, unsecured, long-term subordinated notes due 2066 (Junior Notes A) during the third quarter of 2006. The Operating Partnership used the proceeds from this subordinated debt to temporarily reduce borrowings outstanding under its Multi-Year Revolving Credit Facility and for general partnership purposes. The Operating Partnerships payment obligations under Junior Notes A are subordinated to all of its current and future senior indebtedness (as defined in the Indenture Agreement). Enterprise Products Partners has guaranteed repayment of amounts due under Junior Notes A through an unsecured and subordinated guarantee.
The indenture agreement governing Junior Notes A allows the Operating Partnership to defer interest payments on one or more occasions for up to ten consecutive years subject to certain conditions. The indenture agreement also provides that, unless (i) all deferred interest on Junior Notes A has been paid in full as of the most recent interest payment date, (ii) no event of default under the Indenture has occurred and is continuing and (iii) Enterprise Products Partners is not in default of its obligations under related guarantee agreements, then the Operating Partnership and Enterprise Products Partners cannot declare or make any distributions with respect to any of their respective equity securities or make any payments on indebtedness or other obligations that rank pari passu with or subordinate to Junior Notes A.
The Junior Notes A will bear interest at a fixed annual rate of 8.375% from July 2006 to August 2016, payable semi-annually in arrears in February and August of each year, commencing in February 2007. After August 2016, the Junior Notes A will bear variable rate interest at an annual rate equal to the 3-month LIBOR rate for the related interest period plus 3.708%, payable quarterly in arrears in February, May, August and November of each year commencing in November 2016. Interest payments may be deferred on a cumulative basis for up to ten consecutive years, subject to the certain provisions. The Junior Notes A mature in August 2066 and are not redeemable by the Operating Partnership prior to August 2016 without payment of a make-whole premium.
In connection with the issuance of Junior Notes A, the Operating Partnership entered into a Replacement Capital Covenant in favor of the covered debt holders (as named therein) pursuant to which the Operating Partnership agreed for the benefit of such debt holders that it would not redeem or repurchase such junior notes unless such redemption or repurchase is made from the proceeds of issuance of certain securities.
We were in compliance with the covenants of our consolidated debt agreements at September 30, 2006 and December 31, 2005.
Information regarding variable interest rates paid
The following table shows the range of interest rates paid and the weighted-average interest rate paid on our consolidated variable-rate debt obligations during the nine months ended September 30, 2006.
Consolidated debt maturity table
Our scheduled maturities of debt principal amounts over the next five years and in total thereafter are presented in the following table. No amounts are currently due in 2006 or 2008.
Joint venture debt obligations
We have three unconsolidated affiliates with long-term debt obligations. The following table shows (i) our ownership interest in each entity at September 30, 2006, (ii) total debt of each unconsolidated affiliate at September 30, 2006 (on a 100% basis to the joint venture) and (iii) the corresponding scheduled maturities of such debt.
The credit agreements of our unconsolidated affiliates contain various affirmative and negative covenants, including financial covenants. These businesses were in compliance with such covenants at September 30, 2006.
Amendment of Cameron Highway debt agreement. In March 2006, Cameron Highway amended the note purchase agreement governing its senior secured notes to primarily address the effect of reduced deliveries of crude oil to Cameron Highway resulting from production delays. In general, this amendment modified certain financial covenants in light of production forecasts made by management. In addition, the amendment increased the face amount of the letters of credit required to be issued by the Operating Partnership and an affiliate of our joint venture partner from $18.4 million each to $36.8 million each.
Also, the amendment specifies that Cameron Highway cannot make distributions to its partners during the period beginning March 30, 2006 and ending on the earlier of (i) December 31, 2007 or (ii) the date on which Cameron Highways debt service coverage ratios are not less than 1.5 to 1 for three consecutive fiscal quarters. In order for Cameron Highway to resume paying distributions to its partners, no default or event of default can be present or continuing at the date Cameron Highway desires to start paying such distributions.
Amendment of Poseidon debt agreement. In May 2006, Poseidon amended its revolving credit facility to, among other things, reduce commitments from $170 million to $150 million, extend the maturity date from January 2008 to May 2011 and lower the borrowing rate.
11. Partners Equity
The units of Enterprise GP Holdings L.P. represent limited partner interests, which give the holders thereof the right to participate in distributions and to exercise the other rights and privileges available to them under the First Amended and Restated Agreement of Limited Partnership (the Partnership Agreement) of Enterprise GP Holdings L.P.
In accordance with the Partnership Agreement, capital accounts are maintained for the general partner and the limited partners of Enterprise GP Holdings L.P. The capital account provisions of the Partnership Agreement incorporate principles established for U.S. Federal income tax purposes and are not comparable to the equity accounts reflected under GAAP in our consolidated financial statements. Earnings and cash distributions are allocated to the partners of Enterprise GP Holdings L.P. in accordance with their respective percentage interests.
Our quarterly cash distributions for 2006 are presented in the following table:
For information regarding the distributions paid by the parent company and those the parent company received from Enterprise Products Partners during the first nine months of 2006, see Note 1.
Accumulated other comprehensive income
The following table summarizes transactions affecting our accumulated other comprehensive income since December 31, 2005.
During the remainder of 2006, we will reclassify $1.1 million from accumulated other comprehensive income to earnings as a reduction in consolidated interest expense.
12. Business Segments
We have four reportable business segments: NGL Pipelines & Services, Onshore Natural Gas Pipelines & Services, Offshore Pipelines & Services and Petrochemical Services. Our business segments are generally organized and managed according to the type of services rendered (or technology employed) and products produced and/or sold.
We evaluate segment performance based on the non-GAAP financial measure of gross operating margin. Gross operating margin (either in total or by individual segment) is an important performance measure of the core profitability of our operations. This measure forms the basis of our internal financial reporting and is used by senior management in deciding how to allocate capital resources among business segments. We believe that investors benefit from having access to the same financial measures that our management uses in evaluating segment results. The GAAP measure most directly comparable to total segment gross operating margin is operating income. Our non-GAAP financial measure of total segment gross operating margin should not be considered as an alternative to GAAP operating income.
We define total (or consolidated) segment gross operating margin as operating income before: (i) depreciation, amortization and accretion expense; (ii) operating lease expenses for which we do not have the payment obligation; (iii) gains and losses on the sale of assets; and (iv) general and administrative expenses. Gross operating margin is exclusive of other income and expense transactions, provision for income taxes, minority interest, extraordinary charges and the cumulative effect of changes in accounting principles. Gross operating margin by segment is calculated by subtracting segment operating costs and expenses (net of the adjustments noted above) from segment revenues, with both segment totals before the elimination of intersegment and intrasegment transactions.
Segment revenues and operating costs and expenses include intersegment and intrasegment transactions, which are generally based on transactions made at market-related rates. Our consolidated revenues reflect the elimination of all material intercompany (both intersegment and intrasegment) transactions.
We include equity earnings from unconsolidated affiliates in our measurement of segment gross operating margin and operating income. Our equity investments with industry partners are a vital component of our business strategy. They are a means by which we conduct our operations to align our interests with those of customers and/or suppliers. This method of operation also enables us to achieve favorable economies of scale relative to the level of investment and business risk assumed versus what we could accomplish on a stand-alone basis. Many of these businesses perform supporting or complementary roles to our other business operations.
Our integrated midstream energy asset system (including the midstream energy assets of our equity method investees) provides services to producers and consumers of natural gas, NGLs and petrochemicals. Our asset system has multiple entry points. In general, hydrocarbons enter our asset system in a number of ways, such as an offshore natural gas or crude oil pipeline, an offshore platform, a natural gas processing plant, an onshore natural gas gathering pipeline, an NGL fractionator, an NGL storage facility, or an NGL transportation or distribution pipeline. At each point along our asset system, we typically earn fee-based revenues based on volumes received or we receive ownership of products such as NGLs in lieu of fees.
Many of our equity investees are included within our integrated midstream asset system. For example, we have ownership interests in several offshore natural gas and crude oil pipelines. Other examples include our use of the Promix NGL fractionator to process mixed NGLs extracted by our gas plants. The fractionated NGLs we receive from Promix can then be sold in our NGL marketing activities. Given the integral nature of our equity investees to our operations, we believe the treatment of earnings from our equity method investees as a component of gross operating margin and operating income is meaningful and appropriate.
Historically, our consolidated revenues were earned in the United States and derived from a wide customer base. The majority of our plant-based operations are located in Texas, Louisiana, Mississippi, New Mexico and Wyoming. Our natural gas, NGL and crude oil pipelines are located in a number of regions of the United States including (i) the Gulf of Mexico offshore Texas and Louisiana; (ii) the south and southeastern United States (primarily in Texas, Louisiana, Mississippi and Alabama); and (iii) certain regions of the central and western United States, including the Rocky Mountains. Our marketing activities are headquartered in Houston, Texas and serve customers in a number of regions of the United States including the Gulf Coast, West Coast and Mid-Continent areas. Beginning with the fourth quarter of 2006, a portion of our revenues will be earned in Canada. See Note 19 for information regarding our acquisition of a Canadian affiliate of EPCO in October 2006.
Consolidated property, plant and equipment and investments in and advances to unconsolidated affiliates are assigned to each segment on the basis of each assets or investments principal operations. The principal reconciling difference between consolidated property, plant and equipment and the total value of segment assets is construction-in-progress. Segment assets represent the net book carrying value of facilities and other assets that contribute to gross operating margin of that particular segment. Since assets under construction generally do not contribute to segment gross operating margin, such assets are
excluded from segment asset totals until they are placed in service. Consolidated intangible assets and goodwill are assigned to each segment based on the classification of the assets to which they relate.
The following table shows our measurement of total segment gross operating margin for the periods indicated:
A reconciliation of total segment gross operating margin to operating income and income before provision for income taxes, minority interest and the cumulative effect of change in accounting principle follows:
Information by segment, together with reconciliations to our consolidated totals, is presented in the following table:
The following table summarizes the contribution to consolidated revenues from the sale of NGL, natural gas and petrochemical products for the periods indicated:
13. Related Party Transactions
The following table summarizes our related party transactions for the periods indicated:
General. We have an extensive and ongoing relationship with EPCO and its affiliates, which include the following significant entities:
Unless noted otherwise, our agreements with EPCO are not the result of arms length transactions. As a result, we cannot provide assurance that the terms and provisions of such agreements are at least as favorable to us as we could have obtained from unaffiliated third parties.
EPCO is a private company controlled by Dan L. Duncan, who is also a director and Chairman of EPE Holdings and Enterprise Products GP. At September 30, 2006, EPCO beneficially owned 77,051,403 (or 86.7%) of the parent companys outstanding units. In addition, EPCO beneficially owned 146,379,464 (or 33.9%) of Enterprise Products Partners common units, including 13,454,498 common units owned by the parent company. In addition, at September 30, 2006, EPCO and its affiliates owned 86.7% of the limited partner interests of Enterprise GP Holdings and 100% of its general partner, EPE Holdings. Enterprise GP Holdings owns all of the membership interests of Enterprise Products GP. The principal business activity of Enterprise Products GP is to act as our managing partner. The executive officers and certain of the directors of Enterprise Products GP and EPE Holdings are employees of EPCO.
In connection with its general partner interest in Enterprise Products Partners, Enterprise Products GP received cash distributions of $73.5 million and $55.4 million from Enterprise Products Partners during the nine months ended September 30, 2006 and 2005, respectively. These amounts include $62.5 million and $45.9 million of incentive distributions for the nine months ended September 30, 2006 and 2005, respectively. The parent company owns all of the membership interests of Enterprise Products GP.
We, EPE Holdings, Enterprise Products Partners and Enterprise Products GP are separate legal entities apart from each other and apart from EPCO and its other affiliates, with assets and liabilities that are separate from those of EPCO and its other affiliates. EPCO depends on the cash distributions it receives from us, Enterprise Products Partners and other investments to fund its other operations and to meet its debt obligations. EPCO and its affiliates received $225.5 million and $243.9 million in cash distributions from us during the nine months ended September 30, 2006 and 2005, respectively, in connection with its limited and general partner interests in us.
The ownership interests in the parent company and Enterprise Products Partners that are owned or controlled by EPCO and its affiliates, other than those interests owned by the parent company, Dan Duncan LLC and certain trusts affiliated with Dan L. Duncan, are pledged as security under the credit facility of an affiliate of EPCO. This credit facility contains customary and other events of default relating to EPCO and certain affiliates, including us, Enterprise Products Partners and TEPPCO. The ownership interests in Enterprise Products Partners that are owned or controlled by the parent company are pledged as security under its credit facility.
We have entered into an agreement with an affiliate of EPCO to provide trucking services to us for the transportation of NGLs and other products. We also lease office space in various buildings from affiliates of EPCO. The rental rates in these lease agreements approximate market rates. In addition, we buy and sell NGL products to and from a Canadian affiliate of EPCO at market-related prices in the normal course of business. We acquired this foreign affiliate in October 2006. See Note 19 for additional information regarding this acquisition.
On November 2, 2006, a newly formed and wholly owned subsidiary of Enterprise Products Partners, Duncan Energy Partners, filed its initial registration statement for a proposed public offering of its common units. Duncan Energy Partners will own interests in certain of our midstream energy businesses and will have related party transactions with us and other affiliates of EPCO. For additional information regarding this subsequent event, please read Note 19.
In September 2004, Enterprise Products GP borrowed $370 million from an affiliate of EPCO to finance the purchase of a 50% membership interest in the general partner of GulfTerra. This note payable was repaid in August 2005 using borrowings under the parent companys credit facility. For the three and nine months ended September 30, 2005, we recorded $3.1 million and $15.3 million, respectively, of interest related to this affiliate note payable.
Relationship with TEPPCO. We received $14 million and $31.1 million from TEPPCO during the three and nine months ended September 30, 2006, respectively, from the sale of hydrocarbon products. During the three months ended September 30, 2006 and 2005, we paid TEPPCO $7.1 million and $4 million, respectively, for NGL pipeline transportation and storage services. We paid TEPPCO $17.7 million and $12.6 million for NGL pipeline transportation and storage services during the nine months ended September 30, 2006 and 2005, respectively.
The general partner of TEPPCO and 2,500,000 common units of TEPPCO are owned by a private company subsidiary of EPCO. See Note 15 for recent litigation involving us and TEPPCO.
In March 2006, we paid $38.2 million to TEPPCO for its Pioneer natural gas processing plant located in Opal, Wyoming and certain natural gas processing rights related to production from the Jonah and Pinedale fields located in the Greater Green River Basin in Wyoming. After an in-depth consideration of relevant factors, this transaction was approved by the Audit and Conflicts Committee of the general partner of Enterprise Products Partners and the Audit and Conflicts Committee of the general partner of TEPPCO. In addition, each party received a fairness opinion rendered by an independent advisor. TEPPCO will have no continued involvement in the contracts or in the operations of the Pioneer facility. The unaudited pro forma financial impact of this transaction is not significant.
In August 2006, we announced a joint venture in which we and TEPPCO will be partners in TEPPCOs Jonah Gas Gathering Company (Jonah). Jonah owns the Jonah Gas Gathering System (the Jonah system), located in the Greater Green River Basin of southwestern Wyoming. The Jonah system gathers and transports natural gas produced from the Jonah and Pinedale fields to regional natural gas processing plants and m