UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

 

For the quarterly period ended June 30, 2006

 

OR

 

 

For the transition period from                     to                    

 

Commission File Number 001-14841

 

MARKWEST HYDROCARBON, INC.

(Exact name of registrant as specified in its charter)

 

 

1515 Arapahoe Street, Tower 2, Suite 700, Denver, Colorado 80202

 (Address of principal executive offices)

 

Registrant’s telephone number, including area code:  303-925-9200

 

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  ý    No  o

 

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

 

Large accelerated filer

o

Accelerated filer

ý

Non-accelerated filer

o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes  o    No  ý

 

The registrant had 11,955,006 shares of common stock, $0.01 per share par value, outstanding as of July 14, 2006.

 

 

PART I—FINANCIAL INFORMATION
Item 1.	Financial Statements
	Condensed Consolidated Balance Sheets at June 30, 2006 and December 31, 2005
	Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2006 and 2005
	Condensed Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2006 and 2005
	Condensed Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2006
	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2006 and 2005
	Notes to the Condensed Consolidated Financial Statements
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations
Item 3.	Quantitative and Qualitative Disclosures about Market Risk
Item 4.	Controls and Procedures
PART II—OTHER INFORMATION
Item 1.	Legal Proceedings
Item 4.	Submission of Matters to a Vote of Security Holders
Item 6.	Exhibits
SIGNATURE

 

Glossary of Terms

 

Bbl/d		barrels of oil per day
Btu		British thermal units, an energy measurement
Gal/d		gallons per day
Mcf		thousand cubic feet of natural gas
Mcf/d		thousand cubic feet of natural gas per day
MMBtu		million British thermal units, an energy measurement
MMcf		million cubic feet of natural gas
MMcf/d		million cubic feet of natural gas per day
Net operating margin (a non-GAAP financial measure)		revenues less purchased product costs
NGL		natural gas liquids, such as propane, butanes and natural gasoline

 

2

 

PART I—FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

MARKWEST HYDROCARBON, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited, in thousands, except share data)

 

		June 30, 2006			December 31, 2005
ASSETS
Current assets:
Cash and cash equivalents		$	26,272		$	20,968
Marketable securities		6,527			6,070
Receivables, net of allowances of $165 and $175, respectively		86,848			145,539
Inventories		47,891			41,067
Other current assets		22,554			16,314
Total current assets		190,092			229,958
Property, plant and equipment		599,146			573,198
Less: accumulated depreciation, depletion, amortization and impairment		(93,312		)	(78,500		)
Total property, plant and equipment, net		505,834			494,698
Other assets:
Investment in Starfish		57,211			39,167
Intangible assets, net		339,440			346,496
Deferred financing costs, net of accumulated amortization of $6,127 and $4,424, respectively		17,042			18,463
Deferred contract cost, net of accumulated amortization of $546 and $390, respectively		2,704			2,860
Investment in and advances to other equity investee		183			182
Other long-term assets		2,001			326
Notes receivable from related parties		130			154
Total other assets		418,711			407,648
Total assets		$	1,114,637		$	1,132,304
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Accounts payable (including related party payables of $0 and $25, respectively)		$	96,237		$	119,105
Accrued liabilities		45,157			45,869
Fair value of derivative instruments		15,764			728
Deferred taxes		533			362
Current portion of long-term debt		460			2,738
Total current liabilities		158,151			168,802
Long-term liabilities:
Deferred income taxes		4,383			3,487
Fair value of derivative instruments		658
Debt		593,628			608,762
Other		14,203			10,256
Non-controlling interest in consolidated subsidiary		305,651			301,015
Total liabilities		1,076,674			1,092,322
Commitments and contingencies (Note 11)
Stockholders’ equity (December 31, 2005 adjusted to reflect May 23, 2006 Stock Dividend, See Note 2):
Preferred stock, par value $0.01, 5,000,000 shares authorized, no shares outstanding		—			—
Common stock, par value $0.01, 20,000,000 shares authorized, 11,958,758 and 11,943,733 shares issued, respectively		120			119
Additional paid-in capital		44,958			48,786
Deferred compensation		—			(398		)
Accumulated deficit		(7,725		)	(8,425		)
Accumulated other comprehensive income, net of tax		644			357
Treasury stock, 3,834 and 55,619 shares, respectively		(34		)	(457		)
Total stockholders’ equity		37,963			39,982
Total liabilities and stockholders’ equity		$	1,114,637		$	1,132,304

 

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

 

3

 

MARKWEST HYDROCARBON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited, in thousands, except per share amounts)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Revenues:
Revenues		$	186,590		$	141,280		$	427,470		$	279,540
Derivatives		(13,057		)	(240		)	(14,316		)	(147		)
Total revenue		173,533			141,040			413,154			279,393
Operating expenses:
Purchased product costs		116,858			112,354			298,025			217,053
Facility expenses		14,217			10,985			27,921			20,245
Selling, general and administrative expenses		13,061			9,125			24,437			17,227
Depreciation		7,778			4,995			15,156			9,736
Amortization of intangible assets		4,027			2,095			8,043			4,190
Accretion of asset retirement obligations		26			11			51			21
Total operating expenses		155,967			139,565			373,633			268,472
Income from operations		17,566			1,475			39,521			10,921
Other income (expense):
Equity in earnings in unconsolidated affiliates		1,228			989			2,173			990
Interest income		436			321			842			570
Interest expense		(10,798		)	(4,588		)	(21,842		)	(8,293		)
Amortization of deferred financing costs (a component of interest expense)		(859		)	(558		)	(1,684		)	(1,094		)
Dividend income		109			96			215			188
Miscellaneous income		1,517			148			3,759			235
Income (loss) from operations before non-controlling interest in net income of consolidated subsidiary and income taxes		9,199			(2,117		)	22,984			3,517
Income tax (expense) benefit
Current		(64		)	—			429			—
Deferred		6			802			(896		)	32
Income tax (expense) benefit		(58		)	802			(467		)	32
Non-controlling interest in net income of consolidated subsidiary		(11,273		)	(294		)	(21,817		)	(3,619		)
Net income (loss)		$	(2,132	)	$	(1,609	)	$	700		$	(70	)
Net income (loss) per share:
Basic		$	(0.18	)	$	(0.14	)	$	0.06		$	(0.01	)
Diluted		$	(0.18	)	$	(0.14	)	$	0.06		$	(0.01	)
Weighted average number of outstanding shares of common stock (December 31, 2005 adjusted to reflect May 23, 2006 Stock Dividend, see Note 2):
Basic		11,936			11,861			11,921			11,852
Diluted		11,936			11,861			12,046			11,852
Dividends declared per common share		$	0.24		$	0.091		$	0.415		$	0.182

 

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

 

4

 

MARKWEST HYDROCARBON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited, in thousands)

 

		Three Months Ended June 30,						Six Months Ended June 30,
		2006			2005			2006			2005
Net income (loss)		$	(2,132	)	$	(1,609	)	$	700		$	(70	)
Other comprehensive income (loss):
Unrealized gains on marketable securities, net of tax of $56, $166, $171 and $115, respectively.		94			275			287			191
Unrealized gains (losses) on commodity derivative instruments accounted for as hedges, net of tax of $0, $420, $0 and $(122), respectively.		—			556			—			(197		)
Total other comprehensive income (loss)		94			831			287			(6		)
Comprehensive income (loss)		$	(2,038	)	$	(778	)	$	987		$	(76	)

 

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

 

5

 

MARKWEST HYDROCARBON, INC.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY

(Unaudited, in thousands)

 

		Shares of Common Stock		Shares of Treasury Stock		Common Stock			Additional Paid-In Capital			Deferred Compensation			Accumulated Earnings (Deficit)			Other Comprehensive Income			Treasury Stock			Total Stockholders’ Equity
Balance, December 31, 2005		10,858		(56	)	$	108		$	48,797		$	(398	)	$	(8,425	)	$	357		$	(457	)	$	39,982
May 23, 2006 Stock Dividend Adjustment (Note 2)		1,085		—		11			(11		)	—			—			—			—			—
Adjusted December 31, 2005		11,943		(56	)	119			48,786			(398		)	(8,425		)	357			(457		)	39,982
Stock option exercises		12		18		1			63			—			—			—			166			230
Compensation expense related to equity-based awards				—		—			211			—			—			—			—			211
Issuance of restricted stock		1		34		—			(257		)	—			—			—			257			—
Cashless stock option exercises		3		—		—			—			—			—			—			—			—
Reclassification of unearned compensation related to the adoption of Statement of Financial Accounting Standards No. 123(R) (Note 2)		—		—		—			(398		)	398			—			—			—			—
Net income		—		—		—			—			—			700			—			—			700
Dividend		—		—		—			(3,447		)	—			—			—			—			(3,447		)
Other comprehensive income		—		—		—			—			—			—			287			—			287
Balance, June 30, 2006		11,959		(4	)	$	120		$	44,958		$	—		$	(7,725	)	$	644		$	(34	)	$	37,963

 

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

 

6

 

MARKWEST HYDROCARBON, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited, in thousands)

 

		June 30,
		2006			2005
Cash flows from operating activities:
Net Income		$	700		$	(70	)
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		15,156			9,736
Amortization of intangible assets		8,043			4,190
Amortization of deferred financing costs		1,684			1,094
Amortization of gas contract		156			156
Accretion of asset retirement obligation		51			21
Non-controlling interest in net income of consolidated subsidiary		21,817			3,619
Equity in earnings of unconsolidated affiliates		(2,173		)	(351		)
Unrealized losses (gains) on derivative instruments		14,378			(734		)
Deferred taxes		896			(32		)
Stock option compensation expense		35			979
Restricted stock compensation expense		176			34
Restricted unit compensation expense		571			665
Participation Plan compensation expense		3,944			2,790
Contribution of treasury shares to 401(k) benefit plan		—			168
Imputed interest on debt securities		—			(52		)
Gain from sale of property, plant and equipment		(421		)	(161		)
Gain from sale of marketable securities		—			(56		)
Changes in operating assets and liabilities, net of working capital acquired in acquisitions:
Receivables		53,691			15,834
Inventories		(6,824		)	109
Other assets		(4,924		)	(1,825		)
Accounts payable and accrued liabilities		(20,448		)	(10,802		)
Other long-term liabilities		86			200
Net cash provided by operating activities		86,594			25,512
Cash flows from investing activities:
Purchase of marketable securities		—			(8,725		)
Proceeds from sale of marketable securities		—			3,603
Additional Javelina acquisition costs		(6,582		)	—
Capital expenditures		(25,685		)	(31,442		)
Proceeds from sale of property, plant and equipment		499			162
Investment in Starfish		(15,872		)	(41,688		)
Net cash used in investing activities		(47,640		)	(78,090		)
Cash flows from financing activities:
Proceeds from long-term debt		56,800			65,000
Repayments of long-term debt		(74,212		)	—
Payments for deferred financing costs and registration costs		(459		)	(95		)
Collection of related party notes receivable		24			53
Proceeds from MarkWest Energy’s private placement, net		5,000			—
Distributions to MarkWest Energy unitholders		(17,586		)	(12,865		)
Payment of dividends		(3,447		)	(1,886		)
Exercise of stock options		230			66
Purchase of treasury shares		—			(161		)
Net cash provided by (used in) financing activities		(33,650		)	50,112
Net increase (decrease) in cash and cash equivalents		5,304			(2,466		)
Cash and cash equivalents at beginning of year		20,968			12,844
Cash and cash equivalents at end of year		$	26,272		$	10,378
Cash paid for interest and income taxes
Cash paid for interest, net of amount capitalized		$	19,823		$	8,013
Cash paid for income taxes		$	584		$	523
Deferred offering costs payable
Construction projects in progress		$	1,072		$	3,003
Accrued financing costs		$	1,580		$	—

 

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

 

7

 

MARKWEST HYDROCARBON, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. Organization

 

MarkWest Hydrocarbon, Inc. (“MarkWest Hydrocarbon” or the “Company”) is an energy company primarily focused on marketing natural gas liquids (NGLs) and increasing shareholder value by growing MarkWest Energy Partners, L.P. (“MarkWest Energy Partners” or the “Partnership”), a consolidated subsidiary and publicly-traded master limited partnership. MarkWest Energy Partners is engaged in the gathering, processing and transmission of natural gas; the transportation, fractionation and storage of natural gas liquids; and the gathering and transportation of crude oil. The Company also markets natural gas and NGLs. MarkWest Hydrocarbon and MarkWest Energy Partners provide services primarily in Appalachia, Michigan, Texas, Oklahoma, Gulf Coast and other areas of the southwest.

 

2. Basis of Presentation

 

The Company’s unaudited condensed consolidated financial statements include the accounts of all majority-owned or controlled subsidiaries. Equity investments in which we exercise significant influence but where we do not control and are not the primary beneficiary, are accounted for using the equity method.

 

These condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial reporting. Accordingly, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with GAAP have been condensed or omitted. In management’s opinion, we have made all adjustments necessary for a fair presentation of the Company’s results of operations, financial position and cash flows for the periods shown. These adjustments are of a normal recurring nature. In addition to reviewing these condensed consolidated financial statements and accompanying notes, you should also consult the audited financial statements and notes that makes up the Company’s December 31, 2005, Annual Report on Form 10-K. Finally, consider that results for the six months ended June 30, 2006, are not necessarily indicative of results for the full year 2006, or any other future period.

 

On April 27, 2006, MarkWest Hydrocarbon announced that its Board of Directors approved the issuance of one share of common stock for each ten shares of common stock held by common stockholders. The stock was issued on May 23, 2006, to the stockholders of record as of the close of business on May 11, 2006; the ex-dividend rate was May 9, 2006. 1,084,647 shares were issued at a fair value of $24.4 million, based upon the last sale price on the record date ($22.50 per share). Cash of $3,200 was paid in lieu of fractional shares, based upon the last sale price on the record date. All common stock accounts and per share data have been retroactively adjusted to give effect to the dividend of our common stock.

 

Stock and Incentive Compensation Plans

 

The Company adopted SFAS No. 123R, Accounting for Stock-Based Compensation on January 1, 2006, using the modified prospective method. Prior to adopting SFAS No. 123R, the Company elected to measure compensation expense for equity-based employee compensation plans as prescribed by Accounting Principles Board (“APB”) No. 25, Accounting for Stock Issued to Employees.

 

Under SFAS No. 123R, compensation expense is based on the fair value of the award. SFAS No. 123R classifies stock-based compensation as either equity or liability awards. The fair value on the date of grant for an award classified as equity is recognized over the requisite service period, with a corresponding credit to equity (generally, paid-in capital). The requisite service period is the period during which an individual is required to provide service in exchange for an award, which often is the vesting period. The requisite service period is estimated based on an analysis of the terms of the share-based payment award. Compensation expense for a liability award is based on the award’s fair value, remeasured at each reporting date until the date of settlement. Additionally, compensation expense is reduced by 4.6% for an estimate of expected award forfeitures.

 

Under APB No. 25, compensation expense is based on the intrinsic value (typically the difference between the equity-based instrument to be received and the cost to acquire that equity-based instrument). APB No. 25 classified stock-based compensation as either fixed or variable awards. The intrinsic value on the date of grant for an award classified as fixed is recognized over the requisite service period. Compensation expense for variable awards is based on the award’s intrinsic value, remeasured at each reporting date until the date of settlement.

 

Compensation expense under each plan is included in selling, general and administrative expenses.

 

8

 

MarkWest Hydrocarbon

 

Stock Options

 

Stock options are issued under the Company’s 1996 Stock Incentive Plan and 1996 Non-employee Director Stock Option Plan.  Under SFAS No. 123R, the plans are categorized as equity awards. Under APB No. 25, the plans were categorized as variable awards.

 

Restricted Stock

 

The Company also issues restricted stock, for no consideration, under the Company’s 1996 Stock Incentive Plan and 1996 Non-employee Director Stock Option Plan.  Upon settlement, the individual receives common stock of the Company. Under SFAS No. 123R, the restricted stock qualifies as an equity award, and under APB No. 25 qualified as a fixed award.

 

Participation Plan

 

The Company has also entered into arrangements with certain directors and employees of the Company referred to as the Participation Plan.  Under this plan, the Company sells subordinated partnership units of the Partnership or interests in the Partnership’s general partner, under a purchase and sale agreement.  As the formula used to determine the sale and buy-back price is not based on independent third party valuation, coupled with the attributes of the put-and-call provisions, these transactions are considered compensatory arrangements. The general partner interests have no definite term, but historically have been settled for cash when the employee leaves the Company. The subordinated units convert to common units after a holding period; however, historically, management has settled some subordinated units for cash when individuals left the Company. The subordinated partnership units of the Partnership were also sold to the employees and directors based on a formula that may not necessarily fully reflect fair value, thus the subordinated units are considered compensatory. Under SFAS 123R, the subordinated units and general partner interests are classified as liability awards, while under APB No. 25, they were classified as variable awards.

 

Under Topic 1-B of the codification of the Staff Accounting Bulletins, Allocation of Expenses And Related Disclosure in Financial Statements of Subsidiaries, Divisions or Lesser Business Components of Another Entity, some portion of compensation expense related to services provided by MarkWest Hydrocarbon’s employees and directors recognized under the Participation Plan should be allocated to the Partnership.  The allocation is based on the percent of time that each employee devotes to the Company.  Compensation attributable to interests that were sold to individuals who serve on both the board of MarkWest Hydrocarbon and the Partnership’s Board of Directors is allocated equally.

 

MarkWest Energy Partners

 

Restricted Units

 

The Partnership issues restricted units under the MarkWest Energy Partners, L.P. Long-Term Incentive Plan.  A restricted unit is a “phantom” unit that entitles the grantee to receive a common unit upon the vesting of the phantom unit or, at the discretion of the Compensation Committee, cash equivalent to the value of a common unit.  The restricted units are treated as liability awards under SFAS No. 123R, and were treated as variable awards under APB No. 25.

 

To satisfy common unit awards, common units may be acquired on the open market, from the general partner or any other person, as well as from the issuance of new common units.  The cost of the common unit awards, therefore, will be borne by the Partnership.

 

Pro Formas

 

Had compensation cost for the Company’s stock-based and unit-based compensation plans been determined based on the fair value at the grant dates under those plans consistent with the method prescribed by SFAS No. 123R, Accounting for Stock-Based Compensation, the Company’s net income and earnings per share would have been reduced to the pro forma amounts listed below (in thousands, except per share data):

 

 

9

 

3. Recent Accounting Pronouncements

 

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instruments—an amendment of FASB Statements No. 133 and 140 (“SFAS 155”). This statement amends SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities (“SFAS 133”), and SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities and resolves issues addressed in SFAS 133 Implementation Issue No. D1, “Application of Statement 133 to Beneficial Interest in Securitized Financial Assets.”  This Statement: (a) permits fair value remeasurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation; (b) clarifies which interest-only strips and principal-only strips are not subject to the requirements of SFAS 133; (c) establishes a requirement to evaluate beneficial interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation; (d) clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives; and, (e) eliminates restrictions on a qualifying special-purpose entity’s ability to hold passive derivative financial instruments that pertain to beneficial interests that are or contain a derivative financial instrument. The standard also requires presentation within the financial statements that identifies those hybrid financial instruments for which the fair value election has been applied and information on the income statement impact of the changes in fair value of those instruments. The Partnership is required to apply SFAS 155 to all financial instruments acquired, issued or subject to a remeasurement event beginning January 1, 2007, although early adoption is permitted as of the beginning of an entity’s fiscal year. The adoption of SFAS 155 is not expected to have a material impact on the condensed consolidated financial statements of the Partnership.

 

In March 2006, the FASB issued SFAS No. 156, Accounting for Servicing of Financial Assets – an amendment of FASB Statement No. 140. FAS No. 156 establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities by requiring that they be initially measured at fair value, if practicable. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 156 will have no impact on the Company’s condensed consolidated financial statements of operations or financial position.

 

In June 2006 the FASB issued Interpretation No. 48, Accounting for Uncertainty in Income Taxes. The interpretation clarifies the accounting for uncertainty in income taxes recognized in a company’s financial statements in accordance with Statement of Financial Accounting Standards No. 109, Accounting for Income Taxes. Specifically, the pronouncement prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. The interpretation also provides guidance on the related derecognition, classification, interest and penalties, accounting for interim periods, disclosure and transition of uncertain tax positions. The interpretation is effective for fiscal years beginning after December 15, 2006. The adoption of this pronouncement is not expected to have a material impact on the condensed consolidated financial statements of the Company.

 

4. Acquisitions by MarkWest Energy Partners

 

Javelina Acquisition

 

On November 1, 2005, the Partnership acquired equity interests in Javelina Company, Javelina Pipeline Company and Javelina Land Company, L.L.C., which were 40%, 40% and 20%, respectively, owned by subsidiaries of El Paso Corporation, Kerr-McGee Corporation and Valero Energy Corporation. The Partnership paid consideration of $357.0 million, plus $41.8 million for net working capital that included approximately $35.5 million in cash. The Corpus Christi, Texas, gas-processing facility treats and processes off-gas from six local refineries, two of which are owned by Valero Energy Corporation, two by Koch Industries, Inc. and two by Citgo Petroleum Corporation. Constructed in 1989 to recover up to 28,000 Bbl/d of NGLs, the facility currently processes approximately 125 to 130 MMcf/d of inlet gas and produces approximately 25,400 Bbl/d of NGLs. The Partnership completed its purchase price allocation in May 2006, including a final working capital settlement to the seller of $5.9 million.

 

Starfish Joint Venture

 

On March 31, 2005, the Partnership acquired a 50% non-operating membership interest in Starfish Pipeline

 

10

 

Company, LLC, (“Starfish”) from an affiliate of Enterprise Products Partners L.P. for $41.7 million. The Partnership financed the acquisition by borrowing $40.0 million from its credit facility during the first quarter of 2005. Starfish is a joint venture with Enbridge Offshore Pipelines LLC, which the Partnership accounts for using the equity method. Starfish owns the FERC-regulated Stingray natural gas pipeline, and the unregulated Triton natural gas-gathering system and West Cameron dehydration facility. All are located in the Gulf of Mexico and southwestern Louisiana.

 

The Partnership applies the equity method of accounting for its interests in Starfish. Summarized financial information for 100 percent of Starfish is as follows (in thousands):

 

 

Pro Forma Results of Operations

 

The following table reflects the unaudited pro forma consolidated results of operations for the three months ended March 31, 2005, as though the Starfish acquisition and the Javelina acquisition had occurred on January 1, 2005. The actual results for the six months ended June 30, 2006, are included in the accompanying condensed consolidated statement of operations. The pro forma amounts include certain adjustments, including recognition of depreciation based on the allocated purchase price of property and equipment, amortization of customer contracts, amortization of the excess Starfish purchase price over net book value, amortization of deferred financing costs and interest expense.

 

The unaudited pro forma results do not necessarily reflect the actual results that would have occurred had the entities been combined during the period presented, nor does it necessarily indicate the future results of the combined entities.

 

 

5. Other Long-Term Assets

 

		June 30,			December 31,
		2006			2005
Accrued financing costs		$	1,675		$	—
Other		326			326
		$	2,001		$	326

 

Accrued Financing Costs

 

Accrued financing costs at June 30, 2006, of $1.7 million relate to both a public offering of 3,000,000 common units and a private placement of $200 million aggregate principal amount of the 2016 Senior Notes that closed on July 6, 2006 (See Note 13).

 

6. Debt

 

		June 30, 2006			December 31, 2005
		(in thousands)
MarkWest Hydrocarbon Credit Facility
Revolver facility, 8.75% interest at December 31, 2005, due January 30, 2007		$	—		$	7,500
Partnership Credit Facility
Term loan, 8.75% interest at December 31, 2005, due December 2010		364,088			365,000
Revolver facility, 8.75% interest at December 31, 2005, due December 2010		5,000			14,000
Partnership Senior Notes
Senior Notes, 6.875% interest, due November 2014		225,000			225,000
		594,088			604,000
Less: obligations due in one year		(460		)	(2,738		)
Total long-term debt		$	593,628		$	601,262

 

 

(1)           The balance sheet classification of debt, between current and long-term, reflects the repayment of $318.6 million of the Partnership Credit Facility term loan, using proceeds from the debt and equity transactions, as further described in Note 13.

 

MarkWest Hydrocarbon

 

Credit Facility

 

On January 31, 2006, the Company entered into the First Amended and Restated Credit Agreement, which provide a maximum lending limit of $25.0 million for a one-year term and which amended and restated the October 2004 agreement discussed below. As of June 30, 2006, the Company had $6.0 million of the availability committed to a letter of credit, leaving $19.0 million available for revolving loans.

 

The credit facility bears interest at a variable interest rate, plus basis points.  The variable interest rate is typically based on the London Inter Bank Offering Rate (“LIBOR”); however, in certain borrowing circumstances the rate would be based on the higher of a) the Federal Funds Rate plus 0.5-1%, and b) a rate set by the Facility’s administrative agent, based on the U.S. prime rate. The basis points correspond to the ratio of the Revolver Facility Usage (as defined in the Company Credit Facility) to the Borrowing Base (as defined in the Company Credit Facility), ranging from 0.75% to 1.75% for Base Rate loans, and 1.75% to 2.75% for Eurodollar Rate loans. The Company pays a quarterly commitment fee on the unused portion of the credit facility at an annual rate of 50.0 basis points.

 

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Under the provisions of the Company Credit Facility, the Company is subject to a number of restrictions on its business, including restrictions on its ability to grant liens on assets; make or own certain investments; enter into any swap contracts other than in the ordinary course of business; merge, consolidate or sell assets; incur indebtedness (other than subordinated indebtedness); make distributions on equity investments; declare or make, directly or indirectly, any restricted distributions.

 

The credit facility also contains covenants requiring the Company to maintain:

 

•                  a ratio of not more than 3.50 to 1.00 of total consolidated debt to consolidated EBITDA for any fiscal quarter-end;

 

•                  a minimum net worth of a) $34.0 million plus, b) 50% of consolidated net income (if positive) earned on or after October 1, 2005 plus, c) 100% of net proceeds of all equity issued by the Company subsequent to January 31, 2006; and

 

•                  a minimum available cash and marketable securities reserve of $13.0 million, which is to be reduced to zero in the event the Company restructures a keep-whole contract with one of its significant customers.

 

On March 23, 2006, the Company amended the First Amended and Restated Credit Agreement to reduce the cash reserve requirement from $13.0 million to $5.0 million through December 31, 2006.

 

In October 2004, the Company entered into a $25.0 million senior credit facility with a term of one year.  The $25.0 million revolving facility had a variable interest rate based on the base rate, which is equal to the higher of a) the Federal Funds Rate plus ½ of 1%, and b) the rate of interest in effect for such day as publicly announced from time to time by the Administrative Agent as its prime rate, plus the applicable rate, which is based on a utilization percentage.  In October, November, and December 2005, the Company entered into the first, second and third amendment to the credit agreement.  The first amendment extended the term of the original agreement to November 15, 2005.  The second amendment reduced the lending amount from $25.0 million to $16.0 million, of which $6.0 million of availability is committed to a letter of credit, leaving $10.0 million available for revolving loans.  The second amendment also extended the term of the revolving credit to December 30, 2005.  The third amendment extended the term of the revolving credit to January 31, 2006, and reduced the lending amount from $16.0 million to $13.5 million, of which $6.0 million of availability is committed to a letter of credit, leaving $7.5 million available for revolving loans, at December 31, 2005.

 

MarkWest Energy Partners

 

Partnership Credit Facility

 

On December 29, 2005, MarkWest Energy Operating Company, L.L.C., a wholly owned subsidiary of MarkWest Energy Partners L.P., entered into the fifth amended and restated credit agreement (“Partnership Credit Facility”), which provides for a maximum lending limit of $615.0 million for a five-year term.  The credit facility includes a revolving facility of $250.0 million and a $365.0 million term loan.  The credit facility is guaranteed by the Partnership and all of the Partnership’s subsidiaries and is collateralized by substantially all of the Partnership’s assets and those of its subsidiaries.  The borrowings under the credit facility bear interest at a variable interest rate, plus basis points.  The variable interest rate is typically based on the London Inter Bank Offering Rate (“LIBOR”); however, in certain borrowing circumstances the rate would be based on the higher of a) the Federal Funds Rate plus 0.5 to 1.0%, and b) a rate set by the Facility’s administrative agent, based on the U.S. prime rate.  The basis points vary based on the ratio of the Partnership’s Consolidated Debt (as defined in the Partnership Credit Facility) to Consolidated EBITDA (as defined in the Partnership Credit Facility), ranging from 0.50% to 1.50% for Base Rate loans, and 1.50% to 2.50% for Eurodollar Rate loans.  The basis points will increase by 0.50% during any period (not to exceed 270 days) where the Partnership makes an acquisition for a purchase price in excess of $50.0 million (“Acquisition Adjustment Period”). For the three and six months ended June 30, 2006, the weighted average interest rate on the Partnership Credit Facility was 7.32% and 7.16%.

 

The balance sheet classification of debt, between current and long-term, reflects the repayment of $318.6 million of the Partnership Credit Facility term loan, using proceeds from the debt and equity transactions, as further described in Note 13.

 

2014 Senior Notes

 

In October 2004 the Partnership and its subsidiary, MarkWest Energy Finance Corporation, issued $225.0 million in senior notes (“2014 Senior Notes”) at a fixed rate of 6.875%, payable semi-annually in arrears on May 1 and November 1, and commencing on May 1, 2005. The notes mature on November 2, 2014. The Partnership may redeem some or all of the notes at any time on or after November 1, 2009, at certain redemption prices together with accrued and unpaid interest to the

 

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date of redemption. The Partnership may redeem all of the notes at any time prior to November 1, 2009, at a make-whole redemption price. In addition, prior to November 1, 2007, the Partnership may redeem up to 35% of the aggregate principal amount of the notes with the proceeds of certain equity offerings at a stated redemption price. The Partnership must offer to repurchase the notes at a specified price if it a) sells certain assets and does not reinvest the proceeds or repay senior indebtedness, or b) the Partnership experiences specific kinds of changes in control. Each of the Partnership’s existing subsidiaries, other than MarkWest Energy Finance Corporation, has guaranteed the notes jointly and severally, and fully and unconditionally. The notes are senior unsecured obligations equal in right of payment with all of the Partnership’s existing and future senior debt. They are senior in right of payment to all of the Partnership’s future subordinated debt but effectively junior in right of payment to its secured debt to the extent of the assets securing the debt, including the Partnership’s obligations in respect of its Partnership Credit Facility. The proceeds from these notes were used to pay down the Partnership’s outstanding debt under its credit facility.

 

The indenture governing the 2014 Senior Notes includes certain limitations on the activities of the Partnership and its restricted subsidiaries. Limitations include the ability of the Partnership and its restricted subsidiaries to incur additional indebtedness; declare or pay dividends or distributions, or redeem, repurchase or retire equity interests or subordinated indebtedness; make investments; incur liens; create any consensual limitation on the ability of the Partnership’s restricted subsidiaries to pay dividends, make loans or transfer property to the Partnership; engage in transactions with the Partnership’s affiliates; sell assets, including equity interests of the Partnership’s subsidiaries; make any payment on or with respect to, or purchase, redeem, defease or otherwise acquire or retire for value any subordinated obligation or guarantor subordination obligation (except principal and interest at maturity); and consolidate, merge or transfer assets. Subject to compliance with certain covenants, the Partnership may issue additional notes from time to time under the indenture pursuant to Rule 144A and Regulation S under the Securities Act of 1933.

 

The Partnership agreed to file an exchange offer registration statement or, under certain circumstances, a shelf registration statement, pursuant to a registration rights agreement relating to the 2014 Senior Notes. The Partnership failed to complete the exchange offer in the time provided for in the subscription agreements (April 26, 2005) and, as a consequence, is incurring an interest rate penalty of 0.5% annually, increasing 0.25% every 90 days thereafter up to 1%, until such time as the exchange offer was completed. The registration statement was filed on January 17, 2006, the exchange offer was completed on March 7, 2006, and the interest penalty ceased.

 

7. Derivative Financial Instruments

 

Commodity Instruments

 

MarkWest Hydrocarbon and MarkWest Energy utilizes a combination of fixed-price forward contracts, fixed-for-floating price swaps and options available in the over-the-counter (“OTC”) market, and futures contracts traded on the New York Mercantile Exchange (“NYMEX”).  The Company and the Partnership enter into OTC swaps with financial institutions and other energy company counterparties.  Management conducts a standard credit review on counterparties and has agreements containing collateral requirements where deemed necessary.  The Company and the Partnership use standardized agreements that allow for offset of positive and negative exposures.  Some of the agreements may require margin deposit.

 

The use of derivative instruments may create exposure to the risk of financial loss in certain circumstances, including instances when (i) NGLs do not trade at historical levels relative to crude oil, (ii) sales volumes are less than expected, requiring market purchases to meet commitments, or (iii) our OTC counterparties fail to purchase or deliver the contracted quantities of natural gas, NGLs or crude oil or otherwise fail to perform.  To the extent that the Company, or the Partnership, engage in derivative activities, they may be prevented from realizing the benefits of favorable price changes in the physical market; however, they are similarly insulated against unfavorable changes in such prices.

 

Both the Company and the Partnership have a committee, which is comprised of the senior management team that oversees all of the derivative activity.

 

Fair value is based on available market information for the particular derivative instrument, and incorporates the commodity, period, volume and pricing.  Positive (negative) amounts represent unrealized gains (losses).

 

MarkWest Hydrocarbon

 

MarkWest Hydrocarbon may enter into physical and/or financial positions to manage its risks related to commodity price exposure for its Standalone segment. Due to timing of purchases and sales, direct exposure to price volatility can be created, because there is no longer an offsetting purchase or sale that remains exposed to market pricing.  Through marketing and derivatives activities, direct exposure may occur naturally, or we may choose direct exposure when we favor that exposure over frac spread risk.

 

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The following table summarizes the derivative positions specific to MarkWest Hydrocarbon’s Standalone segment at June 30, 2006:

 

 

The impact of MarkWest Hydrocarbon’s commodity derivative instruments on results of operations and financial position are summarized below (in thousands):

 

 

 

MarkWest Energy Partners

 

The Partnership’s primary risk management objective is to reduce volatility in its cash flows arising from changes in commodity prices related to future sales of natural gas, NGLs and crude.  Swaps and futures contracts may allow the Partnership to reduce volatility in its margins, because losses or gains on the derivative instruments are generally offset by corresponding gains or losses in the Partnership’s physical positions.

 

The following table includes information on MarkWest Energy’s specific derivative positions at June 30, 2006:

 

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