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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10 - Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended SEPTEMBER 30, 2003
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number 000-50195
LINK ENERGY LLC
(Exact name of registrant as specified in its charter)
Delaware 76-0424520
(State or Other Jurisdiction of (I.R.S. Employer
Incorporation or Organization) Identification No.)
2000 West Sam Houston Parkway South,
Suite 400
Houston, Texas 77042
(Address of principal executive offices) (Zip Code)
(713) 993-5200
(Registrant's telephone number, including area code)
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 [ ] No [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]
Indicate by checkmark whether the registrant has filed all documents and
reports to be filed by Section 12, 13, 15(d) of the Securities Exchange Act of
1934 subsequent to the distribution of securities under a plan confirmed by a
court. Yes [X] No [ ]
The number of limited liability company units outstanding as of November
7, 2003 was 12,352,750.
LINK ENERGY LLC
TABLE OF CONTENTS
Page
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Condensed Consolidated Statements of Operations (Unaudited) -
Three Months Ended September 30, 2003 (Successor Company) and
Three Months Ended September 30, 2002 (Predecessor Company) ....... 1
Condensed Consolidated Statements of Operations (Unaudited) - Seven Months
Ended September 30, 2003 (Successor Company), Two Months Ended February 28,
2003 (Predecessor Company) and Nine Months ended September 30, 2002
(Predecessor Company)......... 2
Condensed Consolidated Balance Sheets (Unaudited) -
September 30, 2003 (Successor Company) and
December 31, 2002 (Predecessor Company)............................ 3
Condensed Consolidated Statements of Cash Flows (Unaudited) - Seven Months
Ended September 30, 2003 (Successor Company), Two Months Ended February 28,
2003 (Predecessor Company) and Nine Months Ended September 30, 2002
(Predecessor Company)......... 4
Condensed Consolidated Statement of Members'/Partners' Capital (Unaudited) -
Seven Months Ended September 30, 2003 (Successor Company)
and Two Months Ended February 28, 2003 (Predecessor Company)....... 5
Notes to Condensed Consolidated Financial Statements................. 6
ITEM 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations.......................... 37
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk... 68
ITEM 4. Controls and Procedures ..................................... 69
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings............................................ 71
ITEM 5. Other Matters................................................ 71
ITEM 6. Exhibits and Reports on Form 8-K............................. 76
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Unit Amounts)
(Unaudited)
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
THREE MONTHS | THREE MONTHS
ENDED | ENDED
SEPTEMBER 30, 2003 | SEPTEMBER 30, 2002
------------------ | ------------------
|
Operating Revenue $ 99,857 | $ 99,765
|
Cost of Sales 58,078 | 51,000
Operating Expenses 31,333 | 36,294
Depreciation and Amortization-operating 6,185 | 7,922
-------- | --------
|
Gross Profit 4,261 | 4,549
|
Selling, General and Administrative 12,483 | 16,197
Expenses |
Depreciation and Amortization-corporate & 7 | 823
other |
Other (Income) Expense (1,757) | (186)
Impairment of Assets 2,751 | --
-------- | --------
Operating Income (Loss) (9,223) | (12,285)
|
Interest Expense and Related Charges (9,691) | (12,891)
Interest Income 20 | 17
Other, net 117 | (171)
-------- | --------
Income (Loss) from Continuing Operations (18,777) | (25,330)
|
Income (Loss) from Discontinued Operations (1,320) | (1,287)
-------- | --------
(Note 6) |
|
Net Income (Loss) $(20,097) | $(26,617)
======== | ========
|
Basic Net Income (Loss) Per Unit (Note 11) |
Common Unit N/A | $ --
======== | ========
Subordinated Unit N/A | $ (2.25)
======== | ========
LLC Unit $ (1.63) | N/A
======== | ========
Diluted Net Income (Loss) Per Unit (Note 11) $ (1.63) | $ (0.74)
======== | ========
|
Average Units Outstanding for Diluted Computation 12,330 | 27,476
======== | ========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
1
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In Thousands, Except Per Unit Amounts)
(Unaudited)
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
SEVEN MONTHS | TWO MONTHS NINE MONTHS
ENDED | ENDED ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003 SEPTEMBER 30, 2002
------------------ | ----------------- ------------------
|
Operating Revenue $ 221,915 | $ 72,316 $ 293,346
Cost of Sales 123,662 | 40,829 128,453
Operating Expenses 69,743 | 17,365 96,899
Depreciation and Amortization-operating 13,497 | 4,816 24,069
--------- | --------- ---------
Gross Profit 15,013 | 9,306 43,925
Selling, General and Administrative Expenses 30,385 | 6,917 41,454
Depreciation and Amortization-corporate & other 15 | 519 2,453
Other (Income) Expense (2,958) | (8) (2,322)
Impairment of Assets 2,751 | -- 1,168
--------- | --------- ---------
Operating Income (Loss) (15,180) | 1,878 1,172
Interest Expense and Related Charges (22,582) | (5,645) (36,577)
Interest Income 65 | 58 100
Other, net 10 | 98 54
--------- | --------- ---------
Income (Loss) from Continuing Operations |
Before Reorganization Items, Net Gain |
on Discharge of Debt and |
Fresh Start Adjustments (37,687) | (3,611) (35,251)
Reorganization Items (Note 3) -- | (7,330) --
Net Gain on Discharge of Debt (Note 3) -- | 131,560 --
Fresh Start Adjustments -- | (56,771) --
--------- | --------- ---------
Income (Loss) from Continuing Operations (37,687) | 63,848 (35,251)
Income (Loss) from Discontinued Operations (Note 6) (543) | 395 (994)
--------- | --------- ---------
Income (Loss) Before Cumulative |
Effect of Accounting Changes (38,230) | 64,243 (36,245)
Cumulative Effect of Accounting Changes (Note 15) -- | (3,976) --
--------- | --------- ---------
Net Income (Loss) $ (38,230) | $ 60,267 $ (36,245)
========= | ========= =========
Basic Net Income (Loss) Per Unit (Note 11) |
Common Unit N/A | $ 0.12 $ (0.01)
========= | ========= =========
Subordinated Unit N/A | $ -- $ (3.24)
========= | ========= =========
LLC Unit $ (3.10) | N/A N/A
========= | ========= =========
Diluted Net Income (Loss) Per Unit (Note 11) $ (3.10) | $ 0.08 $ (1.07)
========= | ========= =========
Average Units Outstanding for Diluted Computation 12,323 | 27,476 27,476
========= | ========= =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
2
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands)
(Unaudited)
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
|
SEPTEMBER 30, 2003 | DECEMBER 31, 2002
------------------ | ------------------
|
ASSETS |
Current Assets |
Cash and cash equivalents $ 932 | $ 16,432
Trade and other receivables, net of |
allowance for doubtful accounts of |
$1,210 and $1,210, respectively 458,111 | 407,096
Inventories of continuing operations 15,236 | 33,094
Inventories of discontinued operations 108 | 460
Other 11,799 | 23,888
--------- | ---------
Total current assets 486,186 | 480,970
--------- | ---------
Property, Plant and Equipment 322,664 | 580,883
Less: Accumulated depreciation 13,511 | 210,351
--------- | ---------
Net property, plant and equipment 309,153 | 370,532
--------- | ---------
Long-lived assets of discontinued operations 9,314 | 10,426
Goodwill -- | 7,436
Other Assets 7,391 | 4,070
--------- | ---------
Total Assets $ 812,044 | $ 873,434
========= | =========
|
LIABILITIES AND MEMBERS'/PARTNERS' CAPITAL |
|
Current Liabilities |
Trade and other accounts payable $ 485,088 | $ 389,346
Accrued taxes payable 8,536 | 11,327
Term loans (Note 2) 75,000 | 75,000
Commodity repurchase agreement (Note 2) 75,000 | 75,000
Receivable financing (Note 2) 23,000 | 50,000
Other 21,742 | 23,274
--------- | ---------
Total current liabilities 688,366 | 623,947
--------- | ---------
Long -Term Liabilities |
9% senior notes (Note 2) 104,312 | --
Note payable to Enron Corp. 5,758 | 5,212
Other 14,594 | 10,605
--------- | ---------
Total long-term liabilities 124,664 | 15,817
--------- | ---------
Liabilities Subject to Compromise (Note 3) -- | 292,827
Commitments and Contingencies (Note 13) |
Additional Partnership Interests (Note 10) -- | 9,318
Members'/Partners' Capital (Deficit) |
Partners' Capital (Deficit) -- | (68,475)
Members' Capital (Deficit) (1,161) | --
Accumulated Other Comprehensive Income (Loss) 175 | --
--------- | ---------
Total (986) | (68,475)
--------- | ---------
Total Liabilities and Members'/Partners' Capital $ 812,044 | $ 873,434
========= | =========
The accompanying notes are an integral part of these condensed consolidated
financial statements.
3
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In Thousands)
(Unaudited)
SUCCESSOR COMPANY PREDECESSOR COMPANY
----------------- | -------------------
SEVEN MONTHS | TWO MONTHS NINE MONTHS
ENDED | ENDED ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003 SEPTEMBER 30, 2002
------------------ | ----------------- ------------------
|
CASH FLOWS FROM OPERATING ACTIVITIES |
Reconciliation of net income (loss) to |
net cash provided by (used in) |
operating activities |
|
Net income (loss) $ (38,230) | $ 60,267 $ (36,245)
Depreciation and amortization 13,690 | 5,560 27,835
Impairment of assets 2,751 | -- 1,168
Write-down of liquids operations |
inventories 4,003 | -- --
Net unrealized change in crude oil |
trading activities 1,584 | (2,120) (1,485)
Losses on disposal of assets 690 | -- 16
Non-cash net gain for reorganization |
items and discharge of debt -- | (127,185) --
Fresh start adjustments -- | 56,771 --
Changes in components of working |
capital - |
Receivables (18,750) | (32,177) 104,712
Inventories 7,263 | 7,617 67,552
Other current assets (3,771) | 2,428 5,807
Trade accounts payable 16,388 | 49,500 (116,460)
Accrued taxes payable 3,798 | 1,717 2,160
Other current liabilities 6,036 | (320) 2,359
Other assets and liabilities (3,595) | 2,530 3,626
--------- | --------- ---------
Net Cash Provided by (Used in) (8,143) | 24,588 61,045
--------- | --------- ---------
Operating Activities -- | -- --
CASH FLOWS FROM INVESTING ACTIVITIES |
Proceeds from sale of property, plant |
and equipment 161 | -- 1,606
Additions to property, plant and equipment (5,203) | (285) (31,711)
---------- | ----------- ---------
Net Cash Used In Investing Activities (5,042) | (285) (30,105)
--------- | --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES |
Increase (decrease) in receivable (27,000) | -- 7,500
financing |
Decrease in short-term borrowings -- | -- (8,000)
Decrease in repurchase agreements -- | -- (25,000)
Distributions to unitholders -- | -- (4,712)
Exercise of warrants 382 | -- --
--------- | --------- ---------
Net Cash Used in Financing Activities (26,618) | -- (30,212)
--------- | --------- ---------
Increase (Decrease) in Cash and Cash (39,803) | 24,303 728
Equivalents |
Cash and Cash Equivalents Beginning of 40,735 | 16,432 2,941
Period |
--------- | --------- ---------
Cash and Cash Equivalents End of Period $ 932 | $ 40,735 $ 3,669
========= | ========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW |
INFORMATION |
Cash Paid for Interest $ 17,212 | $ 5,599 $ 26,537
Cash Paid for Reorganization Items 5,892 | 2,867 --
SUPPLEMENTAL NON CASH INVESTING AND |
FINANCING INFORMATION |
Discharge of 11% Senior Notes, |
including accrued interest $ -- | $ 248,481 $ --
Cancellation of additional partnership |
interests -- | 9,318 --
Issuance of 9% Senior Notes 5,200 | 104,000 --
Issuance of new equity of Successor |
Company -- | 36,687 --
The accompanying notes are an integral part of these condensed consolidated
financial statements.
4
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
CONDENSED CONSOLIDATED STATEMENTS OF MEMBERS'/PARTNERS' CAPITAL
(In Thousands)
(Unaudited)
PARTNERS' CAPITAL
-------------------------------- ACCUMULATED
COMMON SUBORDINATED OTHER
UNIT UNIT GENERAL MEMBERS' COMPREHENSIVE
HOLDERS HOLDERS PARTNER CAPITAL INCOME(LOSS) TOTAL
------- ------- ------- ------- ------------- -----
Partners' Capital (Deficit) at
December 31, 2002 .................... $ (2,135) $ -- $ (66,340) $ -- $ -- $ (68,475)
(Predecessor Company)
Loss Before Reorganization Items, Net
Gain on Discharge of Debt and Fresh
Start Adjustments ................... -- -- (7,192) -- -- (7,192)
Reorganization Items and Net Gain on
Discharge of Debt .................... 15,700 36,705 80,033 36,687 -- 169,125
Fresh Start Adjustments .............. (13,565) (36,705) (6,501) -- -- (56,771)
------- ------- ------ ------- ------- -------
Members' Capital at February 28, 2003
(Successor Company) .................. $ -- $ -- $ -- $ 36,687 $ -- $ 36,687
======= ======= ====== ======= ======= =======
- --------------------------------------------------------------------------------------------------------------------------------
Members' Capital at February 28, 2003
(Successor Company) .................. $ -- $ $ -- $ 36,687 $ -- $ 36,687
Net Loss ............................. -- -- -- (38,230) -- (38,230)
Unrealized net losses on derivative
instruments arising during the period -- -- -- -- (39)
Less reclassification adjustment for
net realized losses on derivative
instruments included in net loss .... -- -- -- -- 214 175
-------
Comprehensive loss ................... (38,055)
-------
Exercise of Warrants ................. -- -- -- 382 -- 382
------- ------- ------ ------- ------- -------
Members' Capital at September 30, 2003
(Successor Company) .................. $ -- $ -- $ -- $ (1,161) $ 175 $ (986)
======= ======= ====== ======= ======= =======
The accompanying notes are an integral part of these condensed
consolidated financial statements.
5
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. BASIS OF PRESENTATION
Name Change and Organization
Effective October 1, 2003, EOTT Energy LLC ("EOTT LLC") changed its name
to Link Energy LLC ("Link LLC"). In connection with our name change, we also
changed the names of several of our subsidiaries as listed in the table below.
NEW NAME FORMER NAME
- -------- -----------
Link Energy Limited Partnership EOTT Energy Operating Limited
Partnership
Link Energy Pipeline Limited Partnership EOTT Energy Pipeline Limited
Partnership
Link Energy Canada Limited Partnership EOTT Energy Canada Limited Partnership
Link Energy Finance Corp. EOTT Energy Finance Corp.
Link Energy General Partner LLC EOTT Energy General Partner, L.L.C.
Link Energy Canada, Ltd. EOTT Energy Canada Management Ltd.
Link LLC is a Delaware limited liability company that was formed on
November 14, 2002 in anticipation of assuming and continuing the business
formerly directly owned by EOTT Energy Partners, L.P. (the "MLP"), which, as
described in Note 3 below, filed for Chapter 11 reorganization with its wholly
owned subsidiaries on October 8, 2002. The MLP emerged from bankruptcy and
merged into EOTT Energy Operating Limited Partnership resulting in EOTT LLC
becoming the successor registrant to the MLP on March 1, 2003, the effective
date of the Third Amended Joint Chapter 11 Plan of Reorganization, as
supplemented ("Restructuring Plan"). We operate principally through four
affiliated operating limited partnerships, Link Energy Limited Partnership, Link
Energy Canada Limited Partnership, Link Energy Pipeline Limited Partnership, and
EOTT Energy Liquids, L.P., each of which is a Delaware limited partnership. Link
Energy Finance Corp. was formed in connection with a debt offering to facilitate
certain investors' ability to purchase our former 11% senior notes. Link Energy
General Partner, LLC serves as the general partner for our four affiliated
operating limited partnerships. Until the MLP emerged from bankruptcy, EOTT
Energy Corp. (the "General Partner"), a Delaware corporation and a wholly owned
subsidiary of Enron Corp. ("Enron"), served as the general partner of the MLP
and owned an approximate 1.98% general partner interest in the MLP. The General
Partner filed for bankruptcy on October 21, 2002. Unless the context otherwise
requires, the terms "we," "our," "us," and "Link" refer to Link Energy LLC and
its four affiliated operating limited partnerships, Link Energy Finance Corp.,
and Link Energy General Partner, LLC (the "Subsidiary Entities"), and for
periods prior to our emergence from bankruptcy in March 2003, such terms and
"EOTT" refer to EOTT Energy Partners, L.P. and its sole general partner, EOTT
Energy Corp., as well as the Subsidiary Entities.
Interim Financial Statements
The financial statements presented herein have been prepared by Link in
accordance with generally accepted accounting principles in the United States
and the rules and regulations of the Securities and Exchange Commission. Interim
results are not necessarily indicative of results for a full year. The financial
information included herein has been prepared without audit. The condensed
consolidated balance sheet at December 31, 2002 has been derived from, but does
not include all the disclosures contained in, the audited financial statements
for the year ended December 31, 2002. In the opinion of management, all of these
unaudited statements include all adjustments and accruals consisting only of
normal recurring adjustments, except for those relating to fresh start reporting
and those more fully discussed in Notes 7 and 8, which are necessary for a fair
presentation of the results of the interim periods reported herein. These
condensed consolidated financial statements should be read in conjunction with
the consolidated financial statements and accompanying notes included in our
Annual Report on Form 10-K for the year ended December 31, 2002.
6
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Fresh Start Reporting
As a result of the application of fresh start reporting under the American
Institute of Certified Public Accountants Statement of Position No. 90-7 ("SOP
90-7"), "Financial Reporting by Entities in Reorganization Under the Bankruptcy
Code," as of February 28, 2003 (the date chosen for accounting purposes), Link's
financial results for the nine months ended September 30, 2003 include two
different bases of accounting and accordingly, the financial condition,
operating results and cash flows of the Successor Company and the Predecessor
Company have been separately disclosed. For a further discussion of fresh start
reporting, see Note 4. For purposes of these financial statements, references to
the "Predecessor Company" are references to us for periods through February 28,
2003 (the last day of the calendar month in which we emerged from bankruptcy)
and references to the "Successor Company" are references to Link for periods
subsequent to February 28, 2003. The Successor Company's financial statements
are not comparable to the Predecessor Company's financial statements. See
further discussion in Note 4.
Partnership Status
As a limited liability company, we are generally treated like a
partnership for federal income tax purposes and like a corporation with limited
liability for state law and other non-tax purposes. In other words, for federal
income tax purposes, we do not pay tax on our income or gain, nor are we
entitled to a deduction for our losses, but such gains or losses are allocated
to each member in accordance with the member's interest in us and the member
will be responsible for paying the income tax applicable to such membership
interest. Our taxable income or loss, which may vary substantially from the net
income or net loss we report in our consolidated statement of operations, is
includable in the federal income tax returns of our members. The aggregate
difference in the basis of our net assets for financial and tax reporting
purposes cannot be readily determined as we do not have access to information
about each member's tax attributes in Link. In order for us to continue to be
classified as a partnership for federal income tax purposes, at least 90% of our
gross income for every taxable year must consist of "qualifying income" within
the meaning of the Internal Revenue Code. In 2002 and 2003, we recognized income
from our settlement with Enron and discharge of indebtedness in excess of 10% of
our gross income for each of those years. As disclosed in more detail in our
Third Amended Joint Chapter 11 Plan which is incorporated by reference into our
Annual Report on Form 10-K for the year ended December 31, 2002, we concluded
that income from our settlement with Enron and our debt discharge income
constituted "qualifying income," although the matter was not free from doubt.
We believe that we may not be able to access the capital markets without a
higher degree of certainty as to our classification for federal income tax
purposes. We therefore have decided to seek a private letter ruling from the
Internal Revenue Service either that the income from our settlement with Enron
and the debt discharge income is qualifying income or that the recognition of
such income should be disregarded for purposes of the qualifying income test
because it was an inadvertent result of our bankruptcy.
We are unable to predict how or when the Internal Revenue Service will
rule. If the ruling is favorable, we will continue to be treated as a
partnership for federal income tax purposes for so long as we satisfy the
qualifying income test. If we are unable to obtain a favorable ruling and are
unsuccessful in litigating the matter should we choose to do so, we will be
taxable as a corporation for the year in which we failed to meet the qualifying
income test and every year thereafter. Any classification of us as a corporation
could result in a material reduction in the value of our units.
LLC Agreement
Under our Limited Liability Company Agreement (the "LLC Agreement"), our
Board may, but is not required, to make distributions to each interest holder,
and in any event, our exit credit facilities do not permit us to make any cash
distributions so long as we have any indebtedness or other obligations
outstanding under the exit credit facilities. Similar to a corporation, members
do not share our liability. Under our LLC Agreement, members are also entitled
to certain information about us and to vote for directors and on certain other
matters. The holders of the majority of outstanding units have the right to vote
on mergers and the
7
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
election or removal of directors. The holders of two-thirds of the units have
the right to approve additional issuances of equity and certain amendments to
the LLC Agreement. Members are not entitled to participate in our management
directly, but participate indirectly through the election of our directors.
Reclassifications
Certain reclassifications have been made to prior period amounts to
conform with the current period presentation.
2. CREDIT RESOURCES AND LIQUIDITY
OVERVIEW
We anticipate that our future cash requirements will be funded primarily
from:
- cash generated from operations;
- borrowings under our exit credit facilities (including the Trade
Receivables Agreement and Commodity Repurchase Agreement discussed
below); and
- cash generated from asset dispositions, net of debt repayments.
FACTORS AFFECTING OUR LIQUIDITY
Our ability to fund our liquidity and working capital requirements will be
based on our ability to successfully implement our Restructuring Plan, which has
been adversely affected by various factors, including the following:
- COVENANT BREACHES UNDER EXIT CREDIT FACILITIES. For the four month
period ended September 30, 2003, we were in breach of the covenants
in our Letter of Credit Facility and Term Loan described below. We
have obtained a waiver of these violations from our lenders for the
four month period ended September 30, 2003 and for our expected
breach of these covenants for the four month period ended October
31, 2003. In addition, we have agreed to reduce the lenders' maximum
commitment under the Letter of Credit Facility from $325 million to
$290 million.
- Minimum Consolidated EBIDA. We are required to maintain a
minimum, rolling cumulative four month total of consolidated
Earnings Before Interest Depreciation and Amortization,
subject to certain adjustments, as defined ("Minimum
Consolidated EBIDA"). For the four month period ended
September 30, 2003, we were required to have consolidated
EBIDA of $6.6 million but achieved Minimum Consolidated EBIDA
of only $2.2 million. For the four month periods ending
October 31, November 30, and December 31, 2003, we will be
required to maintain Minimum Consolidated EBIDA of $8.7
million, $10.4 million and $12.7 million. Thereafter, the
requirement continues to increase monthly until it reaches
$17.4 million for the four month period ended September 30,
2004.
- Interest Coverage. We are required to maintain a minimum ratio
of consolidated EBIDA to cash interest expense ("Interest
Coverage Ratio") over rolling consecutive four month periods.
For the four month period ended September 30, 2003, the ratio
must be at least .62 to 1.0, but the ratio we achieved was
only .24 to 1.0. For the four months ending October 31,
November 30, and December 31, 2003, we will be required to
maintain an Interest Coverage Ratio of .79 to 1.0, .93 to 1.0
and 1.11 to 1.0. This ratio requirement continues to increase
monthly until it
8
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
reaches 1.42 to 1.0 for the four month period ended August 31,
2004.
- Prohibition on Indebtedness. We are not permitted to owe or be
liable for indebtedness except as described in the Letter of
Credit Facility and the Term Loan Agreement. As a result of
our change in estimates of crude oil linefill, as described in
Note 7 to these financial statements, we may be deemed to have
incurred indebtedness to our customers in the form of make-up
obligations for customer crude oil that was previously
believed to have been in our pipelines prior to the change in
estimate.
We were unable to satisfy these covenants as of September 30, 2003
due to the $4.6 million charge we recorded as described in Note 7
and the performance of our business being less than expected.
Because the charge we recorded in September 2003 will be included in
the calculations of the covenants for the remainder of 2003 and
because the covenants become increasingly stringent each month, we
expect we will be in default under our exit credit facilities at the
end of each month at least through December 31, 2003 unless our
results of operations show an unexpected significant improvement. A
default under one of our exit facilities, which includes the Letter
of Credit Facility, the Term Loan, the Trade Receivables Agreement
and the Commodity Repurchase Agreement, will cause a cross-default
under all the other exit facilities. Any breaches, unless waived,
could severely limit our access to liquidity and result in our being
required to repay all outstanding debt under the previously
mentioned debt agreements as well as the 9% senior note indenture,
all of which totals approximately $277 million as of September 30,
2003. Although our lenders provided a waiver for our breach of these
covenants as of September 30, 2003 and for our expected breach of
these covenants as of October 31, 2003, there can be no assurance
they will provide waivers for any subsequent period or that any
amendment to our credit facilities required to obtain such waiver
will not adversely affect our liquidity.
- COVENANT BREACH UNDER COMMODITY REPURCHASE AGREEMENT. We have an
agreement with Standard Chartered Trade Services ("SCTS") providing
for the financing of purchases of crude oil inventory utilizing a
forward commodity repurchase agreement ("Commodity Repurchase
Agreement"). The maximum commitment under the Commodity Repurchase
Agreement was $75 million. Under the Commodity Repurchase Agreement,
we are required to maintain 2.4 million barrels of crude oil
linefill. During the third quarter of 2003, we revised downward our
estimate of the physical volume of crude oil linefill in certain of
our pipelines as described in Note 7. As a result of the downward
revision of our estimates of crude oil linefill as of September 30,
2003, we breached the minimum inventory provision of the Commodity
Repurchase Agreement. We have obtained a waiver of this breach,
provided that we maintain a minimum of 2,150,000 barrels of crude
oil inventory.
- MATURITIES OF OUR EXIT FACILITIES. In addition, our Trade
Receivables Agreement and Commodity Repurchase Agreement mature on
March 1, 2004 (although we have an option to extend the maturity to
August 30, 2004) and our Term Loan and Letter of Credit Facility
mature on August 30, 2004. As of September 30, 2003, we had $23
million of outstanding borrowings under our Trade Receivables
Agreement, $75 million of outstanding borrowings under our Commodity
Repurchase Agreement, and $75 million of borrowings under our Term
Loan Agreement.
BUSINESS PERFORMANCE
In evaluating our ability to meet our obligations under our Restructuring
Plan, we relied, in part, on the financial projections and related assumptions
included in Exhibit D to our Third Amended Disclosure Statement dated December
6, 2002, which was incorporated by reference into our Annual Report on Form 10-K
for the fiscal year ended December 31, 2002. The following assumptions, among
others, have proven to be overly optimistic:
- Our ability to win back business lost due to financial instability
and the Chapter 11 filing. Even though we have the capacity to issue
letters of credit to secure additional volumes, our pre-bankruptcy
customers and business partners have been less willing to do
business with us than we anticipated as a result of our being highly
leveraged and having shown no substantive improvement in our
financial performance. Although we assumed that our marketing
9
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
volumes would increase to approximately 350,000 barrels per day by
the end of 2003, our marketing volumes were approximately 250,000
barrels per day in September 2003, and we do not anticipate an
appreciable increase in volumes for the remainder of 2003. Our
Restructuring Plan anticipated a quick return of volume growth in
2003, which has not occurred given the heightened sensitivity to
credit risk in the energy industry and our high credit costs.
Outstanding letters of credit at September 30, 2003 were $244.8
million, with a total commitment amount of $290 million.
- The continued viability of our MTBE operations. The business and
regulatory climate for MTBE has continued to deteriorate
dramatically and has adversely affected our business. Our
Restructuring Plan contemplated earnings from our Liquids Operations
in 2003; however, for the nine months ended September 30, 2003, the
Liquids Operations had an operating loss of $20 million. We recently
decided to phase out our MTBE production after discussions with a
third party regarding a possible sale of these operations terminated
unsuccessfully. As a consequence of the phase out of MTBE
production, we recorded charges for severance of $1.8 million,
impairment of long-lived assets of $2.7 million and write down of
material and supplies of $2.3 million (see Note 6).
OPTIONS FOR ACHIEVING DEBT REDUCTION
In order to improve our liquidity, we must reduce our debt and attract new
volumes. We will likely not be able to achieve volume and earnings growth
without reducing our debt by at least $100 million. We are currently considering
the following options to achieve our debt reduction:
- Pursuing the sale of additional assets. During the period from March
2003 to October 2003, we sold assets for an aggregate consideration
of $26.2 million. We used approximately $25 million of the net
proceeds to pay down amounts outstanding under the Commodity
Repurchase Agreement subsequent to September 30, 2003. We will
continue to pursue asset sales and use the proceeds, if any, to
reduce our debt levels.
- Seeking additional equity. We are evaluating alternatives for
raising additional equity capital, both publicly and privately. Our
efforts to raise additional equity will be limited by the following
factors, among others:
- Under the terms of our LLC Agreement, we are prohibited from
issuing additional equity without a vote of two-thirds of our
unitholders.
- We are unable to issue equity in a public offering or in an
offering pursuant to Regulation D of the Securities Act until
we have satisfied the requirement to have three years of
audited financial statements by completing an audit of our
financial statements for the year ending December 31, 2003.
- We have recognized income from our settlement with Enron and
discharge of indebtedness from our bankruptcy in excess of 10%
of our gross income. We concluded, as disclosed in our Third
Amended Disclosure Statement, that this income constituted
"qualifying income" under the Internal Revenue Code, although
the matter was not free from doubt. We believe that we may not
be able to access the capital markets without a higher degree
of certainty of whether this income is qualifying income and,
therefore, we have decided to seek a private letter ruling
from the Internal Revenue Service. See Note 1.
Due to the absence of volume growth in our core business and the
amount of additional equity required to achieve debt reduction of at
least $100
10
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
million, if we are able to issue additional equity, we will be
required to do so at prices significantly less than the
current trading prices of our units and warrants.
- Conversion of existing debt. We are currently evaluating the
feasibility of our lenders converting a portion of their debt to
equity.
- Evaluating strategic alternatives. If we are unsuccessful in
achieving our debt reduction within a reasonable time period, we
will consider other strategic alternatives, which could include a
sale of the company.
The condensed consolidated financial statements have been prepared
assuming we will continue as a going concern, which contemplates the
realization of assets and settlement of liabilities in the normal course of
business. The factors discussed above raise substantial doubt about our ability
to continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
SUMMARY OF DEBTOR IN POSSESSION ("DIP") FINANCING
On October 18, 2002, we entered into agreements with Standard Chartered,
SCTS, Lehman and other lending institutions for $575 million in DIP financing
facilities. The DIP facilities provided (i) $500 million of credit and financing
facilities through Standard Chartered and SCTS, which included up to $325
million for letters of credit and $175 million of inventory repurchase/accounts
receivable financing through SCTS, and (ii) $75 million of term loans through
Lehman and other lending institutions. The credit facilities were subject to a
borrowing base and were secured by a first-priority lien on all, or
substantially all, of our real and personal property. As of February 28, 2003,
we had outstanding approximately $313.1 million of letters of credit, $125.0
million of inventory repurchase/accounts receivable financing, and $75 million
of term loans. The DIP financing facilities contained certain restrictive
covenants that, among other things, limited distributions, other debt, and
certain asset sales. On February 28, 2003, as we emerged from bankruptcy, the
DIP financing facilities were refinanced by the same institutions. The following
discussion provides an overview of our post-bankruptcy debt.
SUMMARY OF EXIT CREDIT FACILITIES, SENIOR NOTES, AND OTHER DEBT
Our emergence from bankruptcy as of March 1, 2003, was financed through a
combination of exit credit facilities, senior notes and other debt associated
with settlement of claims during our bankruptcy proceedings. The table below
provides a summary of these financing arrangements as of September 30, 2003.
11
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SUMMARY OF FINANCING ARRANGEMENTS
(IN MILLIONS)
COMMITMENT/ AMOUNT
FACE AMOUNT OUTSTANDING MATURITY
----------- ----------- --------
Exit Credit Facilities:
Letter of Credit Facility... $ 325.0(1) $ 244.8 August 30, 2004
Trade Receivables Agreement. 100.0(2) 23.0 March 1, 2004(4)
Commodity Repurchase Agreement 75.0(3) 75.0(3) March 1, 2004(4)
Term Loans.................. 75.0 75.0 August 30, 2004
Senior Notes.................... 109.2 104.3 March 1, 2010(5)(6)
Other Debt:
Enron Note.................. 6.4 7.1 October 1, 2005(5)
Big Warrior Note............ 2.6 2.3 March 1, 2007(5)
Ad Valorem Tax Liability.... 7.2 7.2 March 1, 2009
(1) Subsequent to September 30, 2003, the maximum commitment amount was reduced
to $290 million.
(2) $50 million of this commitment is unavailable ten days each month.
(3) On October 1, 2003, net proceeds of $25 million from the disposition of
assets (see Note 6) were used to reduce the amount outstanding to $50
million and the maximum amount of the commitment under the Commodity
Repurchase Agreement was reduced to $50 million.
(4) We have the option to extend these arrangements for an additional 6 months.
Extension of both facilities would be subject to the payment of extension
fees of $875,000.
(5) These notes were adjusted to fair value pursuant to the adoption of fresh
start reporting required by SOP 90-7.
(6) On September 1, 2003, we issued an additional senior note in the amount of
$5.2 million in lieu of the first semi-annual payment of interest on our
senior notes.
The following is a summary of our scheduled debt maturities at September 30,
2003 (in millions):
After
2003 2004 2005 2006 2007 2007 Total
---- ---- ---- ---- ---- ----- -----
9% Senior Notes .... $ -- $ -- $ -- $ -- $ -- $109.2 $109.2
Term Loans(2) ...... -- 75.0 -- -- -- -- 75.0
Commodity Repurchase
Agreement (1)(2) -- 75.0 -- -- -- -- 75.0
Trade Receivables
Agreement(2) .... -- 23.0 -- -- -- -- 23.0
Enron Note ......... 1.0 1.0 4.4 -- -- -- 6.4
Big Warrior Note ... 0.1 0.3 0.4 0.4 1.4 -- 2.6
Ad Valorem Tax
Liability .......... 0.6 1.2 1.3 1.4 1.5 1.2 7.2
------ ------ ------ ------ ------ ------ ------
$ 1.7 $175.5 $ 6.1 $ 1.8 $ 2.9 $110.4 $298.4
====== ====== ====== ====== ====== ====== ======
(1) On October 1, 2003, net proceeds of $25 million from the disposition of
assets (see Note 6) were used to reduce the amount outstanding to $50
million.
(2) See previous discussion of covenant violations, cross defaults and the
waivers obtained.
Exit Credit Facilities
On February 11, 2003, we entered into our exit credit facilities with the
same lenders and under substantially the same terms in the DIP financing
facilities. These new facilities were effective March 1, 2003 and $2.9 million
of facility and extension fees were paid in connection with these new
facilities. Such fees are being amortized as interest expense over the terms of
the facilities.
12
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Letter of Credit Facility
The Letter of Credit Facility, as amended, with Standard Chartered
provides $290 million of financing until August 30, 2004 and is subject to
defined borrowing base limitations. The borrowing base is (as of the date of
determination) the sum of cash equivalents, specified percentages of eligible
receivables, deliveries, fixed assets, inventory, margin deposits and undrawn
product purchase letters of credit, minus (i) first purchase crude payables,
other priority claims, aggregate net amounts payable by the borrowers under
certain hedging contracts and certain eligible receivables arising from future
crude oil obligations, (ii) the principal amount of loans outstanding and any
accrued and unpaid fees and expenses under the Term Loans, and (iii) all
outstanding amounts under the Amended and Restated Commodity Repurchase
Agreement and the Amended and Restated Receivables Purchase Agreement ("SCTS
Purchase Agreements"). Pursuant to a scheduled advance rate reduction, effective
July 1, 2003, the specified percentages of eligible receivables and fixed assets
in the borrowing base were reduced. Standard Chartered has the right to reduce
these same percentages in the borrowing base at October 31, 2003.
The Letter of Credit Facility required an upfront facility fee of $1.25
million that was paid at closing. An additional reduction fee of $2.5 million
will be payable on March 29, 2004, if Standard Chartered's exposure is not
reduced to $200 million or less by that date. Letter of credit fees range from
2.25% to 2.75% per annum depending on usage. The commitment fee is 0.5% per
annum of the unused portion of the Letter of Credit Facility. Additionally, we
agreed to a fronting fee, which is the greater of 0.25% per annum times the face
amount of the letter of credit or $250. An annual arrangement fee of 1% per
annum times the average daily maximum commitment amount, as defined in the
Letter of Credit Facility, is payable on a monthly basis.
The exit credit facilities include various financial covenants that we
must adhere to on a monthly basis as discussed above in "-Factors Affecting our
Liquidity" and set forth below.
- Minimum Consolidated Tangible Net Worth. At the end of each month,
from March 31, 2003 to December 31, 2003, we are required to
maintain a minimum consolidated tangible net worth, subject to
certain adjustments, as defined ("Minimum Consolidated Tangible Net
Worth"), of $8.5 million. From January 31, 2004 to September 30,
2004, we are required to maintain a Minimum Consolidated Tangible
Net Worth of $10 million.
- Current Ratio. We must maintain a ratio of consolidated current
assets, subject to certain adjustments to consolidated current
liabilities less funded debt, as defined, of 0.90 to 1.00 for the
term of the exit credit facilities.
At September 30, 2003, we were in compliance with the Minimum Consolidated
Tangible Net Worth and Current Ratio covenants.
For purposes of determining the financial information used in the
financial covenants set forth above and in "-Factors Affecting our Liquidity,"
we are required to exclude all items directly attributable to our Liquids Assets
and the West Coast natural gas liquids assets ("Designated Assets") for the
first five months ended May 31, 2003 and to make "permitted adjustments"
(changes due to fresh start reporting, income and expenses attributable to the
Designated Assets during the first five months ended May 31, 2003, changes due
to the cumulative affect of changes in GAAP, which are approved by the bank,
gains or losses from the sales of assets or Designated Assets and any
write-downs on Designated Assets), as defined.
In connection with the sale of the West Coast assets and the ArkLaTex
assets discussed in Note 6, the Letter of Credit Facility was amended to allow
the net proceeds from these asset sales to be used to repay amounts outstanding
under the Commodity Repurchase Agreement.
In addition, there are certain restrictive covenants that, among other
things, limit other debt, certain asset sales, mergers and change in control
transactions. Additionally, the exit credit facilities prohibit us from making
any distributions, or purchases, acquisitions, redemptions or retirement of our
LLC units so long as we have any indebtedness, liabilities or other obligations
outstanding to Standard Chartered, SCTS, Lehman, or any other lenders under
these facilities.
13
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SCTS Purchase Agreements
We have an agreement with SCTS similar to our pre-bankruptcy inventory
repurchase agreement, which provides for the financing of purchases of crude oil
inventory utilizing a forward commodity repurchase agreement ("Commodity
Repurchase Agreement"). The maximum commitment under the Commodity Repurchase
Agreement was $75 million. It required an upfront facility fee of approximately
$378,000 and carried an interest rate of LIBOR plus 3%. On October 1, 2003, net
proceeds of $25 million from the disposition of assets were used to repay
amounts outstanding under the Commodity Repurchase Agreement and the maximum
commitment amount was reduced to $50 million. The Commodity Repurchase Agreement
had an initial term of six months to August 30, 2003, at which time we had the
option to extend for an additional twelve months. In August 2003, we amended the
Commodity Repurchase Agreement to provide us the option to (1) extend the
maturity date to March 1, 2004 and (2) prior to March 1, 2004, extend the
maturity date to August 30, 2004. The election of each option will require the
payment of an extension fee of $375,000. We elected to extend the maturity date
to March 1, 2004, which required the payment of an extension fee of $375,000 and
increased the interest rate to LIBOR plus 7%.
In addition, we also have an agreement with SCTS similar to our
pre-bankruptcy trade receivables agreement, which provides for the financing of
up to an aggregate amount of $100 million of certain trade receivables ("Trade
Receivables Agreement") outstanding at any one time. The discount fee is LIBOR
plus 3% and an upfront facility fee of approximately $504,000 was paid. The
Trade Receivables Agreement had an initial term of six months to August 30,
2003, at which time we had the option to extend for an additional twelve months.
In August 2003, we amended the Trade Receivables Agreement to provide us the
option to (1) extend the maturity date to March 1, 2004 and (2) prior to March
1, 2004, extend the maturity date to August 30, 2004. The election of each
option will require the payment of an extension fee of $0.5 million. We elected
to extend the maturity date to March 1, 2004, which required the payment of an
extension fee of $0.5 million and increased the interest rate to LIBOR plus 7%.
Term Loan Agreement
We entered into an agreement with Lehman, as Term Lender Agent, and other
lenders (collectively, "Term Lenders"), which provides for term loans in the
aggregate amount of $75 million (the "Term Loans"). The Term Loans mature on
August 30, 2004.
The financing included two term notes. The Tier-A Term Note is for $50
million with a 9% per annum interest rate. The Tier-B Term Note is for $25
million with a 10% per annum interest rate. Interest is payable monthly on both
notes. An upfront fee of $750,000 was paid and we agreed to pay a deferred
financing fee in the aggregate amount of $2 million on the maturity date of the
Term Loans. This latter fee was fully accrued as of February 28, 2003.
The Term Loans are collateralized and have certain repayment priorities
with respect to collateral proceeds pursuant to the Intercreditor and Security
Agreement that is discussed below. Under the Term Loan Agreement, term loan debt
outstanding is subject to a borrowing base as defined in the Letter of Credit
Agreement. Further, the Term Loan Agreement contains financial covenants that
mirror those outlined above in the discussion of the Letter of Credit Facility.
Intercreditor and Security Agreement
In connection with the Letter of Credit Facility, the Term Loans and the
SCTS Purchase Agreements, we entered into the Intercreditor and Security
Agreement ("Intercreditor Agreement") with Standard Chartered, Lehman, SCTS and
various other secured parties ("Secured Parties"). This agreement provides for
the sharing of collateral among the Secured Parties and prioritizes the
application of collateral proceeds which provides for repayment of the Tier-A
Term Note and the Standard Chartered letter of credit exposure above $300
million prior to other secured obligations.
14
In addition, to the extent that drawings are made on any letters of
credit, Standard Chartered, as collateral agent, may distribute funds from our
debt service payment account to itself (as letter of credit issuer agent on
behalf of the letter of credit issuer) as needed to allow Link LLC to reimburse
Standard Chartered, as letter of credit issuer, for such drawings.
Senior Notes
On October 1, 1999, we issued to the public $235 million of 11% senior
notes. The senior notes were due October 1, 2009, and interest was paid
semiannually on April 1 and October 1. The senior notes were fully and
unconditionally guaranteed by all of our operating limited partnerships but were
otherwise unsecured. On October 1, 2002, we did not make the interest payment of
$12.9 million on our $235 million 11% senior notes. These notes were cancelled
effective March 1, 2003 as a result of our Restructuring Plan and the holders of
these notes, along with our general unsecured creditors with allowed claims,
will receive a pro rata share of $104 million of 9% senior unsecured notes, plus
Link LLC units.
Link LLC Senior Notes 2010
In February 2003, we issued $104 million of 9% senior unsecured notes to
the Bank of New York, as depositary agent, which will be subsequently allocated
by the depositary agent to former holders of the 11% senior notes described
above and our general unsecured creditors with allowed claims. However, the
exact pro rata allocation of the senior notes cannot be determined until the
precise amount of each allowed claim is determined. This process is underway in
the EOTT Bankruptcy Court as part of our Restructuring Plan. The Bank of New
York, as depositary agent, distributed approximately 90% of the senior unsecured
notes in August 2003 and the final allocation of notes is expected to be
completed by December 2003. The senior notes are due in March 2010, and interest
will be paid semiannually on September 1 and March 1 with the first payment on
September 1, 2003. Under the terms of the indenture governing our senior notes,
we are allowed to pay interest payments in kind by issuing additional senior
notes on the first two interest payment dates. If we make payments in kind, we
must make the payments as if interest were being charged at 10% per annum
instead of 9% per annum. On September 1, 2003, we issued an additional senior
note in the aggregate principal amount of $5.2 million to the Bank of New York
in lieu of the first interest payment. We may not optionally redeem the notes.
The notes are subject to mandatory redemption or sinking fund payments if we
sell assets and use the money for certain purposes or if we have a change of
control. Provisions of the indenture could limit additional borrowings, sale and
lease back transactions, affiliate transactions, purchases of our own equity,
payments on debt subordinated to the senior notes, distributions to members,
certain merger, consolidation or change in control transactions, or sale of
assets if certain financial performance ratios are not met.
Enron Note and Big Warrior Note
In connection with our settlement with Enron as part of the Restructuring
Plan, we executed a $6.2 million note payable to Enron ("Enron Note") that is
guaranteed by our subsidiaries. The Enron Note is secured by an irrevocable
letter of credit and bears interest at 10% per annum. Interest is paid
semiannually on April 1 and October 1, beginning on April 1, 2003 and we are
allowed to pay interest payments in kind on the first two interest payment
dates. Principal payments of $1 million are payable in October 2003 and October
2004 with the remaining principal balance due in October 2005. On October 1,
2003, we paid our first principal payment of $1.0 million and elected to pay our
interest payment of $0.3 million in kind, which increases the principal balance
of the Enron Note.
In connection with a settlement with Big Warrior Corporation ("Big
Warrior") during our bankruptcy, we executed a $2.7 million note payable to Big
Warrior, which is secured by a second lien position in one of our Mississippi
pipelines. The four-year note is payable in quarterly installments which began
June 1, 2003 based on a seven-year amortization schedule, at an interest rate of
6% per annum. A final balloon payment is due March 1, 2007. Effective July 31,
2003, Farallon Capital Partners, L.P. ("Farallon") and Tinicum Partners, L.P.
("Tinicum") purchased this note from Big Warrior. Farallon and Tinicum are Term
Lenders and holders of allowed claims,
15
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
which will allow them to receive a pro rata allocation of our 9% senior
unsecured notes and LLC units from the depositary agent.
Ad Valorem Tax Liability
In conjunction with our Restructuring Plan, we agreed to pay accrued but
unpaid ad valorem taxes over six years from the effective date of our
Restructuring Plan. This debt bears interest at 6% with principal and interest
payments due quarterly. The first payment was made on June 1, 2003.
3. BANKRUPTCY PROCEEDINGS AND RESTRUCTURING PLAN
On October 8, 2002, the MLP and the Subsidiary Entities filed
pre-negotiated voluntary petitions for reorganization under Chapter 11 of the
United States Bankruptcy Code (the "EOTT Bankruptcy"). The filing was made in
the United States Bankruptcy Court for the Southern District of Texas, Corpus
Christi Division (the "EOTT Bankruptcy Court"). Additionally, the General
Partner filed a voluntary petition for reorganization under Chapter 11 on
October 21, 2002 in the EOTT Bankruptcy Court in order to join in the voluntary,
pre-negotiated Restructuring Plan. On October 24, 2002, the EOTT Bankruptcy
Court administratively consolidated, for distribution purposes, the General
Partner's bankruptcy filing with the previously filed cases. We operated as
debtors-in-possession under the Bankruptcy Code, which means we continued to
remain in possession of our assets and properties and continued our day-to-day
operations. The EOTT Bankruptcy Court confirmed our Restructuring Plan on
February 18, 2003, and it became effective March 1, 2003.
We entered into an agreement, dated October 7, 2002, with Enron, Standard
Chartered Bank ("Standard Chartered"), Standard Chartered Trade Services
Corporation ("SCTS"), Lehman Commercial Paper Inc. ("Lehman Commercial") and
holders of approximately 66% of the outstanding principal amount of our 11%
senior notes (the "Restructuring Agreement"). Under this Restructuring
Agreement, Enron, Standard Chartered, SCTS, Lehman Commercial and approximately
66% of our 11% senior note holders agreed to vote in favor of the Restructuring
Plan, and to refrain from taking actions not in support of the Restructuring
Plan.
The Restructuring Plan, however, was subject to the approval of the EOTT
Bankruptcy Court, and the Settlement Agreement with Enron ("Settlement
Agreement") was subject to the additional approval of the United States
Bankruptcy Court for the Southern District of New York (the "Enron Bankruptcy
Court"), where Enron and certain of its affiliates filed for Chapter 11
bankruptcy protection. The EOTT Bankruptcy Court approved the settlement
agreement with Enron on November 22, 2002, and the Enron Bankruptcy Court
approved the settlement agreement on December 5, 2002. The major provisions of
the Restructuring Plan, which became effective March 1, 2003, are as follows:
- Enron has no further affiliation with us. The General Partner will
be liquidated as soon as reasonably possible with no material effect
to EOTT.
- We consummated the Settlement Agreement with Enron effective
December 31, 2002. In the fourth quarter of 2002, we recognized a
gain of $45.5 million related to the Settlement Agreement with
Enron.
- We converted to a limited liability company structure and EOTT LLC
became the successor registrant to the MLP. The MLP was merged into
EOTT Energy Operating Limited Partnership.
- We are now managed by a seven-member Board of Directors. One of the
directors is the chief executive officer of EOTT LLC, and the
remaining six directors were selected by the former senior note
holders who signed the Restructuring Agreement.
- We cancelled our outstanding $235 million of 11% senior unsecured
notes. Our former senior unsecured note holders and holders of
allowed general unsecured claims will receive a pro rata share of
$104 million of 9% senior unsecured notes and a pro rata share of
11,947,820 limited liability
16
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
company units of EOTT LLC representing 97% of the newly issued
units. The $104 million senior unsecured notes and the 11,947,820
units have been issued to the Bank of New York, the depositary
agent, and the depositary agent has distributed approximately 90% of
the senior unsecured notes and units to our creditors. The $104
million senior unsecured notes and 11,947,820 units are deemed to be
issued and outstanding for purposes of these financial statements.
See further discussion in Note 2 and Note 10.
- We cancelled the MLP's publicly traded common units, and the former
holders of the MLP's common units received 369,520 limited liability
company units of EOTT LLC, representing 3% of newly issued units,
and 957,981 warrants to purchase an additional 7% of the new units.
We cancelled the MLP's subordinated units and additional partnership
interests. See Note 10.
- We were authorized to develop, and the board has subsequently
approved, a management incentive plan. The incentive plan reserves
1.2 million of EOTT LLC's authorized units for issuance to certain
key employees and directors. See Note 9.
- We closed exit credit facilities with Standard Chartered, SCTS,
Lehman Brothers Inc. ("Lehman"), and other lenders on February 28,
2003. See further discussion in Note 2.
17
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
As a result of the confirmation of our Restructuring Plan, the following
liabilities that were deemed subject to compromise were either discharged by the
EOTT Bankruptcy Court or retained as ongoing obligations of the Successor
Company. Estimated liabilities subject to compromise at December 31, 2002 were
as follows (in thousands):
11% Senior Notes $ 235,000
Interest payable - 11% Senior Notes 13,481
Accounts payable and suspense payable 34,876
Allowed claims for environmental settlements and contingencies 7,970
Other 1,500
--------
Total $ 292,827
========
The following reorganization items and net gain on discharge of debt,
which were specifically related to the EOTT Bankruptcy, were recorded during the
two months ended February 28, 2003, (in thousands):
Reorganization items - legal and professional fees $ (7,330)
Net gain on discharge of 11% senior notes,
related accrued interest and other debt (1) $ 131,560
(1) The gain on discharge of debt was recorded net of the 9% senior
notes and limited liability company units issued to the creditors
upon emergence from bankruptcy.
4. FRESH START REPORTING
As previously discussed, the unaudited condensed consolidated financial
statements reflect the adoption of fresh start reporting required by SOP 90-7
for periods subsequent to our emergence from bankruptcy. In accordance with the
principles of fresh start reporting, we have adjusted our assets and liabilities
to their fair values as of February 28, 2003. The net effect of the fresh start
reporting adjustments was a loss of $56.8 million, which is reflected in the
results of operations of the Predecessor Company for the two months ended
February 28, 2003.
The enterprise value of Link on the effective date of the Restructuring
Plan was determined to be approximately $363 million. The enterprise value was
determined with the assistance of a third party financial advisor using
discounted cash flow, comparable transaction and capital market comparison
analyses, adjusted for the actual working capital as of the effective date of
the Restructuring Plan. The discounted cash flow analyses were based upon five
year projected financial results, including an assumption for terminal values
using cash flow multiples, discounted at our estimated post-restructuring
weighted-average cost of capital.
Pursuant to SOP 90-7, the reorganization value of Link on the effective
date of the Restructuring Plan was determined to be approximately $856 million,
which represented the enterprise value plus the fair value of current
liabilities exclusive of funded debt on February 28, 2003. We have allocated the
reorganization value as of February 28, 2003 to tangible and identifiable
intangible assets in conformity with SFAS No. 141, "Business Combinations",
using discounted cash flow and replacement cost valuation analyses, and
liabilities, including debt, were recorded at their net present values.
Independent third-party valuation specialists were used to determine the
allocation of the reorganization value to our tangible and identifiable
intangible assets and to determine the fair value of our long-term liabilities.
The valuations were based on a number of estimates and assumptions, which
are inherently subject to significant uncertainties and contingencies beyond our
control. Accordingly, there can be no assurance that the valuations will be
realized, and actual results could vary significantly. The determination of the
fair values is complete.
The effects of the reorganization pursuant to the Restructuring Plan and
the application of fresh start reporting on the Predecessor Company's
consolidated balance sheet as of February 28, 2003 are as follows (in
thousands):
18
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
PREDECESSOR DEBT DISCHARGE
COMPANY AND RECLASS FRESH START SUCCESSOR COMPANY
FEBRUARY 28, 2003 ADJUSTMENTS ADJUSTMENTS FEBRUARY 28, 2003
----------------- ----------- ----------- -----------------
Assets
Current Assets
Cash and cash equivalents ............ $ 40,735 $ -- $ -- $ 40,735
Trade and other receivables .......... 439,361 -- -- 439,361
Inventories .......................... 25,860 -- 750(g) 26,610
Other ................................ 12,911 -- (2,021)(h) 10,890
--------- --------- --------- --------
Total current assets ............ 518,867 -- (1,271) 517,596
--------- --------- --------- --------
Property, Plant and Equipment, at cost 598,633 -- (267,654)(i) 330,979
Less: Accumulated depreciation ....... 223,188 -- (223,188)(i) --
--------- --------- --------- --------
Net property, plant and equipment 375,445 -- (44,466) 330,979
--------- --------- --------- --------
Goodwill ............................. 7,436 -- (7,436)(j) --
--------- --------- --------- --------
Other Assets ......................... 10,762 -- (2,880)(h) 7,882
--------- --------- --------- --------
Total Assets .................... $ 912,510 $ -- $ (56,053) $856,457
========= ========= ========= ========
Liabilities and Members'/Partners'
Capital
Current Liabilities
Trade and other accounts payable ..... $ 451,294 $ 17,406(a) $ -- $468,700
Accrued taxes payable ................ 13,045 (8,307)(b) -- 4,738
Term loans ........................... 75,000 (75,000)(c) -- --
Repurchase agreement ................. 75,000 (75,000)(c) -- --
Receivable financing ................. 50,000 -- -- 50,000
Other ................................ 19,226 2,815(a)(b) 318(k) 22,359
--------- --------- --------- --------
Total current liabilities ....... 683,565 (138,086) 318 545,797
--------- --------- --------- --------
Long-Term Liabilities
9% Senior Notes ...................... -- 98,800(d) -- 98,800
Term loans ........................... -- 75,000(c) -- 75,000
Repurchase agreement ................. -- 75,000(c) -- 75,000
Ad valorem tax liability ............. -- 6,992(b) -- 6,992
Other ................................ 17,781 -- 400(k) 18,181
--------- --------- --------- --------
Total long-term liabilities ..... 17,781 255,792 400 273,973
--------- --------- --------- --------
Liabilities Subject to Compromise .... 284,843 (284,843)(a) -- --
Additional Partnership Interests ..... 9,318 (9,318)(e) -- --
Members'/Partners' Capital (Deficit) . (82,997) 176,455(f) (56,771) 36,687
--------- --------- --------- --------
Total Liabilities and
Members'/Partners' Capital ....... $ 912,510 $ -- $ (56,053) $856,457
========= ========= ========= ========
Notes:
(a) Liabilities subject to compromise have been adjusted to reflect the
settlement of the claims and discharge of the 11% senior notes and
related accrued interest in connection with the Restructuring Plan.
See further discussion in Note 2.
(b) To reclassify current and long - term amounts due to taxing
authorities for accrued but unpaid ad valorem taxes in connection
with the Restructuring Plan.
(c) To reflect the refinancing on a long-term basis of amounts
outstanding under the Debtor-in-Possession Financing Facilities.
(d) To reflect the issuance of 9% senior unsecured notes (face amount of
$104 million) to all former senior note holders and general
unsecured creditors with allowed claims in connection with the
Restructuring Plan, recorded at fair value.
(e) To reflect the cancellation of the additional partnership interests
in connection with the Restructuring Plan.
(f) To reflect the issuance of limited liability company units pursuant
to the Restructuring Plan and the net gain on extinguishment of
debt.
(g) To adjust inventory to fair value.
(h) To reflect the elimination of deferred turnaround costs, which are
included in the fair value of property, plant and equipment of the
Successor Company.
(i) To adjust property, plant, and equipment to fair value.
(j) To reflect the elimination of goodwill resulting from the fair value
allocation.
(k) To reflect the Enron and Big Warrior notes at fair value.
19
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
5. PROPERTY, PLANT AND EQUIPMENT
As discussed in Note 3, property, plant and equipment was adjusted to fair
value due to the adoption of fresh start reporting as required by SOP 90-7. The
components of gross property, plant and equipment and accumulated depreciation
at September 30, 2003 and December 31, 2002 are as follows (in thousands):
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
SEPTEMBER 30, 2003 | DECEMBER 31, 2002
------------------ | -----------------
|
Operating PP&E, including pipelines, storage tanks, etc $ 277,636 | $ 477,834
Liquids hydrocarbon processing & storage facilities ... 29,691 | 28,689
Office PP&E, buildings and leasehold improvements ..... 2,709 | 54,405
Tractors, trailers and other vehicles ................. 1,201 | 10,739
Land .................................................. 11,427 | 9,216
--------- | ---------
322,664 | 580,883
Less: Accumulated Depreciation ................... (13,511) | (210,351)
--------- | ---------
$ 309,153 | $ 370,532
========= | =========
6. ASSET DISPOSITIONS/REORGANIZATION
Sale of West Coast Assets - Discontinued Operations
Effective June 25, 2003, we signed a definitive agreement to sell all of
the assets comprising our natural gas gathering, processing, natural gas liquids
fractionation, storage and related trucking and distribution facilities located
on the West Coast. A sale of these assets to a third party had been one of the
options considered by us since we emerged from bankruptcy. The sales price for
the assets exclusive of inventory was $9.9 million. The proceeds from the sale
of the West Coast natural gas liquids assets could be increased by up to $1.4
million depending on the operating results of the West Coast natural gas liquids
assets during the twelve month period following closing. The closing occurred on
October 1, 2003, and $9.0 million of the net proceeds from the sale were used to
pay down amounts outstanding under the Commodity Repurchase Agreement.
Revenues and results of operations for the West Coast natural gas liquids
assets for the three and seven months ended September 30, 2003, the two months
ended February 28, 2003, and the three months and nine months ended September
30, 2002 are shown below (in thousands). We did not allocate any interest
expense to the discontinued operations for any of the periods presented below.
SUCCESSOR COMPANY | PREDECESSOR COMPANY
---------------------------------------- | -----------------------------------------------------------
THREE MONTHS SEVEN MONTHS | TWO MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED | ENDED ENDED ENDED
SEPTEMBER 30, 2003 SEPTEMBER 30, 2003 | FEBRUARY 28, 2003 SEPTEMBER 30, 2002 SEPTEMBER 30, 2002
------------------ ------------------ | ----------------- ------------------ ------------------
|
Revenues ................ $ 8,465 $ 20,496 | $5,571 $ 6,671 $ 21,785
======= ======== | ====== ======= ========
Income (loss) from |
discontinued operations . $(1,320) $ (543) | $ 395 $(1,287) $ (994)
======= ======== | ====== ======= ========
The income (loss) from discontinued operations for the three and seven
months ended September 30, 2003 includes a loss on disposal of $0.6 million and
$0.8 million, respectively. At December 31, 2002, we recorded an impairment
charge of $22.9 million to reflect these assets at their estimated fair values
at December 31, 2002. The West Coast natural gas liquids operations were
historically presented in the West Coast operating segment.
20
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Sale of Certain Marketing and Transportation Assets
On October 1, 2003, we sold certain crude oil marketing and transportation
assets in the Arkansas, Louisiana and Texas ("ArkLaTex") area to Plains
Marketing L.P. and All American Pipeline, L.P., a wholly owned subsidiary of
Plains Resources, Inc. The sales price for these assets, including linefill, was
approximately $17 million. Subsequent to closing, $16.2 million of the net
proceeds from the sale were used to pay down amounts outstanding under the
Commodity Repurchase Agreement. The gain on the sale of these assets is
estimated to be approximately $11 million and will be recorded in the fourth
quarter of 2003. The long-lived assets to be disposed of were historically
presented in the North American Crude Oil and Pipeline Operations operating
segments.
Liquids Operations-Phase Out of MTBE Production
Over the past year, we considered several alternatives due to the
deteriorating business and regulatory climate for MTBE, including a sale of the
Liquids Operations. Effective October 1, 2003, pursuant to a previously
announced plan to reduce our Liquids Operations, we began to phase out our
methyl tertiary-butyl ether ("MTBE") production at the Morgan's Point Facility.
The decision to cease production of MTBE and end our financial exposure to the
MTBE market was made after discussions with a third party regarding a possible
sale of the Liquids Operations terminated unsuccessfully. During the seven
months ended September 30, 2003, the Liquids Operations had an operating loss of
$20 million. We will continue to operate certain liquids processing, storage
and marketing facilities at the Morgan's Point Facility, which will be
integrated with our existing natural gas liquids storage and transportation
operations at Mont Belvieu. Activities associated with the phase out of MTBE
production are expected to be completed by year end 2003.
In connection with the phase out of MTBE production, the following charges
were recorded in September 2003 (in thousands):
Severance costs............................................. $1,832
Impairment of assets........................................ $2,751
Material and supplies write-down............................ $2,280
The severance costs were accrued pursuant to our pre-existing severance
plan in accordance with Statement of Financial Accounting Standards ("SFAS") No.
112, "Employers' Accounting for Post Employment Benefits - an Amendment of FASB
Statements No. 5 and 43" and are recorded in operating expenses in the Condensed
Consolidated Statement of Operations.
The impairment charges reflect adjustments to the carrying values of
long-lived assets used in the MTBE manufacturing operations to reflect their
fair values. Impairment charges are included in impairment of assets in the
Condensed Consolidated Statement of Operations.
The charge for materials and supplies represents an adjustment to the
carrying values of inventory items to reflect their net realizable values. The
market for surplus MTBE related materials and supplies has been severely
impacted by recent plant shut downs. The charge to adjust the carrying values of
materials and supplies is included in operating expenses in the Condensed
Consolidated Statement of Operations.
7. CHANGE IN ESTIMATE OF CRUDE OIL LINEFILL
Measuring the physical volumes of crude oil linefill in certain of the
pipelines we operate in the West Texas and New Mexico area is inherently
difficult. Because these pipelines are operated under very little pressure,
unlike the vast majority of our other pipelines, we cannot use traditional
engineering based methods
21
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
to estimate the physical volumes in the system but instead have utilized certain
operational assumptions and topographical information which take into
consideration the measurement limitations.
As a part of our pipeline integrity management program, we are in the
process of removing from service various pipelines we operate in this area, some
of which were acquired from Texas New Mexico Pipeline Company in 1999. The
actual physical volume of crude oil linefill we removed from the line we took
out of service during the third quarter of 2003 was less than our estimate of
linefill volume for the applicable pipeline. Following this discovery, we
initiated a thorough review of our estimates for all of our pipelines which are
operated under very little pressure. We also engaged the services of a third
party consultant to review our methodology of estimating linefill volumes. After
completing this review, we revised downward our estimates of the physical volume
of crude oil linefill in certain of our pipelines by approximately 170,000
barrels. As a result, we recorded a charge of $4.6 million to reflect our change
in estimate of physical linefill volumes based on September 30, 2003 market
prices. The charge was recorded in cost of sales in the Condensed Consolidated
Statement of Operations.
We currently estimate that we will complete the program to remove these
pipelines from service in early 2004. The amount of crude oil linefill we
ultimately remove from the affected pipelines could differ materially from our
current estimates. Therefore, additional charges could be required in the near
term.
8. INVENTORY AND ACCOUNTS PAYABLE RECONCILIATIONS
We recently identified control deficiencies with inventory and accounts
payable reconciliation procedures in our pipelines and liquids operations. In
order to address these issues, we designed and implemented additional procedures
to provide reasonable assurance that these control deficiencies did not lead to
a material misstatement in our consolidated financial statements. Related to
this matter, we recorded charges in the third quarter of 2003 of $1.8 million
(the impact to prior period financial statements was not material). The
adjustment, properly recorded in the respective periods, would have increased
(decreased) income from continuing operations by $(1.6) million, none and $(0.4)
million for the years ended December 31, 2002, 2001 and 2000.
9. LINK ENERGY LLC EQUITY INCENTIVE PLAN
In August 2003, the Board of Directors of Link Energy LLC adopted the
Link Energy LLC Equity Incentive Plan ("Equity Plan"), which authorizes 1.2
million restricted units to be issued to certain key employees and directors.
The Equity Plan has a ten-year term, beginning June 1, 2003. Each award of
restricted units under the Equity Plan will be evidenced by an Award Agreement,
which will set forth the number of restricted units granted, the vesting period
and other material terms of the restricted unit award.
On October 1, 2003, 865,000 restricted units were awarded to certain key
employees. The restricted units awarded will vest 50% on June 1, 2004, 25% on
June 1, 2005 and 25% on June 1, 2006. Based on the market value of the LLC units
on October 1, 2003, compensation expense of $13.0 million will be recorded
against earnings over the three year vesting period.
10. CAPITAL
As part of the Restructuring Plan, EOTT's common units, subordinated units
and additional partnership interests were canceled and 14,475,321 new limited
liability company units ("LLC units") were authorized. Holders of common units
received 369,520 LLC units and 957,981 warrants to purchase additional LLC
units. The warrants have a five-year term, a strike price of $12.50, are
exercisable after June 30, 2003 and had an estimated fair value of $0.01 per
warrant as of the effective date of the Restructuring Plan. Holders of EOTT's
former 11% senior notes and general unsecured creditors with allowed claims will
receive their pro rata allocation of 11,947,820 LLC units, which were originally
issued to the Bank of New York, the depositary agent. The depositary agent
distributed approximately 90% of the LLC units in August 2003 and the final
allocation of units is expected to be completed by December 2003. All of the LLC
units are
22
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
deemed to be issued and outstanding for the purposes of these financial
statements. Additionally, 1.2 million LLC units have been reserved for a
management incentive plan for issuance to certain key employees and directors.
See further discussion in Note 9.
The following is a rollforward of LLC units and warrants outstanding:
Common Subordinated LLC
Units Units Units Warrants
----- ----- ----- --------
Units Outstanding at December 31, 2002 ..................... 18,476,011 9,000,000 -- --
Units Cancelled in Connection with Restructuring Plan ...... (18,476,011) (9,000,000) -- --
Issuance of New LLC Units and Warrants ..................... -- -- 12,317,340 957,981
LLC Units and Warrants Outstanding as of February 28, 2003 . -- -- 12,317,340 957,981
----------- ---------- ---------- --------
Exercise of Warrants ....................................... -- -- 30,512 (30,512)
----------- ---------- ---------- --------
LLC Units and Warrants Outstanding at September 30, 2003 ... -- -- 12,347,852 927,469
=========== ========== ========== ========
The LLC units and the warrants were issued pursuant to an exemption from
the registration requirements of the Securities Act of 1933, as amended (the
"Securities Act") and applicable state law, pursuant to the exemptions afforded
under Section 1145, Title 11 of the U.S. Bankruptcy Code. The LLC units and the
warrants have been registered pursuant to the Securities Exchange Act of 1934,
as amended (the "Exchange Act") pursuant to Section 12(g) and we are therefore a
reporting company under the Exchange Act. Neither the LLC units nor the warrants
are traded on any national exchange or pursuant to an automated quotation system
administered by the National Association of Securities Dealers ("NASD").
The LLC units issued pursuant to the Restructuring Plan are subject to the
terms of a Registration Rights Agreement effective March 1, 2003. Following
completion of the audit of our financial statements for the year ending December
31, 2003, any holders of 10% or more of the securities eligible for registration
under the terms of the Registration Rights Agreement will be entitled to demand
registration of their LLC units, subject to certain conditions. The Registration
Rights Agreement also provides for customary piggyback registration rights
entitling holders of LLC units to include their units in any registration in
which we may engage, subject to certain conditions. We will be required to pay
all registration expenses in connection with any such registrations.
The LLC units are subject to the terms of an LLC Agreement, which
currently, among other things, restricts the issuance of additional equity
interests in the LLC without the approval of holders of at least two-thirds of
the outstanding units.
11. EARNINGS PER UNIT
Basic earnings per unit include the weighted average impact of outstanding
units (i.e., it excludes unit equivalents). Diluted earnings per unit consider
the impact of all potentially dilutive securities.
Successor Company
Basic and diluted net loss per unit for the Successor Company were $1.63
and $3.10 for the three and seven months ended September 30, 2003, respectively.
The warrants outstanding were determined to be antidilutive during the periods.
Basic and diluted net loss per unit from continuing operations were $1.52 and
$3.06 for the three and seven months ended September 30, 2003, respectively.
Basic and diluted net loss per unit from discontinued operations were $0.11 and
$0.04 for the three and seven months ended September 30, 2003, respectively.
23
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
Predecessor Company
Total and per unit information related to income (loss) from continuing
operations, discontinued operations, the cumulative effect of an accounting
change and net income (loss) for the Predecessor Company is shown in the tables
below. All amounts exclude amounts allocated to the General Partner (in
thousands, except per unit amounts):
Two Months Ended February 28, 2003
---------------------------------------------------------------------------------
Basic (1)
--------------------------------------
Common Subordinated Diluted (2)
------------------------ -------------------- ------------------------
Income Per Income Per Income Per
(Loss) Unit (Loss) Unit (Loss) Unit
------ ---- ------ ---- ------ ----
Income (Loss) from Continuing Operations $ 2,343 $ 0.13 $ -- $ -- $ 2,343 $ 0.09
Income (Loss) from Discontinued
Operations(3) ........................ (208) (0.01) -- -- (208) (0.01)
Cumulative Effect of Accounting Changes -- -- -- -- -- --
------- ---------- ---------- ------ ------- ----------
Net Income (Loss) ...................... $ 2,135 $ 0.12 $ -- $ -- $ 2,135 $ 0.08
======= ========== ========== ====== ======= ==========
Weighted Average Units Outstanding ..... 18,476 9,000 27,476
========== ====== ==========
Three Months Ended September 30, 2002
------------------------------------------------------------------------------
Basic (1)
-------------------------------------
Common Subordinated Diluted (2)
------------------------ ----------------------- ------------------------
Income Per Income Per Income Per
(Loss) Unit (Loss) Unit (Loss) Unit
Income (Loss) from Continuing Operations .. $ -- $ -- $ (20,195) $ (2.24) $ (20,195) $ (0.74)
Income (Loss) from Discontinued Operations -- -- (80) (0.01) (80) --
---------- ---------- ---------- ---------- ---------- ----------
Net Income (Loss) ......................... $ -- $ -- $ (20,275) $ (2.25) $ (20,275) $ (0.74)
========== ========== ========== ========== ========== ==========
Weighted Average Units Outstanding ........ 18,476 9,000 27,476
========== ========== ==========
Nine Months Ended September 30, 2002
-----------------------------------------------------------------------------
Basic (1)
------------------------------------
Common Subordinated Diluted (2)
----------------------- ----------------------- -----------------------
Income Per Income Per Income Per
(Loss) Unit (Loss) Unit (Loss) Unit
------ ---- ------ ---- ------ ----
Income (Loss) from Continuing Operations ... $ (409) $ (0.02) $ (29,155) $ (3.24) $ (29,564) $ (1.08)
Income (Loss) from Discontinued Operations . 208 0.01 -- -- 208 0.01
-------- ---------- ---------- ---------- ---------- ----------
Net Income (Loss) .......................... $ (201) $ (0.01) $ (29,155) $ (3.24) $ (29,356) $ (1.07)
======== ========== ========== ========== ========== ==========
Weighted Average Units Outstanding ......... 18,476 9,000 27,476
========== ========== ==========
(1) Net income (loss), excluding the approximate two percent General Partner
interest, has been apportioned to each class of unitholder based on the
ownership of total units outstanding in accordance with the Partnership
Agreement. Net losses are not allocated to the common and subordinated
unitholders to the extent that such allocations would cause a deficit
capital account balance or increase any existing deficit capital account
balance. Any remaining losses are allocated to the General Partner as a
result of the balances in the capital accounts of the common and
subordinated unitholders. Effective with the third quarter of 2002, all
losses were being allocated to the General Partner. The disproportionate
allocation of 2002 net losses among the unitholders and the General
Partner was recouped during the two months ended February 28, 2003.
(2) The diluted earnings (loss) per unit calculation assumes the conversion of
subordinated units into common units.
(3) Earnings (loss) per unit from discontinued operations has been determined
based on the difference between the amount of net income (loss) allocated
to each class of unitholder and the amount of income (loss) from
continuing operations allocated to each class of unitholder. Earnings
(loss) per unit for the two months ended February 28, 2003, have been
impacted by the disproportionate allocation of income and loss discussed
above.
24
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
12. DERIVATIVES AND HEDGING ACTIVITIES
We utilize derivative instruments to minimize our exposure to commodity
price fluctuations. Generally, as we purchase lease crude oil at prevailing
market prices, we enter into corresponding sales transactions involving either
physical deliveries of crude oil to third parties or a sale of futures contracts
on the NYMEX. Price risk management strategies, including those involving price
hedges using NYMEX futures contracts, are very important in managing our
commodity price risk. Such hedging techniques require resources for managing
both future positions and physical inventories. We effect transactions both in
the futures and physical markets in order to deliver the crude oil to its
highest value location or otherwise to maximize the value of the crude oil we
control. Throughout the process, we seek to maintain a substantially balanced
risk position at all times. We do have certain risks that cannot be completely
hedged such as basis risks (the risk that price relationships between delivery
points, grades of crude oil or delivery periods will change) and the risk that
transportation costs will change.
Effective January 1, 2001, we began reporting derivative activities in
accordance with Statement of Financial Accounting Standards ("SFAS") No. 133,
"Accounting for Derivative Instruments and Hedging Activities," as amended. SFAS
No. 133 requires that derivative instruments be recorded in the balance sheet as
either assets or liabilities measured at fair value. Under SFAS No. 133, we are
required to "mark-to-fair value" all of our derivative instruments at the end of
each reporting period. SFAS No. 133 requires that changes in the derivative's
fair value be recognized currently in earnings unless specific hedge accounting
criteria are met. Qualifying criteria include, among other requirements, that we
formally designate, document, and assess the effectiveness of the hedging
instruments as they are established and at the end of each reporting period.
Special accounting for qualifying hedges allows a derivative's gains and losses
to offset related results from the hedged item in the income statement. Changes
in the fair value of derivatives designated as cash flow hedges are deferred to
Other Comprehensive Income (Loss) ("OCI"), a component of Members' Capital, and
reclassified into earnings when the associated hedged transaction affects
earnings. Deferral of derivative gains and losses through OCI is limited to the
portion of the change in fair value of the derivative instrument which
effectively hedges the associated hedged transaction; ineffective portions are
recognized currently in earnings. The ineffective portions of our hedged
transactions were not material to our earnings for the quarter and seven months
ended September 30, 2003. Realized derivative gains and losses are included in
Operating Revenue in our Statement of Operations.
Beginning in the second quarter of 2003, we designated certain of our
derivative instruments as cash flow hedges of forecasted transactions. These
hedges were for a maximum of two-months and had no material effect on our OCI or
earnings for the quarter and seven months ended September 30, 2003. SFAS No. 133
requires that any cash flow hedges, for which it is probable that the original
forecasted transactions will not occur by the end of the originally specified
time period, be discontinued and reclassified into earnings, and that such
reclassifications be recorded and separately disclosed. We had no such
reclassifications for the quarter and seven months ended September 30, 2003. All
unrealized derivative gains and losses included in accumulated other
comprehensive income (loss) at September 30, 2003 are expected to be
reclassified to net income (loss) within the next twelve months.
13. COMMITMENTS AND CONTINGENCIES
Operating Leases. There was no significant change in our commitments
related to operating leases as a result of the bankruptcy.
Indemnities. In November 2002, the Financial Accounting Standards Board
("FASB") issued Interpretation No. 45, "Guarantor's Accounting and Disclosure
Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of
Others" ("FIN 45"). FIN 45 requires disclosures to be made by a guarantor in its
financial statements about its obligations under certain guarantees it has
issued and that a guarantor recognize, at the inception of a guarantee, a
liability for the fair value of the obligation under the guarantee. We are a
party to various contracts entered into in the ordinary course of business that
contain indemnity provisions. Our obligations under the indemnities are
contingent upon the occurrence of events or
25
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
circumstances specified in the contracts. No such events or circumstances have
occurred to date and we do not consider our liability under the indemnities to
be material to our financial position or results of operations.
Litigation. We are, in the ordinary course of business, a defendant in
various lawsuits, some of which are covered in whole or in part by insurance. We
believe that the ultimate resolution of litigation, individually and in the
aggregate, will not have a materially adverse impact on our financial position
or results of operations. Generally, as a result of our bankruptcy, all pending
litigation against us was stayed while we continued our business operations as
debtors-in-possession. Several litigation claims were settled during the course
of the bankruptcy proceedings or are still being negotiated post confirmation.
Additionally, we agreed to lift the stay as to certain proceedings we permitted
to continue. How each matter was or is being handled is set forth in the summary
of each case. For matters where the parties negotiated a settlement during our
bankruptcy proceedings, the settlement amount was recorded at December 31, 2002
as an allowed general unsecured claim in "Other Income (Expense)" in the
Consolidated Statement of Operations. In connection with our Restructuring Plan,
general unsecured creditors with allowed claims will receive a pro rata share of
$104 million of 9% senior unsecured notes and a pro rata share of 11,947,820
Link LLC units. See further discussion in Notes 2 and 10. Prior to and since the
commencement of our bankruptcy proceedings, various legal actions arose in the
ordinary course of business, of which the significant actions are discussed
below.
John H. Roam, et al. vs. Texas-New Mexico Pipe Line Company and EOTT
Energy Pipeline Limited Partnership, Cause No. CV43296, In the District Court of
Midland County, Texas, 238th Judicial District (Kniffen Estates Suit). The
Kniffen Estates Suit was filed on March 2, 2001, by certain residents of the
Kniffen Estates, a residential subdivision located outside of Midland, Texas.
The allegations in the petition state that free crude oil products were
discovered in water wells in the Kniffen Estates area, on or about October 3,
2000. The plaintiffs claim that the crude oil products are from a 1992 release
from a pipeline then owned by the Texas-New Mexico Pipe Line Company ("Tex-New
Mex"). We purchased that pipeline from Tex-New Mex in 1999. The plaintiffs have
alleged that Tex-New Mex was negligent, grossly negligent, and malicious in
failing to accurately report and remediate the spill. With respect to us, the
plaintiffs were seeking damages arising from any contamination of the soil or
groundwater since we acquired the pipeline in question. No specific amount of
money damages was claimed in the Kniffen Estate Suit, but the plaintiffs did
file proofs of claim in our bankruptcy proceeding totaling $62 million. In
response to the Kniffen Estates Suit, we filed a cross-claim against Tex-New
Mex. In the cross-claim, we claimed that, in relation to the matters alleged by
the plaintiffs, Tex-New Mex breached the Purchase and Sale Agreement between the
parties dated May 1, 1999, by failing to disclose the 1992 release and by
failing to undertake the defense and handling of the toxic tort claims, fair
market value claims, and remediation claims arising from the release. On April
5, 2002, we filed an amended cross-claim which alleges that Tex-New Mex
defrauded us as part of Tex-New Mex's sale of the pipeline systems to us in
1999. The amended cross-claim also alleges that various practices employed by
Tex-New Mex in the operation of its pipelines constitute gross negligence and
willful misconduct and void our obligation to indemnify Tex-New Mex for
remediation of releases that occurred prior to May 1, 1999. In the Purchase and
Sale Agreement, we agreed to indemnify Tex-New Mex only for certain remediation
obligations that arose before May 1, 1999, unless these obligations were the
result of the gross negligence or willful misconduct of Tex-New Mex prior to May
1, 1999. EOTT Energy Pipeline Limited Partnership ("PLP") and the plaintiffs
agreed to a settlement during our bankruptcy proceedings. The settlement
provides for the plaintiffs' release of their claims filed against PLP in this
proceeding and in the bankruptcy proceedings, in exchange for an allowed general
unsecured claim in our bankruptcy of $3,252,800 (as described above, the
plaintiffs filed proofs of claim in our bankruptcy proceedings totaling $62
million). The allowed general unsecured claim was accrued at December 31, 2002.
On April 1, 2003, we filed a second amended cross-claim in this matter. In
addition to the claims filed in the previous cross-claims, we requested (i)
injunctive relief for Tex-New Mex's refusal to honor its indemnity obligations;
(ii) injunctive relief requiring Tex-New Mex to identify, investigate and
remediate sites where the conduct alleged in our cross-claim occurred; and (iii)
restitution damages of over $125,000,000. Tex-New Mex filed a motion to compel
arbitration of these issues. The motion to compel arbitration was denied at a
hearing held on April 11, 2003. At the April 11, 2003 hearing, the court also
severed into a separate action EOTT's cross-claims against Tex-New Mex that
extend beyond the crude oil release and groundwater contamination in the Kniffen
Estates subdivision ("EOTT's Over-Arching Claim"). Prior to the trial of the
plaintiff's claims against Tex-New Mex and EOTT's original
26
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
cross-claim against Tex-New Mex arising from the crude oil release and
groundwater contamination in the Kniffen Estates subdivision ("EOTT's Kniffen
Claims"), Tex-New Mex reached a settlement with the plaintiffs that provided for
the release of the plaintiffs' claims. The trial of EOTT's Kniffen Claims
commenced on June 16, 2003, and the jury returned its verdict on July 2, 2003.
The jury found that Tex-New Mex's gross negligence and willful misconduct caused
the contamination in the Kniffen Estates. The jury also found that Tex-New Mex
committed fraud against us with respect to the Kniffen Estates site. The jury
awarded us actual damages equal to the expenses we have incurred to date in
remediating the Kniffen Estates site (approximately $6.1 million) and punitive
damages in the amount of $50 million. On August 29, 2003, the court entered its
final judgment based on the jury verdict. The final judgment provides for the
award to us of (i) actual damages in the amount of $7,701,938, (ii) attorney's
fees in the amount of $1,400,000, (iii) prejudgment interest in the amount of
$953,774, and (iv) punitive damages in the amount of $20,111,424. The punitive
damages were reduced from the jury's award of $50 million in accordance with
Texas' statutory caps on punitive damages awards. The final judgment also
contains a finding that Tex-New Mex is obligated to indemnify us for future
remediation costs incurred at the Kniffen Estates site. On September 26, 2003,
Tex-New Mex filed a motion for new trial and a motion seeking modification of
the judgment. At a hearing held on November 10, 2003, the court denied Tex-New
Mex's motion for new trial but partially granted Tex-New Mex's motion to modify
the judgment. The court ruled that prejudgment interest should not be included
in the calculation for determining the statutory cap on punitive damages.
Accordingly, our punitive damages award will be reduced further by approximately
$1.9 million. A judgment reflecting the modification ordered by the court is
being prepared and will be submitted for entry by the court on November 24,
2003. We cannot predict the outcome of Tex-New Mex's appellate efforts.
Bankruptcy Issues related to Claims Made by Texas-New Mexico Pipeline
Company and its affiliates. Tex-New Mex, Shell Oil Company and Equilon filed
proofs of claim in our bankruptcy, each filing similar claims in the amount of
$112 million. Equilon Pipeline Company LLC guaranteed, under certain
circumstances, the obligations of Tex-New Mex under the Purchase and Sale
Agreement dated May 1, 1999. According to Shell Oil Company's 2002 Annual
Report, in 2002, Shell became the sole owner of Equilon, which was merged into
Shell Oil Products US. The three claims filed each included the same supporting
information, consisting of indemnity claims under the Purchase and Sale
Agreement. In essence, there is only one claim of $112 million filed by the
three entities and we have objected in our bankruptcy court to having the same
claim filed three times. The amount of the $112 million claim is equivalent to
the sum of the total amount of the proofs of claim filed in our bankruptcy
proceedings by owners of property on which the Tex-New Mex system is located and
the attorneys fees incurred by Tex-New Mex in defending the Kniffen Estates Suit
and other lawsuits (including our bankruptcy proceedings) with respect to the
Tex-New Mex system. The majority of these owners were plaintiffs in the Kniffen
Estates Suit and a group of New Mexico environmental claimants, with whom we
settled during our bankruptcy proceeding and accrued the allowed general
unsecured claim at December 31, 2002. In July of 2003 we entered into an
agreement with Shell, Tex-New Mex and Equilon whereby all of their claims were
either withdrawn, estimated or allowed, leaving the value of the claims
estimated for distribution purposes at $56,924.52. We are currently working to
fully resolve these claims in the bankruptcy claims resolution process.
Jimmie B. Cooper and Shryl S. Cooper vs. Texas-New Mexico Pipeline
Company, Inc., EOTT Energy Pipeline Limited Partnership and Amerada Hess
Corporation, Case No. CIV 01-1321 M/JHG, In the United States District Court for
the District of New Mexico. Plaintiffs in this lawsuit, filed on October 5,
2001, are surface interest owners of certain property located in Lea County, New
Mexico. The plaintiffs allege that aquifers underlying their property and water
wells located on their property have been contaminated as a result of spills and
leaks from a pipeline running across their property that is or was owned by
Tex-New Mex and us. The plaintiffs also allege that oil and gas operations
conducted by Amerada Hess Corporation resulted in leaks or spills of pollutants
that ultimately contaminated the plaintiffs' aquifers and water wells. Our
initial investigation of this matter indicated that the alleged contamination of
the aquifers underlying the plaintiffs' property was not caused by leaks from
the pipeline now owned by us that traverses the plaintiffs' property. EOTT and
the plaintiffs have agreed to the terms of a settlement, whereby the plaintiffs
will release their claims against EOTT and receive an allowed general unsecured
claim in our bankruptcy in the amount of $300,000. The allowed general unsecured
claim was accrued at December 31, 2002. The settlement
27
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
documents have been executed and the case was dismissed with prejudice on
October 16, 2003. This matter is closed and will no longer be reported.
Jimmie T. Cooper and Betty P. Cooper vs. Texas-New Mexico Pipeline Company,
Inc., EOTT Energy Pipeline Limited Partnership, and EOTT Energy Corp., Case No.
D-0101-CV-2002-02122, In the 1st Judicial District Court, Santa Fe County, New
Mexico. This lawsuit was filed on October 1, 2002. The plaintiffs in this
lawsuit are surface interest owners of certain property located in Lea County,
New Mexico. The plaintiffs are alleging that aquifers underlying their property
and water wells located on their property have been contaminated as a result of
spills and leaks from a pipeline running across their property that is or was
owned by Tex-New Mex and us. The plaintiffs do not specify when the alleged
spills and leaks occurred. The plaintiffs are seeking payment of costs that
would be incurred in investigating and remediating the alleged crude oil
releases and replacing water supplies from aquifers that have allegedly been
contaminated. The plaintiffs are also seeking damages in an unspecified amount
arising from the plaintiffs' alleged fear of exposure to carcinogens and the
alleged interference with the plaintiffs' quiet enjoyment of their property. The
plaintiffs are also seeking an unspecified amount of punitive damages. EOTT and
the plaintiffs agreed to the terms of a settlement, whereby the plaintiffs will
release their claims against us and will receive an allowed general unsecured
claim in our bankruptcy in the amount of $1,027,000. The allowed general
unsecured claim was accrued at December 31, 2002. The settlement documents have
been finalized. When the case is dismissed against us, it will no longer be
reported.
David A. Huettner, et al v. EOTT Energy Partners, L.P., et al, Case No.
1:02 CV-917, In the United States District Court, Northern District of Ohio,
Eastern Division ("Securities Suit"). This lawsuit was filed on May 15, 2002,
for alleged violations of the Securities and Exchange Act of 1934 and common law
fraud. The suit was brought by three of our former unitholders who claim that
the General Partner, certain of the officers and directors of Enron and the
General Partner and our previous independent accountants were aware of material
misstatements or omissions of information within various press releases, SEC
filings and other public statements, and failed to correct the alleged material
misstatements or omissions. Plaintiffs maintain that they were misled by our
press releases, SEC filings, and other public statements when purchasing our
common units and were financially damaged thereby. On June 28, 2002, the
Judicial Panel on Multidistrict Litigation issued a Conditional Transfer Order
that provides for the transfer of this case to the Southern District of Texas
for consolidated pretrial proceedings with other lawsuits asserting securities
claims against Enron and Arthur Andersen. On September 20, 2002, EOTT Energy
Partners, L.P. filed a motion to dismiss on the basis of the plaintiff's failure
to state a claim upon which relief can be granted. EOTT Energy Corp. joined in
that motion on October 11, 2002. The plaintiffs filed a motion to lift the stay,
which was denied by the bankruptcy court judge. Additionally, the plaintiffs
filed proofs of claim in our bankruptcy proceedings in the amount of $500,000
each. We filed objections to these proofs of claim on February 21, 2003, and
pursued settlement negotiations with the plaintiffs. We reached a settlement
with the plaintiffs in May, 2003 that provided the plaintiffs with one allowed
unsecured claim in our bankruptcy proceeding in the amount of $550,000 in
exchange for a release as to EOTT and the individually named defendants. The
settlement documents have been finalized, and a final order resolving this
matter has been entered by the Bankruptcy Court. The lawsuit was dismissed in
the United States District Court for the Southern District of Texas, Houston
Division, by order dated October 10, 2003. This matter is closed and will no
longer be reported.
In re EOTT Energy Partners, L.P., Case No. 02-21730, EOTT Energy Finance
Corp., Case No. 02-21731, EOTT Energy General Partner, L.L.C., Case No.
02-21732, EOTT Energy Operating Limited Partnership, Case No. 02-21733, EOTT
Energy Canada Limited Partnership, Case No. 02-21734, EOTT Energy Liquids, L.P.,
Case No. 02-21736, EOTT Energy Corp., Case No. 02-21788, Debtors (Jointly
Administered under Case No. 02-21730), In the United States Bankruptcy Court for
the Southern District of Texas, Corpus Christi Division. On October 8, 2002, we
and all of our subsidiaries filed voluntary petitions for relief under Chapter
11 of the United States Bankruptcy Code in the United States Bankruptcy Court
for the Southern District of Texas (the "EOTT Bankruptcy Court") to facilitate
reorganization of our business and financial affairs for the benefit of us, our
creditors and other interested parties. Additionally, the General Partner filed
its voluntary petition for reorganization under Chapter 11 on October 21, 2002
in the EOTT Bankruptcy Court. The General Partner filed in order to join in our
voluntary, pre-negotiated restructuring
28
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
plan filed on October 8, 2002. On October 24, 2002, the EOTT Bankruptcy Court
administratively consolidated, for distribution purposes, the General Partner's
bankruptcy filing with our previously filed cases. Pursuant to the automatic
stay provisions of the Bankruptcy Code, all actions to collect pre-petition
claims from us and to interfere with our business as well as most other pending
litigation against us, were stayed. In addition, as debtor-in-possession, we had
the right, subject to the approval of the EOTT Bankruptcy Court, to assume or
reject any pre-petition executory contracts or unexpired leases. The EOTT
Bankruptcy Court approved payment of certain pre-petition liabilities, such as
employee wages and benefits, trust fund taxes in the ordinary course of business
and certain pre-petition claims of crude oil suppliers, critical vendors and
foreign vendors. In addition, the EOTT Bankruptcy Court allowed for the payment
of the certain bankruptcy professionals and retention of the professionals in
the ordinary course of business. Finally, the EOTT Bankruptcy Court extended the
time within which we must assume or reject any unexpired leases of
nonresidential property. Our Restructuring Plan was confirmed on February 18,
2003 and became effective on March 1, 2003. The provisions of the Restructuring
Plan are further described in Note 2. Shell and Tex-New Mex filed a notice of
appeal to our plan confirmation on February 24, 2003. We filed a motion to
dismiss the appeal as being moot in May of 2003. A hearing on the appeal was
held in the District Court on August 19, 2003, where the judge ruled the appeal
was moot. The ruling became final on October 24, 2003. The bankruptcy remains
open while we resolve the outstanding claims. Until all of the claims are fully
resolved, we cannot complete the allocation of the 11,947,820 LLC units and the
$104 million senior unsecured notes to certain creditors under the Restructuring
Plan. The Bank of New York, as depositary agent, allocated the majority of the
LLC units and senior unsecured notes in August 2003. As of the date of the
initial distribution in August 2003, we had resolved approximately $256 million
of the outstanding claims and had approximately $8 million of unresolved claims.
The final allocation is expected to be completed by December 2003. Until the
final allocation is made, we will not know how many units each of our
unitholders is entitled to vote.
EPA Section 308 Request. In July 2001, Enron received a request for
information from the Environmental Protection Agency ("EPA") under Section 308
of the Clean Water Act, requesting information regarding certain spills and
releases from oil pipelines owned or operated by Enron and its affiliated
companies for the time period July 1, 1998 to July 11, 2001. The only domestic
crude oil pipelines owned or operated by Enron at the time of the request were
our pipelines. For the time period in question, our pipelines were operated by
either EOTT Energy Corp., the General Partner for EOTT Energy Partners, L.P. and
a wholly owned subsidiary of Enron, or EPSC, also an Enron subsidiary. At the
time the EPA issued the Section 308 request to Enron, EPSC operated our
pipelines. The General Partner and EPSC retain operator liability for the time
period at issue. Enron responded to the EPA's Section 308 request in its
capacity as the operator of the pipelines actually owned by us. We retain all
liability for the pipelines for which an owner would be responsible. In addition
to the retention of ownership liability, under the terms of the Enron Settlement
Agreement dated October 8, 2002, we would be required to indemnify the General
Partner and its Affiliates with regard to any environmental charges, except for
claims of gross negligence and willful misconduct. EOTT Energy Corp. and its
affiliated company, EPSC, operated our pipelines under an Operation and Service
Agreement, which was terminated on December 31, 2002 pursuant to the Enron
Settlement Agreement. Additionally, under the terms of the MLP Partnership
Agreement, which was in place until March 1, 2003, we were obligated to
indemnify the General Partner and its affiliates (including Enron) for all
losses associated with activities undertaken on our behalf. This indemnification
obligation is limited to actions undertaken in good faith, may only be satisfied
from our assets, and was reaffirmed in the Enron Settlement Agreement.
Consequently, neither our bankruptcy nor Enron's bankruptcy affects our
liability as owner of the pipelines, nor does it affect our indemnification
obligations to EOTT Energy Corp. or its affiliates under the Enron Settlement
Agreement. While we cannot predict the outcome of the EPA's Section 308 review,
the EPA could seek to impose liability on us with respect to the matters being
reviewed. The outcome of the EPA 308 request is not yet known, and we are
unaware of any potential liability of us, Enron, or its affiliates. However, we
assume that we are fully responsible as owner for any environmental claims or
fines in relation to the pipelines (subject to insurance claims or other third
party claims to which we may be entitled). Our bankruptcy proceedings did not
relieve us from potential environmental liability. Consequently, we do not
believe either our bankruptcy or Enron's bankruptcy has had any material impact
on our environmental liability.
Environmental. We are subject to extensive federal, state and local laws
and regulations covering the discharge of materials into the environment, or
otherwise relating to the protection of the environment, and
29
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
which require expenditures for remediation at various operating facilities and
waste disposal sites, as well as expenditures in connection with the
construction of new facilities. At the federal level, such laws include, among
others, the Clean Air Act, the Clean Water Act, the Oil Pollution Act, the
Resource Conservation and Recovery Act, the Comprehensive Environmental
Response, Compensation and Liability Act, and the National Environmental Policy
Act, as each may be amended from time to time. Failure to comply with these laws
and regulations may result in the assessment of administrative, civil, and
criminal penalties or the imposition of injunctive relief.
Prior to the reduction in operations at our Morgan's Point Facility, we
produced MTBE at our Morgan's Point Facility. MTBE is used as an additive in
gasoline. Due to health concerns around MTBE, there have been lawsuits filed
against companies involved in the production of MTBE. We have not been named in
any such actions, nor do we anticipate being included in any such actions.
However, we can provide no assurances that we may not be included in such
actions due to our past production of MTBE.
In 2001, expenses incurred for spill clean up and remediation costs
related to the assets purchased from Tex-New Mex increased significantly. Based
on our experience with these assets, we filed an amended cross-claim against
Tex-New Mex alleging contingent claims for potential remediation issues not yet
known to us. We allege that Tex-New Mex failed to report spills, underreported
spills, failed to properly respond to leaks in the pipeline and engaged in other
activities with regard to the pipeline that may result in future remediation
liabilities. We obtained $20 million in insurance coverage in connection with
the acquisition from Tex-New Mex believing that amount would be sufficient to
cover our remediation requirements along the pipeline for a ten-year period.
After four years into the term of the insurance policy, we have made claims in
excess of the amount of insurance coverage.
In addition to costs associated with the assets acquired from Tex-New Mex,
we have also incurred spill clean up and remediation costs in connection with
other properties we own in various locations throughout the United States. We
also have insurance coverage to cover clean up and remediation costs that may be
incurred in connection with properties not acquired from Tex-New Mex. However,
no assurance can be given that the insurance will be adequate to cover any such
cleanup and remediation costs.
The following are summaries of environmental remediation expense,
estimated environmental liabilities, and amounts receivable under insurance
policies for the indicated periods (in thousands):
SUCCESSOR COMPANY | PREDECESSOR COMPANY
-------------------------------- | ------------------------------------------------------
THREE MONTHS SEVEN MONTHS | TWO MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED | ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, | FEBRUARY 28, SEPTEMBER 30, SEPTEMBER 30,
2003 2003 | 2003 2002 2002
---- ---- | ---- ---- ----
|
Remediation expense .......... $1,753 $ 5,731 | $ 1,979 $ 3,762 $ 10,791
Estimated insurance recoveries -- (425) | (79) (281) (1,764)
------ ------- | ------- ------- --------
Net remediation expense ...... $1,753 $ 5,306 | $ 1,900 $ 3,481 $ 9,027
====== ======= | ======= ======= ========
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
SEVEN MONTHS | TWO MONTHS
ENDED | ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003
------------------ | -----------------
|
Environmental Liability at Beginning of Period ................. $ 13,440 | $ 13,440
Remediation expense ............................................ 5,731 | 1,979
Cash expenditures .............................................. (7,439) | (1,979)
-------- | --------
Environmental Liability at End of Period ....................... $ 11,732 | $ 13,440
======== | ========
30
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
SEVEN MONTHS | TWO MONTHS
ENDED | ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003
------------------ | -----------------
|
Environmental Insurance Receivable at |
Beginning of Period .............. $ 8,837 | $ 8,803
Estimated recoveries ................ 425 | 79
Cash receipts ....................... (4,073) | (45)
------- | -------
Environmental Insurance Receivable at |
End of Period .................... $ 5,189 | $ 8,837
======= | ========
The environmental liability was classified in Other Current and Other
Long-Term Liabilities and the insurance receivable was classified in Trade and
Other Receivables at September 30, 2003 and December 31, 2002.
We may experience future releases of crude oil into the environment or
discover releases that were previously unidentified. While an inspection program
is maintained on our pipelines to prevent and detect such releases, and
operational safeguards and contingency plans are in place for the operation of
our processing facilities, damages and liabilities incurred due to any future
environmental releases could affect our business. We believe that our operations
and facilities are in substantial compliance with applicable environmental laws
and regulations and that there are no outstanding potential liabilities or
claims relating to safety and environmental matters of which we are currently
aware, the resolution of which, individually or in the aggregate, would have a
materially adverse effect on our financial position or results of operations.
However, we could be significantly adversely impacted by additional repair or
remediation costs related to the pipeline assets we acquired from Tex-New Mex if
the need for any additional repairs or remediation arises and we do not obtain
reimbursement for any such costs as a result of the pending litigation
concerning those assets. Our environmental expenditures include amounts spent on
permitting, compliance and response plans, monitoring and spill cleanup and
other remediation costs. In addition, we could be required to spend substantial
sums to ensure the integrity of our pipeline systems, and in some cases, we may
take pipelines out of service if we believe the costs of upgrades will exceed
the value of the pipelines.
No assurance can be given as to the amount or timing of future
expenditures for environmental remediation or compliance, and actual future
expenditures may be different from the amounts currently estimated. In the event
of future increases in costs, we may be unable to pass on those increases to our
customers.
Tax Status
For information regarding our continued qualification as a partnership for
federal income tax purposes, please read Note 1.
14. OPERATING REVENUES
Revenues and cost of sales related to our crude oil and refined product
marketing and trading activities have been presented on a net basis in
accordance with the provisions of Emerging Issues Task Force ("EITF") Issue
02-03. Gross revenues and purchase costs that have been netted are as follows
(in thousands):
31
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
SUCCESSOR | PREDECESSOR
-------------------------------- | ----------------------------------------------------
THREE MONTHS SEVEN MONTHS | TWO MONTHS THREE MONTHS NINE MONTHS
ENDED ENDED | ENDED ENDED ENDED
SEPTEMBER 30, SEPTEMBER 30, | FEBRUARY 28, SEPTEMBER 30, SEPTEMBER 30,
2003 2003 | 2003 2002 2002
---- ---- | ---- ---- ----
|
Gross revenue .................. $1,320,420 $2,993,355 | $831,187 $1,108,713 $3,558,718
Purchase costs reclassified .... 1,279,130 2,894,806 | 803,495 1,072,366 3,431,666
---------- ---------- | -------- ---------- ----------
Operating revenues for marketing |
and trading activities, net . 41,290 98,549 | 27,692 36,347 127,052
Gross revenue from other |
operations .................. 58,567 123,366 | 44,624 63,418 166,294
---------- ---------- | -------- ---------- ----------
Operating revenue .............. $ 99,857 $ 221,915 | $ 72,316 $ 99,765 $ 293,346
========== ========== | ======== ========== ==========
15. NEW ACCOUNTING STANDARDS
In June 2001, the FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement requires entities to record the fair
value of a liability for legal obligations associated with the retirement
obligations of tangible long-lived assets in the period in which it is incurred.
When the liability is initially recorded, a corresponding increase in the
carrying value of the related long-lived asset would be recorded. Over time,
accretion of the liability is recognized each period, and the capitalized cost
is depreciated over the useful life of the related asset. Upon settlement of the
liability, an entity either settles the obligation for its recorded amount or
incurs a gain or loss on settlement. We adopted the accounting principle
required by the new statement effective January 1, 2003. Determination of the
fair value of the retirement obligation is based on numerous estimates and
assumptions including estimated future third-party costs, future inflation rates
and the future timing of settlement of the obligations.
Our long-lived assets consist primarily of our crude oil gathering and
transmission pipelines and associated field storage tanks, our liquids
processing and handling facilities at Morgan's Point, our underground storage
facility and associated pipeline grid system, and transportation facilities at
Mont Belvieu and our gas processing and fractionation plant and related storage
and distribution facilities on the West Coast.
We identified asset retirement obligations that are within the scope of
the new statement, including contractual obligations included in certain
right-of-way agreements, easements and surface leases associated with our crude
oil gathering, transportation and storage assets and obligations pertaining to
closure and/or removal of facilities and other assets associated with our
Morgan's Point, Mont Belvieu and West Coast facilities. We have estimated the
fair value of asset retirement obligations based on contractual requirements
where the settlement date is reasonably determinable. We cannot currently make
reasonable estimates of the fair values of certain retirement obligations,
principally those associated with certain right-of-way agreements and easements
for our pipelines, our Morgan's Point, Mont Belvieu and West Coast facilities,
because the settlement dates for the retirement obligations cannot be reasonably
determined. We will record retirement obligations associated with these assets
in the period in which sufficient information exists to reasonably estimate the
settlement dates of the respective retirement obligations.
As a result of the adoption of SFAS 143 on January 1, 2003, we recorded a
liability of $1.7 million, property, plant and equipment, net of accumulated
depreciation of $0.1 million and a cumulative effect of a change in accounting
principle of $1.6 million. The effect of adoption of the new accounting
principle was not material to the results of operations for the one month ended
March 31, 2003, the two months ended February 28, 2003 nor would it have had a
material impact on our net income for the three and nine months ended September
30, 2002. The asset retirement obligation as of January 1, 2002 was not
material.
32
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
In September 2003, we recorded additional asset retirement obligations
resulting from the planned reduction in our operations at the Morgan's Point
Facility to phase out the production of MTBE. The following is a rollforward of
our asset retirement obligations for the nine months ended September 30, 2003:
SUCCESSOR COMPANY | PREDECESSOR COMPANY
SEVEN MONTHS | TWO MONTHS
ENDED | ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003
------------------ | -----------------
|
Balance at beginning of period $1,678 | $ --
Additions to liability ....... 1,525 | 1,675
Accretion expense ............ 9 | 3
Liabilities settled .......... -- | --
Revisions to estimates ....... -- | --
------ | ------
Balance at end of period ..... $3,212 | $1,678
====== | ======
In October 2002, the EITF reached a consensus in EITF Issue 02-03, "Issues
Involved in Accounting for Derivative Contracts Held for Trading Purposes and
Contracts Involved in Energy Trading and Risk Management Activities." The EITF
reached a consensus to rescind Issue 98-10, and related interpretive guidance,
and preclude mark to market accounting for energy trading contracts that are not
derivative instruments pursuant to SFAS 133. The consensus requires that gains
and losses (realized and unrealized) on all derivative instruments held for
trading purposes be shown net in the income statement, whether or not the
instrument is settled physically. The consensus to rescind Issue 98-10
eliminated our basis for recognizing physical inventories at fair value. The
consensus to rescind Issue 98-10 was effective for all new contracts entered
into (and physical inventory purchased) after October 25, 2002. For energy
trading contracts and physical inventories that existed on or before October 25,
2002, that remained at December 31, 2002, the consensus was effective January 1,
2003 and was reported as a cumulative effect of a change in accounting
principle. The cumulative effect of the accounting change on January 1, 2003 was
a loss of $2.4 million. With the rescission of Issue 98-10, inventories
purchased after October 25, 2002 have been valued at average cost. See Note 14.
In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities - an Interpretation of ARB No. 51"
("FIN 46"). FIN 46 is an interpretation of Accounting Research Bulletin 51,
"Consolidated Financial Statements", and addresses consolidation by business
enterprises of variable interest entities ("VIE"). FIN 46 requires an enterprise
to consolidate a VIE if that enterprise has a variable interest that will absorb
a majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both. This guidance
applies immediately to VIE's created after January 31, 2003, and to VIE's in
which an enterprise obtains an interest after that date. We implemented FIN 46
effective with the adoption of fresh start reporting on March 1, 2003. This
statement did not have any impact on our financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133 on
Derivative Instrument and Hedging Activities." The statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
133. The new statement is effective for contracts entered into or modified after
June 30, 2003 (with certain exceptions) and for hedging relationships designated
after June 30, 2003. The accounting guidance in the new statement is to be
applied prospectively. We implemented SFAS 149 effective with the adoption of
fresh start reporting on March 1, 2003. This statement did not have any impact
on our financial statements.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain Financial
Instruments with Characteristics of Both Liabilities and Equity." This statement
establishes standards for how a company classifies and measures certain
financial instruments with characteristics of both liabilities and equity. This
statement is effective for financial instruments entered into or modified after
May 31, 2003 and otherwise is effective at the
33
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
beginning of the first interim period beginning after June 15, 2003. The
statement will be implemented by reporting the cumulative effect of a change in
accounting principle for financial instruments created before the issuance date
of the statement and still existing at the beginning of the period of adoption.
We implemented SFAS 150 effective with the adoption of fresh start reporting on
March 1, 2003. The adoption of this statement did not have any impact on our
financial statements.
16. BUSINESS SEGMENT INFORMATION
We have three reportable segments, which management reviews in order to
make decisions about resources to be allocated and assess performance: North
American Crude Oil, Pipeline Operations and Liquids Operations. The North
American Crude Oil segment primarily purchases, gathers, transports and markets
crude oil. The Pipeline Operations segment operates approximately 7,200 miles of
active common carrier pipelines in 12 states. The Liquids Operations includes
the Morgan's Point Facility and the Mont Belvieu Facility. Effective June 1,
2002, we sold our West Coast refined products marketing operations. Effective
June 25, 2003, we signed a definitive agreement to sell all of our natural gas
liquids assets on the West Coast, which subsequently closed on October 1, 2003
and therefore the results of operations related to these assets previously
included in the West Coast Operations segment have been reclassified to
discontinued operations for all periods presented herein.
The accounting policies of the segments are the same as those described in
the summary of significant accounting policies as discussed in Note 2 included
in our Annual Report on Form 10-K for the year ended December 31, 2002. We
evaluate performance based on operating income (loss).
We account for intersegment revenue for our North American Crude Oil and
our Liquids Operations as if the sales were to third parties, that is, at
current market prices. Intersegment revenues for Pipeline Operations are based
on published pipeline tariffs.
FINANCIAL INFORMATION BY BUSINESS SEGMENT
(IN THOUSANDS)
NORTH CORPORATE
AMERICAN PIPELINE AND
CRUDE OIL OPERATIONS LIQUIDS OTHER (B) CONSOLIDATED
--------- ---------- ------- --------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2003
(SUCCESSOR COMPANY)
Revenue from external customers .......... $ 41,290 $ 4,051 $ 54,516 $ -- $ 99,857
Intersegment revenue (a) ................. (6,967) 22,849 89 (15,971) --
-------- ------- -------- -------- --------
Total operating revenue ............... 34,323 26,900 54,605 (15,971) 99,857
-------- ------- -------- -------- --------
Gross profit (loss) ...................... 2,718 5,074 (3,531) -- 4,261
-------- ------- -------- -------- --------
Operating income (loss) .................. (907) 2,730 (6,382) (4,664) (9,223)
Other expenses, net ...................... -- -- -- (9,554) (9,554)
-------- ------- -------- -------- --------
Income (loss) from continuing operations . (907) 2,730 (6,382) (14,218) (18,777)
-------- ------- -------- -------- --------
Depreciation and amortization ............ 661 4,948 576 7 6,192
-------- ------- -------- -------- --------
Impairment of assets ..................... -- -- 2,751 -- 2,751
-------- ------- -------- -------- --------
34
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NORTH CORPORATE
AMERICAN PIPELINE AND
CRUDE OIL OPERATIONS LIQUIDS OTHER (B) CONSOLIDATED
--------- ---------- ------- --------- ------------
THREE MONTHS ENDED SEPTEMBER 30, 2002
(PREDECESSOR COMPANY)
Revenue from external customers .......... $ 36,347 $ 6,553 $56,951 $ -- $ 99,851
Intersegment revenue (a) ................. (2,777) 20,021 -- (17,330) (86)
-------- ------- ------- -------- --------
Total operating revenue ............... 33,570 26,574 56,951 (17,330) 99,765
-------- ------- ------- -------- --------
Gross profit (loss) ...................... (815) 4,394 970 -- 4,549
-------- ------- ------- -------- --------
Operating income (loss) .................. (4,523) 1,087 784 (9,633) (12,285)
Other expenses, net ...................... -- -- -- (13,045) (13,045)
-------- ------- ------- -------- --------
Income (loss) from continuing operations . (4,523) 1,087 784 (22,678) (25,330)
-------- ------- ------- -------- --------
Depreciation and amortization ............ 1,381 5,171 1,370 823 8,745
-------- ------- ------- -------- --------
NORTH CORPORATE
AMERICAN PIPELINE AND
CRUDE OIL OPERATIONS LIQUIDS OTHER (B) CONSOLIDATED
--------- ---------- ------- --------- ------------
SEVEN MONTHS ENDED SEPTEMBER 30, 2003
(SUCCESSOR COMPANY)
Revenue from external customers .......... $ 98,549 $ 8,086 $ 115,303 $ -- $ 221,938
Intersegment revenue (a) ................. (16,030) 54,012 165 (38,170) (23)
-------- ------- --------- -------- ---------
Total operating revenue ................ 82,519 62,098 115,468 (38,170) 221,915
-------- ------- --------- -------- ---------
Gross profit (loss) ...................... 9,847 21,754 (16,588) -- 15,013
-------- ------- --------- -------- ---------
Operating income (loss) .................. 3,237 16,659 (19,568) (15,508) (15,180)
Other expenses, net ...................... -- -- -- (22,507) (22,507)
-------- ------- --------- -------- ---------
Income (loss) from continuing operations . 3,237 16,659 (19,568) (38,015) (37,687)
-------- ------- --------- -------- ---------
Depreciation and amortization ............ 1,516 10,644 1,337 15 13,512
-------- ------- --------- -------- ---------
Impairment of assets ..................... -- -- 2,751 -- 2,751
-------- ------- --------- -------- ---------
NORTH CORPORATE
AMERICAN PIPELINE AND
CRUDE OIL OPERATIONS LIQUIDS OTHER (B) CONSOLIDATED
--------- ---------- ------- --------- ------------
TWO MONTHS ENDED FEBRUARY 28, 2003
(PREDECESSOR COMPANY)
Revenue from external customers .......... $ 27,692 $ 4,287 $ 40,337 $ -- $72,316
Intersegment revenue (a) ................. (1,768) 11,828 -- (10,060) --
-------- ------- -------- -------- -------
Total operating revenue ................ 25,924 16,115 40,337 (10,060) 72,316
-------- ------- -------- -------- -------
Gross profit (loss) ...................... 4,231 5,450 (375) -- 9,306
-------- ------- -------- -------- -------
Operating income (loss) .................. 2,844 3,492 (446) (4,012) 1,878
Other income, net (c) .................... -- -- -- 61,970 61,970
-------- ------- -------- -------- -------
Income (loss) from continuing operations . 2,844 3,492 (446) 57,958 63,848
-------- ------- -------- -------- -------
Depreciation and amortization ............ 837 3,286 693 519 5,335
-------- ------- -------- -------- -------
35
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NORTH CORPORATE
AMERICAN PIPELINE AND
CRUDE OIL OPERATIONS LIQUIDS OTHER (B) CONSOLIDATED
--------- ---------- ------- --------- ------------
NINE MONTHS ENDED SEPTEMBER 30, 2002
(PREDECESSOR COMPANY)
Revenue from external customers ......... $ 126,138 $ 19,352 $147,028 $ 914 $ 293,432
Intersegment revenue (a) ................ (10,245) 62,991 -- (52,832) (86)
--------- -------- -------- -------- ---------
Total revenue ........................ 115,893 82,343 147,028 (51,918) 293,346
--------- -------- -------- -------- ---------
Gross profit (loss) ..................... 5,833 27,361 11,174 (443) 43,925
--------- -------- -------- -------- ---------
Operating income (loss) ................. (8,059) 20,354 10,526 (21,649) 1,172
Other expenses, net ..................... -- -- -- (36,423) (36,423)
--------- -------- -------- -------- ---------
Income (loss) from continuing operations (8,059) 20,354 10,526 (58,072) (35,251)
--------- -------- -------- -------- ---------
Depreciation and amortization ........... 4,299 15,548 4,092 2,583 26,522
--------- -------- -------- -------- ---------
Impairment of assets .................... 1,168 -- -- -- 1,168
--------- -------- -------- -------- ---------
TOTAL ASSETS AT SEPTEMBER 30, 2003 (D) .. 527,057 211,429 52,383 21,175 812,044
--------- -------- -------- -------- ---------
TOTAL ASSETS AT DECEMBER 31, 2002 (D) ... 475,889 286,769 60,666 50,110 873,434
--------- -------- -------- -------- ---------
(a) Intersegment revenue for North American Crude Oil and the Liquids
Operations is at prices comparable to those received from external
customers. Intersegment revenue for Pipeline Operations is primarily
transportation costs charged to North American Crude Oil for the
transport of crude oil at published pipeline tariffs.
(b) Corporate and Other includes results from the West Coast refined
products operations and intersegment eliminations.
(c) Includes a loss from reorganization items of $7.3 million, a net
gain on the discharge of debt of $131.6 million and a loss from
fresh start adjustments of $56.8 million.
(d) Corporate and Other includes assets related to the West Coast
discontinued operations.
36
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion should be read in conjunction with the Condensed
Consolidated Financial Statements and Notes contained in this report and the
Consolidated Financial Statements, Notes and Management's Discussion and
Analysis of Financial Condition and Results of Operations contained in our
Annual Report on Form 10-K for the year ended December 31, 2002.
INFORMATION REGARDING FORWARD-LOOKING INFORMATION
The statements in this Form 10-Q that are not historical information are
forward-looking statements. You can identify forward-looking statements by words
such as "anticipate," "believe," "estimate," "expect," "intend," "plan",
"forecast", "budget", "goal" or other words that convey the uncertainty of
future events or outcomes. Forward-looking statements are not guarantees of
future performance and involve significant risks and uncertainties. Actual
results may vary materially from those in the forward-looking statements as a
result of various factors. These risks, uncertainties and other factors include,
among others, the risk factors described herein as well as in "-Bankruptcy
Proceedings and Restructuring Plan," "Liquidity and Capital Resources," Item 5
and elsewhere in this Form 10-Q. Although we believe that our expectations
regarding future events are based on reasonable assumptions, we can give no
assurance that these are all the factors that could cause actual results to vary
materially or that our expectations regarding future developments will prove to
be correct. Each forward-looking statement speaks only as of the date of the
particular statement, and we undertake no obligation to publicly update or
revise any forward-looking statements.
OVERVIEW
There are a number of items that have occurred, which we continue to
address, that have had a significant effect on our financial condition, results
of operations and cash flows in the near term.
Factors Affecting Our Liquidity
- For the four month period ended September 30, 2003, we were in
breach of the covenants in our Letter of Credit Facility and Term
Loan and also breached the minimum inventory provision of the
Commodity Repurchase Agreement. We have obtained a waiver of these
violations from our lenders for the four month period ended
September 30, 2003 and for our expected breach of these covenants
for the four month period ended October 31, 2003. In addition, we
have agreed to reduce the lenders' maximum commitment under the
Letter of Credit Facility from $325 million to $290 million. See
"Credit Resources and Liquidity".
- We were in breach of the Minimum Consolidated EBIDA, Interest
Coverage and Prohibition on Indebtedness covenants in our Letter of
Credit Facility and Term Loan. In addition, we breached the minimum
inventory provision of the Commodity Repurchase Agreement. We were
unable to satisfy these covenants as of September 30, 2003 due to
the $4.6 million charge we took as described in Note 7 to the
Condensed Consolidated Financial Statements and the performance of
our business being less than we expected. Because the charge we
recorded in September 2003 will be included in the calculations of
the covenants for the remainder of 2003 and because the covenants
become increasingly stringent each month, we expect we will be in
default under our exit credit facilities at the end of each month at
least through December 31, 2003 unless our results of operations
show an unexpected significant improvement. Approximately $98
million of our indebtedness as of September 30, 2003 matures on
March 1, 2004, although we have an option to extend to August 30,
2004, and $75 million of our indebtedness matures on August 30,
2004. Any breaches of covenants, unless waived, could severely limit
our access to liquidity and result in our being required to repay
this debt as well as our senior notes.
- In addition, our Trade Receivables Agreement and Commodity
Repurchase Agreement mature on March 1, 2004 (although we have an
option to extend the maturity to August 30, 2004) and our Term Loan
and Letter of Credit Facility mature on August 30, 2004. As of
September 30, 2003, we had $23 million of outstanding borrowings
under our Trade Receivables Agreement, $75 million of outstanding
borrowings under our Commodity Repurchase Agreement, and $75 million
of borrowings under our Term Loan Agreement.
- We emerged from bankruptcy a highly leveraged company and have not
been able to significantly reduce our debt to date.
37
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Core Business Performance
We are experiencing weakness in our core business.
- Even though we have the capacity to issue letters of credit to
secure additional volumes, our pre-bankruptcy customers and business
partners have been less willing to do business with us than we
anticipated as a result of us being highly leveraged and having
shown no substantive improvement in our financial performance.
- Although we assumed that our marketing volumes would increase to
approximately 350,000 barrels per day by the end of 2003, our
marketing volumes were approximately 250,000 barrels per day in
September 2003, and we do not anticipate an appreciable increase in
volumes for the remainder of 2003. Our Restructuring Plan
anticipated a quick return of volume growth in 2003, which has not
occurred given the heightened sensitivity to credit risk in the
energy industry and our higher credit costs.
Third Quarter Charges
- As previously discussed in our quarterly filings in 2003, since
emerging from bankruptcy, the business and regulatory climate for
MTBE has continued to deteriorate dramatically and has adversely
affected our business. Our Restructuring Plan contemplated
earnings from our Liquids Operations in 2003; however, for the seven
months ended September 30, 2003, the Liquids Operations had an
operating loss of $20 million. We recently decided to phase out the
production of MTBE and, as a consequence, recorded charges for
severance costs of $1.8 million, impairment of long-lived assets of
$2.7 million and write-down of material and supplies of $2.3
million. See Note 6 to the Condensed Consolidated Financial
Statements.
- Measuring the physical volumes of crude oil linefill in certain of
the pipelines we operate in the West Texas and New Mexico area is
inherently difficult. Because these pipelines are operated under
very little pressure, unlike the vast majority of our other
pipelines, we cannot use traditional engineering based methods to
estimate the physical volumes in the system but instead have
utilized certain operational assumptions and topographical
information which take into consideration the measurement
limitations.
As a part of our pipeline integrity management program, we are in
the process of removing from service various pipelines we operate in
this area, some of which were acquired from Texas New Mexico
Pipeline Company in 1999. The actual physical volume of crude oil
linefill we removed from the line we have taken out of service
during the third quarter of 2003 was less than our estimate of
linefill volume for the applicable pipeline. Following this
discovery, we initiated a thorough review of our estimates for all
of our pipelines which are operated under very little pressure. We
also engaged the services of a third party consultant to review our
methodology of estimating linefill volumes. After completing this
review, we revised downward our estimates of the physical volume of
crude oil linefill in certain of our pipelines by approximately
170,000 barrels. As a result, we recorded a charge of $4.6 million
to reflect our change in estimate of physical linefill volumes based
on September 30, 2003 market prices. We have recorded the charge in
cost of sales in the Condensed Consolidated Statement of Operations.
38
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- We recently identified control deficiencies with inventory and
accounts payable reconciliation procedures in our pipelines and
liquids operations. In order to address these issues, we designed
and implemented additional procedures to provide reasonable
assurance that these control deficiencies did not lead to a material
misstatement in our consolidated financial statements. Related to
this matter, we recorded charges in the third quarter of 2003 of
$1.8 million (the impact to prior period financial statements was
not material). The adjustment, properly recorded in the respective
periods, would have increased (decreased) income from continuing
operations by $(1.6) million, none and $(0.4) million for the years
ended December 31, 2002, 2001 and 2000.
Options for Achieving Significant Debt Reduction
We will likely not be able to achieve volume and earnings growth without
reducing our debt by at least $100 million. We are currently considering the
following options to achieve our debt reduction:
- Pursuing the sale of additional assets. During the period from March
2003 to October 2003, we sold assets for an aggregate consideration
of $26.2 million. We used approximately $25 million of the net
proceeds to pay down amounts outstanding under the Commodity
Repurchase Agreement subsequent to September 30, 2003. We will
continue to pursue asset sales and use the proceeds, if any, to
reduce our debt levels.
- Seeking additional equity. We are evaluating alternatives for
raising additional equity capital, both publicly and privately. Our
efforts to raise additional equity will be limited by the following
factors, among others:
- Under the terms of our LLC Agreement, we are prohibited from
issuing additional equity without a vote of two-thirds of our
unitholders.
- We are unable to issue equity in a public offering or in an
offering pursuant to Regulation D of the Securities Act until
we have satisfied the requirement to have three years of
audited financial statements by completing an audit of our
financial statements for the year ending December 31, 2003.
- We have recognized income from our settlement with Enron and
discharge of indebtedness from our bankruptcy in excess of 10%
of our gross income. We concluded, as disclosed in our Third
Amended Disclosure Statement, that this income constituted
"qualifying income" under the Internal Revenue Code, although
the matter was not free from doubt. We believe that we may not
be able to access the capital markets without a higher degree
of certainty of whether this income is qualifying income and
therefore we have decided to seek a private letter ruling from
the Internal Revenue Service.
Due to the absence of volume growth in our core business and the
amount of additional equity required to achieve debt reduction of at
least $100 million, if we are able to issue additional equity, we
will be required to do so at prices significantly less than the
current trading prices of our units and warrants.
- Conversion of existing debt. We are currently evaluating the
feasibility of our lenders converting a portion of their debt to
equity.
39
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- Evaluating strategic alternatives. If we are unsuccessful in
achieving our debt reduction within a reasonable time period, we
will consider other strategic alternatives, which could include a
sale of the company.
The condensed consolidated financial statements have been prepared
assuming we will continue as a going concern, which contemplates the
realization of assets and settlement of liabilities in the normal course of
business. The factors discussed above raise substantial doubt about our ability
to continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
We face significant risks in successfully implementing our Restructuring
Plan, some of which are described in Item 5 of Part II of this report.
NAME CHANGE
On October 1, 2003, we changed our name from EOTT Energy LLC to Link
Energy LLC ("Link LLC"). In connection with our name change, we have also made
comparable changes to the names of several subsidiaries.
NEW NAME FORMER NAME
- -------- -----------
Link Energy Limited Partnership EOTT Energy Operating Limited Partnership
Link Energy Pipeline Limited Partnership EOTT Energy Pipeline Limited Partnership
Link Energy Canada Limited Partnership EOTT Energy Canada Limited Partnership
Link Energy Finance Corp. EOTT Energy Finance Corp.
Link Energy General Partner LLC EOTT Energy General Partner, L.L.C.
Link Energy Canada Ltd. EOTT Energy Canada Management Ltd.
Unless the context otherwise requires, the term "we", "our", "us" and "Link"
refer to Link Energy LLC and its four affiliated limited partnerships, Link
Energy Finance Corp. and Link Energy General Partner LLC, and for periods prior
to our emergence from bankruptcy in March 2003, such terms as "EOTT" refer to
EOTT Energy Partners, L.P. and its sole general partner, EOTT Energy Corp. as
well as the Subsidiary Entities.
BANKRUPTCY PROCEEDINGS AND RESTRUCTURING PLAN
On October 8, 2002, EOTT Energy Partners, L.P. (the "MLP"), our four
affiliated operating limited partnerships, EOTT Energy Finance Corp. and EOTT
Energy General Partner, L.L.C. (the "Subsidiary Entities") filed pre-negotiated
voluntary petitions for reorganization under Chapter 11 of the United States
Bankruptcy Code (the "EOTT Bankruptcy"). The filing was made in the United
States Bankruptcy Court for the Southern District of Texas, Corpus Christi
Division (the "EOTT Bankruptcy Court"). Additionally, EOTT Energy Corp. (the
"General Partner") filed a voluntary petition for reorganization under Chapter
11 on October 21, 2002 in the EOTT Bankruptcy Court in order to join in the
voluntary, pre-negotiated bankruptcy proceedings filed on October 8, 2002. On
October 24, 2002, the EOTT Bankruptcy Court administratively consolidated for
distribution purposes the General Partner's bankruptcy filing with the
previously filed cases. We operated as debtors-in-possession under the
Bankruptcy Code, which means we continued to remain in possession of our assets
and properties and continued our day-to-day operations.
The EOTT Bankruptcy Court confirmed our Third Amended Joint Chapter 11
Plan of Reorganization, as supplemented ("Restructuring Plan") on February 18,
2003, and it became effective on March 1, 2003. We emerged from bankruptcy as a
limited liability company structure named EOTT Energy LLC ("EOTT LLC"), which
became the successor registrant to the MLP. The consummation of our
Restructuring Plan and the level of success of our Restructuring Plan will
materially affect matters described in this report. For a discussion of the
Restructuring Plan, see Note 2 to the Condensed Consolidated Financial
Statements.
As of February 28, 2003 (the date chosen for accounting purposes), we
adopted fresh start reporting in accordance with the American Institute of
Certified Public Accountants Statement of Position 90-7, "Financial Reporting by
Entities in Reorganization Under the Bankruptcy Code" ("SOP 90-7"). Under fresh
start reporting, we adjusted our assets and liabilities to their fair values as
of February 28, 2003. Our reorganization
40
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
value of approximately $856 million was determined based on discounted cash
flow, comparable transaction and capital market comparison analyses. The
valuation was based upon a number of estimates and assumptions, which are
inherently subject to significant uncertainties and contingencies beyond our
control. Accordingly, there can be no assurance that the valuations will be
realized, and actual results could vary significantly. See Note 3 to our
Condensed Consolidated Financial Statements.
As a result of the application of fresh start reporting under SOP 90-7,
our financial results for the quarter ended March 31, 2003 include two different
bases of accounting and accordingly, the financial condition, operating results
and cash flows of the Successor Company and the Predecessor Company have been
separately disclosed. For purposes of this Management's Discussion and Analysis
of Financial Condition and Results of Operations and the financial statements
contained elsewhere herein, references to the "Predecessor Company" are
references to us for periods through February 28, 2003 (the last day of the
calendar month in which we emerged from bankruptcy) and references to the
"Successor Company" are references to us for periods subsequent to February 28,
2003.
DESCRIPTION OF BUSINESS
Through our four operating limited partnerships, Link Energy Limited
Partnership, Link Energy Canada Limited Partnership, Link Energy Pipeline
Limited Partnership, and EOTT Energy Liquids, L.P., we purchase, gather,
transport, store, process and resell crude oil, refined petroleum products,
natural gas liquids ("NGL") and other related products. Our principal business
segments are our North American Crude Oil Operations, our Pipeline Operations
and our Liquids Operations. Our gathering and marketing operations are
characterized by large volume and narrow profit margins on purchase and sale
transactions and the absolute price levels for crude oil do not necessarily bear
a relationship to gross profit. See Note 15 to our Consolidated Financial
Statements for certain financial information by business segment.
ASSET DISPOSITIONS/REORGANIZATION
Sale of West Coast Assets
Effective June 25, 2003, we signed a definitive agreement to sell all of
the assets comprising our natural gas gathering, processing, natural gas liquids
fractionation, storage and related trucking and distribution facilities located
on the West Coast. A sale of these assets to a third party had been one of the
options considered by us since we emerged from bankruptcy. The sales price for
the assets exclusive of inventory was $9.9 million. The closing occurred on
October 1, 2003, and $9.0 million of the net proceeds from the sale were used to
pay down amounts outstanding under the Commodity Repurchase Agreement.
Sale of Certain Marketing and Transportation Assets
On October 1, 2003, we sold certain crude oil marketing and transportation
assets in the Arkansas, Louisiana and Texas ("ArkLaTex") area to Plains
Marketing L.P. and All American Pipeline, L.P., a wholly owned subsidiary of
Plains Resources, Inc.. The sales price of these assets, including linefill, was
approximately $17 million. Subsequent to closing, $16.2 million of the net
proceeds from the sale were used to pay down amounts outstanding under the
Commodity Repurchase Agreement. The gain on the sale of these assets is
estimated to be approximately $11 million and will be recorded in the fourth
quarter of 2003. The long-lived assets to be disposed of were historically
presented in the North American Crude Oil and Pipeline Operations operating
segment.
Liquids Operations-Phase Out of MTBE Production
Over the past year, we considered several alternatives to the
deteriorating business and regulatory climate for MTBE, including a sale of the
Liquids Operations. Effective October 1, 2003, pursuant to a
41
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
previously announced plan to reduce our Liquids Operations, we began to phase
out our methyl tertiary-butyl ether ("MTBE") production at the Morgan's Point
Facility. The decision to cease production of MTBE and end our financial
exposure to the MTBE market was made after discussions with a third party
regarding a possible sale of the Liquids Operations terminated unsuccessfully.
During the seven months ended September 30, 2003, the Liquids Operations had an
operating loss of $20 million. We will continue to operate certain liquids
processing, storage and marketing facilities at the Morgan's Point Facility,
which will be integrated with our existing natural gas liquids storage and
transportation operations at Mont Belvieu. Activities associated with the phase
out of MTBE production are expected to be completed by year end 2003.
In connection with the phase out of MTBE production, the following charges
were recorded in September 2003 (in thousands):
Severance Cost........................................... $1,832
Impairment of assets..................................... $2,751
Material and supplies write-down......................... $2,280
The severance costs were accrued pursuant to our pre-existing severance
plan in accordance with Statement of Financial Accounting Standards ("SFAS") No.
112, "Employers' Accounting for Post Employment Benefits - an Amendment of FASB
Statements No. 5 and 43" and are recorded in operating expenses in the Condensed
Consolidated Statement of Operations.
The impairment charges reflect adjustments to the carrying values of
long-lived assets used in the MTBE manufacturing operations to reflect their
fair values. Impairment charges are included in impairment of assets in the
Condensed Consolidated Statement of Operations.
The charge for materials and supplies represents an adjustment to the
carrying values of inventory items to reflect their net realizable values. The
market for surplus MTBE related materials and supplies has been severely
impacted by recent plant shut downs by competitors. The charge to adjust the
carrying values of materials and supplies is included in operating expenses in
the Condensed Consolidated Statement of Operations.
RESULTS OF OPERATIONS
The following review of our results of operations and financial condition
should be read in conjunction with our Condensed Consolidated Financial
Statements and Notes thereto appearing elsewhere in this report. As discussed
above, we emerged from bankruptcy and adopted fresh start reporting pursuant to
SOP 90-7 effective as of February 28, 2003. Accordingly, the financial
statements of the Successor Company and Predecessor Company are not comparable
in total; however, operating revenues, gross profit and operating income (loss)
(excluding changes in depreciation and amortization where noted) and interest
and financing costs (except where noted) are comparable.
For purposes of this Management's Discussion and Analysis, we have
supplementally combined actual operating results for the Successor Company for
the seven months ended September 30, 2003 and for the Predecessor Company for
the two months ended February 28, 2003 in order to enhance a reader's
understanding of our results of operations. Ordinarily, such comparison would
not be presented under SOP 90-7. However, since the reorganization and the
adoption of fresh start reporting only impacted our depreciation and
amortization, as a result of the change in the carrying amount of our long-lived
assets, and our interest expense, primarily through the discharge of debt
related to our senior notes, comparison of our results of operations pre- and
post-reorganization is useful once a reader understands the impact on
depreciation and amortization expense and interest and financing costs.
Variations resulting from reorganization items, net gain on discharge of debt
and fresh start adjustments will be discussed separately where significant.
42
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Overview of Results of Operations
We reported a net loss of $38.2 million for the seven months ended
September 30, 2003, which was primarily related to operating losses from our
Liquids Operations and high financing costs. The operating losses of $19.6
million from our Liquids Operations were primarily attributable to: (1) higher
butane and methanol feedstock costs as well as lower MTBE prices; (2)
operational problems at our Morgan's Point Facility, which required
unanticipated downtime and additional repair expenses of approximately $1.9
million; (3) a lower of cost or market inventory adjustment of approximately
$3.0 million in the first quarter due to the volatility of the commodities
market and the higher than normal levels of inventory as a result of the
unanticipated downtime; (4) charges associated with the phase out of MTBE
production at Morgan's Point including severance ($1.8 million), impairment of
long-lived assets ($2.7 million), and write-down of materials and supplies ($2.3
million); and (5) charges of $1.7 million for inventory and accounts payable
reconciliation adjustments. In addition, we reported $3.2 million of operating
income from our crude oil marketing activities due to more favorable market
conditions and lower operating expenses, $16.7 million of operating income from
our Pipeline Operations, which includes a $4.6 million charge related to a
downward revision of our estimate of physical crude oil linefill in certain
pipelines we operate in West Texas and New Mexico, and $22.5 million of interest
and related charges.
We reported net income of $60.3 million for the two months ended February
28, 2003. Net income for the two months ended February 28, 2003 is primarily
attributable to: (1) reorganization expenses of $7.3 million related to legal
and professional fees related to the bankruptcy proceedings; (2) a net gain on
the discharge of debt of $131.6 million in connection with the Restructuring
Plan; (3) fresh start adjustments of $56.8 million resulting from adjusting
assets and liabilities to fair value in accordance with SOP 90-7; (4) losses
from the cumulative effect of accounting changes related to the adoption of
Emerging Issues Task Force ("EITF") 02-03 and Statement of Financial Accounting
Standards ("SFAS") 143; (5) operating losses of $0.4 million from our Liquids
Operations primarily due to higher prices for normal butane and methanol
feedstocks as well as lower MTBE prices; (6) operating income of $6.3 million
from our crude oil marketing and transportation activities; and (7) interest and
related charges of $5.6 million.
43
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO THREE MONTHS ENDED SEPTEMBER
30, 2002
The following table contains selected financial data for our business for
the three months ended September 30, 2003 and 2002 (in millions):
SUCCESSOR COMPANY | PREDECESSOR COMPANY
THREE MONTHS ENDED | THREE MONTHS ENDED
SEPTEMBER 30, 2003 | SEPTEMBER 30, 2002
------------------ | ------------------
|
Operating Revenues: |
|
N.A. CRUDE OIL............................... $ 34.3 | $ 33.6
Pipeline Operations.......................... 26.9 | 26.6
Liquids Operations........................... 54.6 | 56.9
Intersegment Eliminations/Other.............. (16.0) | (17.3)
------------------ | -------------------
Total.................................. $ 99.8 | $ 99.8
================== | ===================
|
Gross Profit: |
|
N.A. Crude Oil(1)............................ $ 2.7 | $ (0.8)
Pipeline Operations.......................... 5.1 | 4.4
Liquids Operations........................... (3.5) | 1.0
Corporate and Other.......................... -- | --
------------------ | -------------------
Total.................................. $ 4.3 | $ 4.6
================== | ===================
|
Operating Income (Loss): |
|
N.A. Crude Oil............................... $ (0.9) | $ (4.5)
Pipeline Operations.......................... 2.8 | 1.1
Liquids Operations........................... (6.4) | 0.8
Corporate and Other.......................... (4.7) | (9.7)
------------------ | -------------------
Total.................................. $ (9.2) | $ (12.3)
================== | ===================
|
Interest and Financing Costs....................... $ 9.7 | $ 12.9
================== | ===================
Income from Discontinued Operations................ $ (1.3) | $ (1.3)
================== | ===================
(1) Includes intersegment transportation costs from our Pipeline
Operations segment for the transport of crude oil at published
pipeline tariffs and purchases of crude oil inventory from our
Pipeline Operations segment. Intersegment transportation costs and
net purchases of crude oil inventory from our Pipeline Operations
segment were $22.8 million and $20.0 million for the three months
ended September 30, 2003, and 2002, respectively.
Operating loss was $9.2 million in the three months ended September 30,
2003 compared to an operating loss of $12.3 million for the same period in 2002.
Interest and financing costs decreased $3.2 million as compared to 2002. The
following details the primary factors affecting operating income, interest and
financing costs and income from discontinued operations.
North American Crude Oil
Operating loss from our North American Crude Oil business segment was $0.9
million in the third quarter of 2003 compared to an operating loss of $4.5
million for the same period in 2002. The primary factors that affected gross
profit and operating income in this segment during the three months ended
September 30, 2003 and 2002 were:
- P+ averaged $4.03 per barrel in the third quarter of 2003 compared
to $3.44 per barrel for the same period in 2002. P+ is the forward
price spread between field postings and liquid market locations.
Gross profit on approximately 20% of our purchases of lease crude
oil are impacted by P+. The price difference between West Texas
Intermediate and West Texas Sour
44
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
crude oil ("WTI/WTS differential") was $2.44 per barrel in the third
quarter of 2003 versus $1.03 per barrel in the same period in 2002.
The larger the WTI/WTS differential, the higher our gross profit.
Approximately 5% of our purchases of lease crude oil are impacted by
the WTI/WTS differential.
- Crude oil lease volumes averaged 248,000 barrels per day ("bpd") in
the third quarter of 2003 compared to 267,000 bpd in the third
quarter of 2002. Total sales volumes averaged 501,000 bpd in the
third quarter of 2003 compared to 456,000 bpd in the third quarter
of 2002. The reduction in marketing activities and lease volumes
purchased reflects the loss of certain lease and spot barrels as a
result of increased requests for letters of credit from our
suppliers and other factors resulting from Enron's bankruptcy and
our bankruptcy. Although crude oil lease volumes have increased
since year end 2002, lease volumes have remained relatively constant
since the first quarter of 2003 and have not increased each quarter
as contemplated in the Restructuring Plan.
- Gross profit per lease barrel was $0.12 per barrel in the third
quarter of 2003 compared to a $0.03 per barrel loss in the third
quarter of 2002 due to more favorable market conditions, the
renegotiation or termination of low margin per barrel contracts
during 2002 and 2003 as a part of our Restructuring Plan initiatives
and lower operating expenses.
- In the second quarter of 2003, we received contaminated crude oil
from one of our suppliers. We incurred an additional $0.2 million of
costs related to the contaminated crude during the third quarter of
2003. We intend to pursue all available remedies to recover our
costs resulting from the contamination and have instituted legal
action against the supplier.
- In the third quarter of 2003, we reversed an accrued liability of
approximately $2 million, that is no longer required, related to a
pipeline imbalance obligation on a third party pipeline that
originally occurred in 1999.
- Total expenses decreased approximately $2.8 million in the third
quarter of 2003 primarily due to lower employee related expenses of
$0.8 million, lower safety and environmental expenses of $0.1
million, severance costs of $0.7 million recorded in the third
quarter of 2002, and lower depreciation of $0.7 million. The
decrease in depreciation is attributable to the reduction in
carrying value of assets resulting from fresh start reporting.
Pipeline Operations
Operating income from our Pipeline Operations was $2.8 million in the
third quarter of 2003 compared to $1.1 million for the same period in 2002. The
primary factors that affected this business during the three months ended
September 30, 2003 and 2002 were:
- Revenues from our Pipeline Operations were relatively flat. Average
volumes transported in the third quarter of 2003 were 387,000 bpd
compared to 391,000 bpd in the third quarter of 2002. Although
volumes transported are relatively flat in the comparable periods,
our revenues have been enhanced due to our ability to effectively
manage the different qualities of crude oil in our pipelines.
Revenue per barrel was $0.76 per barrel in the third quarter of 2003
compared to $0.74 per barrel in the third quarter of 2002.
- Total expenses for our Pipeline Operations decreased approximately
$1.4 million. The primary factors affecting total expenses were:
45
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- Lower safety and environmental expenses of $4.0 million, lower
employee related costs of $1.0 million, lower operating costs
of $0.7 million, lower depreciation of $0.2 million, and
severance costs of $0.3 million recorded in the third quarter
of 2002. The decrease in depreciation is attributable to the
reduction in carrying value of assets resulting from fresh
start reporting.
- Higher cost of sales of $4.9 million due primarily to the $4.6
million charge related to the downward revision of our
estimate of physical crude oil linefill volumes in certain
pipelines we operate in West Texas and New Mexico.
Liquids Operations
Operating losses from our Liquids Operations were $6.4 million in the
third quarter of 2003 compared to operating income of $0.8 million in the same
period in 2002. The primary factors that affected our Liquids Operations during
the three months ended September 30, 2003 and 2002 were:
- MTBE equivalent product margin per gallon was relatively unchanged
at $0.21 per gallon in the third quarter of 2003 and 2002.
- MTBE equivalent sales volume in the third quarter of 2003 was 12,200
bpd compared to the third quarter of 2002 sales of 14,900 bpd.
- Total expenses from our Liquids Operations increased approximately
$3.8 million. The primary factors affecting expenses were:
- In connection with the phase out of MTBE production, we
recorded in September 2003 severance expenses of $1.8 million,
an impairment of long-lived assets used in the MTBE operations
of $2.7 million and a reduction in the carrying value of
materials and supplies of $2.3 million.
- Lower depreciation and amortization costs of $0.8 million,
lower employee related costs of $0.7 million and lower
operating costs of $0.6 million, as compared to the third
quarter of 2002. The decrease in depreciation and amortization
is attributable to the fourth quarter 2002 impairment.
- In connection with the inventory and accounts payable
reconciliations completed in the third quarter of 2003, we recorded
a $1.7 million charge to cost of sales.
Corporate and Other
Corporate and other costs decreased approximately $5.0 million in the
third quarter of 2003 due to lower legal and severance costs (down $1.9 million
and $0.5 million respectively) as well as lower depreciation expense (down $0.8
million) and a $1.3 million gain due to a settlement with Pacific Marketing and
Transportation LLC ("Pacific"). In 2001, we recorded a liability in connection
with the sale of our West Coast crude oil assets to Pacific, and in August 2003,
we negotiated the settlement and release of any remaining obligations related to
the sale for a payment to Pacific of $0.2 million. Legal and severance costs
were higher in 2002 as a result of our change in attorneys associated with the
Enron bankruptcy, and costs incurred in preparation for our Chapter 11
bankruptcy filing. The decrease in depreciation is attributable to the reduction
in carrying value of assets resulting from fresh start reporting.
46
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Interest and Financing Costs
The primary factors that affected interest and financing costs for the
three months ended September 30, 2003 and 2002 were:
- Facility fees on the credit facilities and term loan with Standard
Chartered, SCTS and Lehman were $1.0 million lower during the third
quarter of 2003 compared to the third quarter of 2002.
- Interest on working capital loans was $0.2 million lower during the
third quarter of 2003 compared to the third quarter of 2002
resulting from lower average debt outstanding. Amounts outstanding
under financing facilities were $98 million and $125 million at
September 30, 2003 and 2002, respectively. Borrowing rates under the
SCTS financing facilities range from LIBOR plus 75 basis points to
LIBOR plus 250 basis points (prior to the bankruptcy) to LIBOR plus
300 basis points (through August 29, 2003) and LIBOR plus 700 basis
points (effective August 30, 2003) under the exit facilities.
- Letter of credit costs were $2.1 million in the third quarter of
2003 under the credit facilities with Standard Chartered as compared
to $2.0 million for the third quarter of 2002. Higher letter of
credit usage resulted from our bankruptcy and higher crude oil
prices. Letter of credit fees averaged 3.0%.
- Interest on the Term Loan totaled $1.9 million in the third quarter
of 2003. The Term Loan was entered into in connection with our DIP
Facilities in October 2002 and refinanced under the exit credit
facilities in February 2003.
- Interest expense on the 9% senior notes issued March 1, 2003 totaled
$2.8 million during the third quarter of 2003. Interest on the 11%
senior notes was $6.5 million in the third quarter of 2002. The
decrease in interest expense is a result of the discharge of debt
related to our $235 million of 11% senior notes in connection with
our bankruptcy.
Discontinued Operations
We had an operating loss of $1.3 million in the third quarter of 2003 from
our discontinued West Coast Operations, which is comparable to the same period
in 2002.
47
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 2003 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
2002
The following table contains selected financial data for our business for
the seven months ended September 30, 2003, two months ended February 28, 2003,
supplemental information for the nine months ended September 30, 2003 and for
the nine months ended September 30, 2002 (in millions):
SUCCESSOR COMPANY | PREDECESSOR COMPANY PREDECESSOR COMPANY
----------------- | ------------------- SUPPLEMENTAL -------------------
SEVEN MONTHS ENDED | TWO MONTHS ENDED NINE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003 SEPTEMBER 30, 2003(1) SEPTEMBER 30, 2002
------------------ | ------------------- --------------------- -------------------
|
Operating Revenues: |
|
N.A. Crude Oil........................ $ 82.5 | $ 25.9 $ 108.4 $ 115.9
Pipeline Operations................... 62.1 | 16.1 78.2 82.4
Liquids Operations.................... 115.5 | 40.3 155.8 147.0
Intersegment Eliminations/Other....... (38.2) | (10.0) (48.2) (51.9)
------------------ | ------------------- --------------------- -------------------
Total........................... $ 221.9 | $ 72.3 $ 294.2 $ 293.4
================== | =================== ===================== ===================
|
Gross Profits: |
|
N.A. Crude Oil (2).................... $ 9.8 | $ 4.3 $ 14.1 $ 5.8
Pipeline Operations................... 21.8 | 5.4 27.2 27.3
Liquids Operations.................... (16.6) | (0.4) (17.0) 11.2
Corporate and Other................... -- | -- -- (0.4)
------------------ | ------------------- --------------------- -------------------
Total........................... $ 15.0 | $ 9.3 $ 24.3 $ 43.9
================== | =================== ===================== ===================
|
Operating Income (Loss): |
|
N.A. Crude Oil........................ $ 3.2 | $ 2.9 $ 6.1 $ (8.1)
Pipeline Operations................... 16.7 | 3.5 20.2 20.4
Liquids Operations.................... (19.6) | (0.4) (20.0) 10.5
Corporate and Other................... (15.5) | (4.1) (19.6) (21.6)
------------------ | ------------------- --------------------- -------------------
Total........................... $ (15.2) | $ 1.9 $ (13.3) $ 1.2
================== | =================== ===================== ===================
|
Interest and Finance Costs............... $ 22.5 | $ 5.6 $ 28.1 $ 36.5
================== | =================== ===================== ===================
Reorganization Items, Net Gain on |
Discharge of Debt and Fresh Start |
Adjustments.............................. $ -- | $ 67.5 $ 67.5 $ --
================== | =================== ===================== ===================
|
Income from Discontinued Operations...... $ (0.5) | $ 0.4 $ (0.1) $ (1.0)
================== | =================== ===================== ===================
Cumulative Effect of Accounting Changes.. $ -- | $ (4.0) $ (4.0) $ --
================== | =================== ===================== ===================
(1) We have combined actual operating results for the Successor Company for
the seven months ended September 30, 2003 and for the Predecessor Company
for the two months ended February 28, 2003 in order to facilitate a
comparative analysis to the prior fiscal period.
(2) Includes intersegment transportation costs from our Pipeline Operations
segment for the transport of crude oil at published pipeline tariffs and
purchases of crude oil inventory from our Pipeline Operations segment.
Intersegment transportation costs and net purchases of crude oil inventory
from our Pipeline Operations segment were $65.8 million and $63.0 million
for the nine months ended September 30, 2003, and 2002, respectively.
Operating loss was $13.3 million in the first nine months of 2003 compared
to operating income of $1.2 million for the same period in 2002. Interest and
financing costs decreased $8.4 million as compared to 2002. The following
details the primary factors affecting operating income, interest and financing
costs, reorganization and fresh start adjustments, the cumulative effect of
accounting changes and income from discontinued operations.
North American Crude Oil
Operating income from our North American Crude Oil business segment was
$6.1 million in the nine months ended September 30, 2003 compared to an
operating loss of $8.1 million for the same period in 2002.
48
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
The primary factors that affected gross profit and operating income in this
segment for the nine months ended September 30, 2003 and 2002 were:
- P+ averaged $4.26 per barrel in the first nine months of 2003
compared to $3.18 per barrel in the same period in 2002. The WTI/WTS
differential was $2.66 per barrel in the first nine months of 2003,
versus $1.26 per barrel in the same period in 2002.
- Crude oil lease volumes averaged 249,000 barrels per day
("bpd") in the first nine months of 2003 compared to 288,000
bpd in the first nine months of 2002. Total sales volumes
averaged 475,000 bpd in the first nine months of 2003 compared
to 554,000 bpd in the first nine months of 2002. The reduction
in marketing activities and lease volumes purchased reflects
the loss of certain lease and spot barrels as a result of
increased requests for credit from our suppliers and other
factors resulting from Enron's bankruptcy and our bankruptcy
as well as the overall credit environment in the energy
industry.
- Gross profit per lease barrel was $0.21 per barrel in the
first nine months of 2003 compared to $0.07 per barrel in the
first nine months of 2002 due to more favorable market
conditions, low margin per barrel contracts renegotiated or
terminated during 2002 and 2003 as a part of our Restructuring
Plan initiatives and lower operating expenses.
- In the second quarter of 2003, we received contaminated crude
oil from one of our suppliers. We incurred a $1.2 million loss
on the sale of the contaminated crude as well as we have
incurred approximately $0.4 million of costs. We intend to
pursue all available remedies to recover our costs resulting
from the contamination and have pursued legal action against
the supplier.
- Total expenses decreased approximately $13.4 million due to
lower employee related expenses of $6.3 million, lower
operating expenses of $0.8 million (primarily due to the
significant decline in lease volumes transported by our fleet
operations), lower safety and environmental expenses of $0.8
million, lower depreciation of $1.9 million, severance costs
of $0.7 million recorded in the third quarter of 2002 and an
impairment charge of $1.2 million related to a marine facility
in 2002. The decrease in depreciation is attributable to the
reduction in carrying value of assets resulting from fresh
start reporting.
Pipeline Operations
Operating income from our Pipeline Operations was $20.2 million in the
first nine months of 2003 compared to operating income of $20.4 million for the
same period in 2002. The primary factors that affected this business in the nine
months ended September 30, 2003 and 2002 were:
- Revenues from our Pipeline Operations decreased $4.0 million
reflecting reduced lease volumes transported by our North American
Crude Oil business segment offset by our ability to enhance revenues
by effectively managing the different qualities of crude oil in our
pipelines. Average volumes transported in the first nine months of
2003 were 396,000 bpd compared to 418,000 bpd in the first nine
months of 2002. Revenue per barrel was $0.72 per barrel in the first
nine months of 2003 and 2002.
- Total expenses for our Pipeline Operations decreased approximately
$4.0 million. The primary factors affecting total expenses are:
- Lower employee expenses of $1.4 million, lower operating costs
of $1.4 million, lower depreciation of $1.6 million, an $0.8
million reduction in our litigation accrual
49
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
due to the settlement/resolution of claims made with respect
to environmental contingencies during our bankruptcy, lower
safety and environmental costs of $2.2 million and severance
costs of $0.3 million recorded in 2002. The decrease in
depreciation is attributable to the reduction in carrying
value of assets resulting from fresh start reporting.
- Higher cost of sales of $4.0 million primarily due to the $4.6
million charge related to the downward revision of our
estimate of physical crude oil linefill volumes in certain
pipelines we operate in West Texas and New Mexico.
Liquids Operations
Operating losses from our Liquids Operations were $20.0 million in the
first nine months of 2003 compared to operating income of $10.5 million in the
same period in 2002. The primary factors that affected our Liquids Operations in
the nine months ended September 30, 2003 and 2002 were:
- MTBE equivalent product margin per gallon declined from $0.27 per
gallon in the first nine months of 2002 to $0.10 per gallon in the
first nine months of 2003 due to higher prices for normal butane and
methanol feedstocks. Our feedstock prices increased due to upward
pressure from crude oil and natural gas markets, while the price for
MTBE was under pressure due to the phase out of MTBE by certain
California refiners.
- MTBE equivalent sales volume in the first nine months of 2003 was
12,100 bpd compared to sales of 13,300 bpd during the same period in
2002. Production in both years was curtailed due to facility
maintenance normally conducted in the first quarter of the year. In
2003, we discovered operational problems at the Morgan's Point
Facility that required additional repair expenses and unanticipated
downtime.
- During March 2003, the unexpected downtime of the Morgan's Point
Facility resulted in a build of feedstock inventories beyond our
operational requirements. Due to the volatility in the commodities
market and the higher than normal levels of inventory, we recorded a
lower of cost or market adjustment of approximately $3.0 million at
the end of the first quarter of 2003.
- In the third quarter of 2003, we recorded a $1.7 million charge in
cost of sales related to the inventory and accounts payable
reconciliations.
- Total expenses from Liquids Operations increased approximately $3.3
million. The primary factors affecting expenses are:
- In connection with the phase out of MTBE production, we
recorded in September 2003 severance expenses of $1.8 million,
an impairment of long-lived assets used in the MTBE operations
of $2.7 million and a reduction in the carrying value of
materials and supplies of $2.3 million.
- Lower depreciation and amortization costs of $2.1 million, and
lower employee costs of $1.3 million. The decrease in
depreciation and amortization is attributable to the fourth
quarter 2002 impairment.
50
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Corporate and Other
Corporate and other costs decreased approximately $2.0 million, which
principally reflects lower employee costs of $1.4 million, lower severance costs
of $0.7 million, lower depreciation of $1.9 million and a $1.3 million gain due
to the settlement with Pacific discussed previously. These amounts were offset
by higher legal costs of $0.5 million primarily related to the Kniffen Estates
litigation, higher insurance costs of $0.6 million, recovery from the settlement
of an insurance claim for $1.1 million and a gain on the sale of NYMEX seats for
$1.3 million in 2002. The decrease in depreciation is attributable to the
reduction in carrying value of assets resulting from fresh start reporting.
Reorganization Items, Net Gain on Discharge of Debt and Fresh Start Adjustments
The reorganization items of $7.3 million are primarily comprised of legal
and professional fees related to the bankruptcy proceedings. The net gain on the
discharge of debt of $131.6 million was recorded net of the 9% senior notes and
limited liability company units issued to the creditors upon emergence from
bankruptcy. The fresh start adjustments of $56.8 million result from adjusting
assets and liabilities to fair value.
Interest and Financing Costs
The primary factors that affected interest and financing costs for the
nine months ended September 30, 2003 and 2002 were:
- Facility fees on the credit facilities and term loan with Standard
Chartered, SCTS and Lehman were $2.0 million lower during the first
nine months of 2003 compared to the first nine months of 2002.
- Interest on working capital loans was $1.1 million lower in the
first nine months of 2003 compared to the first nine months of 2002
as a result of lower average debt outstanding. Amounts outstanding
under financing facilities were $98 million and $125 million at
September 30, 2003 and 2002, respectively. Borrowing rates ranged
from LIBOR plus 75 basis points to LIBOR plus 250 basis points
(prior to the bankruptcy) to LIBOR plus 300 basis points (through
August 29, 2003) and LIBOR plus 700 basis points (effective August
30, 2003) under the exit facilities.
- Letter of credit costs were $6.7 million in the first nine months of
2003 under the credit facilities with Standard Chartered as compared
to $4.5 million for the first nine months of 2002. Higher letter of
credit usage resulted from our bankruptcy and higher crude oil
prices. Letter of credit fees averaged 3.0%.
- Interest on the Term Loan totaled $6.7 million in the first nine
months of 2003. The Term Loan was entered into in connection with
our DIP facilities in October 2002 and refinanced under the exit
credit facilities in February 2003.
- Interest on the 9% senior notes issued March 1, 2003 was $6.4
million for the period from March 1, 2003 to September 30, 2003
compared to interest of $19.4 million recognized on the 11% senior
notes during the first nine months of 2002. The decrease in interest
expense is a result of the discharge of debt related to our $235
million of 11% senior notes in connection with our bankruptcy.
51
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Discontinued Operations
Our discontinued West Coast Operations had an operating loss of $0.1
million in the first nine months of 2003 compared to $1.0 million loss in the
first nine months of 2002. The lower operating loss in 2003 is primarily
attributable to lower depreciation as a result of the fourth quarter 2002
impairment.
Cumulative Effect of Accounting Changes
The EITF reached a consensus in EITF Issue 02-03 to rescind EITF 98-10
effective January 1, 2003. The cumulative effect of the accounting change on
January 1, 2003, was a loss of $2.4 million. See further discussion in Note 11
to the Condensed Consolidated Financial Statements. In addition, we adopted SFAS
No. 143, "Accounting for Asset Retirement Obligations", on January 1, 2003. In
connection with the adoption of SFAS 143, we recorded a $1.6 million loss as a
cumulative effect of an accounting change. See further discussion in Note 15 to
the Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
We anticipate that our future cash requirements will be funded primarily
from:
- cash generated from operations;
- borrowings under our exit credit facilities (including the
Trade Receivables Agreement and Commodity Repurchase Agreement
discussed below); and
- cash generated from asset dispositions, net of debt repayments.
FACTORS AFFECTING OUR LIQUIDITY
Our ability to fund our liquidity and working capital requirements will be
based on our ability to successfully implement our Restructuring Plan, which has
been adversely affected by various factors, including the following:
- COVENANT BREACHES UNDER EXIT CREDIT FACILITIES. For the four month
period ended September 30, 2003, we were in breach of the covenants
in our Letter of Credit Facility and Term Loan described below. We
have obtained a waiver of these violations from our lenders for the
four month period ended September 30, 2003 and for our expected
breach of these covenants for the four month period ended October
31, 2003. In addition, we have agreed to reduce the lenders' maximum
commitment under the Letter of Credit Facility from $325 million to
$290 million.
- Minimum Consolidated EBIDA. We are required to maintain a
minimum, rolling cumulative four month total of consolidated
Earnings Before Interest Depreciation and Amortization,
subject to certain adjustments, as defined ("Minimum
Consolidated EBIDA"). For the four month period ended
September 30, 2003, we were required to have consolidated
EBIDA of $6.6 million but achieved Minimum Consolidated EBIDA
of only $2.2 million. For the four month periods ending
October 31, November 30, and December 31, 2003, we will be
required to maintain Minimum Consolidated EBIDA of $8.7
million, $10.4 million and $12.7 million. Thereafter, the
requirement continues to increase monthly until it reaches
$17.4 million for the four month period ended September 30,
2004.
52
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- Interest Coverage. We are required to maintain a minimum ratio
of consolidated EBIDA to cash interest expense ("Interest
Coverage Ratio") over rolling consecutive four month periods.
For the four month period ended September 30, 2003, the ratio
must be at least .62 to 1.0, but the ratio we achieved was
only .24 to 1.0. For the four months ending October 31,
November 30, and December 31, 2003, we will be required to
maintain an Interest Coverage Ratio of .79 to 1.0, .93 to 1.0
and 1.11 to 1.0. This ratio requirement continues to increase
monthly until it reaches 1.42 to 1.0 for the four month period
ended August 31, 2004.
- Prohibition on Indebtedness. We are not permitted to owe or be
liable for indebtedness except as described in the Letter of
Credit Facility and the Term Loan Agreement. As a result of
our change in estimates of crude oil linefill, as described in
Note 7 to these financial statements, we may be deemed to have
incurred indebtedness to our customers in the form of make-up
obligations for customer crude oil that was previously
believed to have been in our pipelines prior to the change in
estimate.
We were unable to satisfy these covenants as of September 30, 2003
due to the $4.6 million charge we recorded as described in Note 7 to
the Condensed Consolidated Financial Statements and the performance
of our business being less than we expected. Because the charge we
recorded in September 2003 will be included in the calculations of
the covenants for the remainder of 2003 and because the covenants
become increasingly stringent each month, we expect we will be in
default under our exit credit facilities at the end of each month at
least through December 31, 2003 unless our results of operations
show an unexpected significant improvement. A default under one of
our exit facilities, which includes the Letter of Credit Facility,
the Term Loan, the Trade Receivables Agreement and the Commodity
Repurchase Agreement, will cause a cross-default under all the other
exit facilities. Any breaches, unless waived, could severely limit
our access to liquidity and result in our being required to repay
all outstanding debt under the previously mentioned debt agreements
as well as the 9% senior note indenture, all of which totals
approximately $277 million as of September 30, 2003. Although our
lenders provided a waiver for our breach of these covenants as of
September 30, 2003 and for our expected breach of these covenants as
of October 31, 2003, there can be no assurance they will provide
waivers for any subsequent period or that any amendment to our
credit facilities required to obtain such waiver will not adversely
affect our liquidity.
- COVENANT BREACH UNDER COMMODITY REPURCHASE AGREEMENT. We have
an agreement with Standard Chartered Trade Services providing for
the financing of purchases of crude oil inventory utilizing a
forward commodity repurchase agreement ("Commodity Repurchase
Agreement"). The maximum commitment under the Commodity Repurchase
Agreement was $75 million. Under the Commodity Repurchase Agreement,
we are required to maintain 2.4 million barrels of crude oil
linefill. During the third quarter of 2003, we revised downward our
estimate of the physical volume of crude oil linefill in certain of
our pipelines as described in Note 7. As a result of the downward
revision of our estimates of crude oil linefill as of September 30,
2003, we breached the minimum inventory provision of the Commodity
Repurchase Agreement. We have obtained a waiver of this breach,
provided that we maintain a minimum of 2,150,000 barrels of crude
oil inventory.
- MATURITIES OF OUR EXIT FACILITIES. In addition, our Trade
Receivables Agreement and Commodity Repurchase Agreement mature on
March 1, 2004 (although we have an option to extend the maturity to
August 30, 2004) and our Term Loan and Letter of Credit Facility
mature on August 30, 2004. As of September 30, 2003, we had $23
million of outstanding borrowings under our Trade Receivables
Agreement, $75 million of outstanding borrowings under our
Commodity Repurchase Agreement, and $75 million of borrowings under
our Term Loan Agreement.
53
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
BUSINESS PERFORMANCE
In evaluating our ability to meet our obligations under our Restructuring
Plan, we relied, in part, on the financial projections and related assumptions
included in Exhibit D to our Third Amended Disclosure Statement dated December
6, 2002, which was incorporated by reference into our Annual Report on Form 10-K
for the fiscal year ended December 31, 2002. The following assumptions, among
others, have proven to be overly optimistic:
- Our ability to win back business lost due to financial instability
and the Chapter 11 filing. Even though we have the capacity to issue
letters of credit to secure additional volumes, our pre-bankruptcy
customers and business partners have been less willing to do
business with us than we anticipated as a result of our being highly
leveraged and having shown no substantive improvement in our
financial performance. Although we assumed that our marketing
volumes would increase to approximately 350,000 barrels per day by
the end of 2003, our marketing volumes were approximately 250,000
barrels per day in September 2003, and we do not anticipate an
appreciable increase in volumes for the remainder of 2003. Our
Restructuring Plan anticipated a quick return of volume growth in
2003, which has not occurred given the heightened sensitivity to
credit risk in the energy industry and our high credit costs.
Outstanding letters of credit at September 30, 2003 were $244.8
million, with a total commitment amount of $290 million.
- The continued viability of our MTBE operations. The business and
regulatory climate for MTBE has continued to deteriorate
dramatically and has adversely affected our business. Our
Restructuring Plan contemplated earnings from our Liquids Operations
in 2003; however, for the nine months ended September 30, 2003, the
Liquids Operations had an operating loss of $20 million. We recently
decided to phase out our MTBE production after discussions with a
third party regarding a possible sale of these operations terminated
unsuccessfully. As a consequence of the phase out of MTBE
production, we recorded charges for severance of $1.8 million,
impairment of long-lived assets of $2.7 million and write down of
material and supplies of $2.3 million (see Note 6).
OPTIONS FOR ACHIEVING DEBT REDUCTION
In order to improve our liquidity, we must reduce our debt and attract new
volumes. We will likely not be able to achieve volume and earnings growth
without reducing our debt by at least $100 million. We are currently considering
the following options to achieve our debt reduction:
- Pursuing the sale of additional assets. During the period from March
2003 to October 2003, we sold assets for an aggregate consideration
of $26.2 million. We used approximately $25 million of the net
proceeds to pay down amounts outstanding under the Commodity
Repurchase Agreement subsequent to September 30, 2003. We will
continue to pursue asset sales and use the proceeds, if any, to
reduce our debt levels.
- Seeking additional equity. We are evaluating alternatives for
raising additional equity capital, both publicly and privately. Our
efforts to raise additional equity will be limited by the following
factors, among others:
- Under the terms of our LLC Agreement, we are prohibited from
issuing additional equity without a vote of two-thirds of our
unitholders.
54
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
- We are unable to issue equity in a public offering or in an
offering pursuant to Regulation D of the Securities Act until
we have satisfied the requirement to have three years of
audited financial statements by completing an audit of our
financial statements for the year ending December 31, 2003.
- We have recognized income from our settlement with Enron and
discharge of indebtedness from our bankruptcy in excess of 10%
of our gross income. We concluded, as disclosed in our Third
Amended Disclosure Statement, that this income constituted
"qualifying income" under the Internal Revenue Code, although
the matter was not free from doubt. We believe that we may not
be able to access the capital markets without a higher degree
of certainty of whether this income is qualifying income and,
therefore, we have decided to seek a private letter ruling
from the Internal Revenue Service. See Note 1.
Due to the absence of volume growth in our core business and the
amount of additional equity required to achieve debt reduction of at
least $100 million, if we are able to issue additional equity, we
will be required to do so at prices significantly less than the
current trading prices of our units and warrants.
- Conversion of existing debt. We are currently evaluating the
feasibility of our lenders converting a portion of their debt
to equity.
- Evaluating strategic alternatives. If we are unsuccessful in
achieving our debt reduction within a reasonable time period, we
will consider other strategic alternatives, which could include a
sale of the company.
The condensed consolidated financial statements have been prepared
assuming we will continue as a going concern, which contemplates the
realization of assets and settlement of liabilities in the normal course of
business. The factors discussed above raise substantial doubt about our ability
to continue as a going concern. The consolidated financial statements do not
include any adjustments that might result from the outcome of this uncertainty.
CASH FLOWS FROM OPERATING ACTIVITIES
Cash flow from operating activities for the nine months ended September
30, 2003 was $16.4 million as compared to $61.0 million during the same period
in 2002. The decrease in cash flow from operating activities during the nine
months ended September 30, 2003 as compared to the same period in 2002 is due
primarily to (1) a liquidation of crude oil inventories in 2002 as crude oil
markets shifted out of contango into backwardation (changes in inventory during
the nine months ended September 30, 2002 were $67.6 million), (2) cash operating
losses in our liquids operations ($20 million net operating loss in the nine
months ended September 30, 2003 as compared to $11 million in operating income
in the same period in 2002) and (3) a net increase of approximately $13 million
during the nine months ended September 30, 2003 as compared to the same period
in 2002 attributable to buy/sell contracts with a single customer involving
settlement of the buy-side (i.e., cash outflow) in December 2002 and settlement
of the sell-side (i.e., cash inflow) in January 2003. It is unlikely that future
operating cash flows will be materially effected by buy/sell contracts whose two
components (i.e., one buy and one sale) are settled in different periods.
Crude oil market conditions can significantly impact our cash flows from
period to period. During periods when demand for crude oil is weak (i.e., a
"contango" market), storing crude oil is favorable because it can be sold at
higher prices for future delivery. Storing crude oil will decrease current
period cash from operations. When market conditions change such that there is a
higher demand than supply for crude oil (i.e., a "backwardated" market), storing
crude oil is no longer advantageous because we can capture a higher price for
current month deliveries. The liquidation of crude oil inventory triggered by
the change in market conditions will increase current period cash from
operations. This is illustrated by the previously mentioned improvement in cash
from operations in the first nine months of 2002. Our ability to benefit in
future periods, as we did in 2002 as discussed above from significant storage
activities could be adversely affected by the amount of credit support available
to us under our credit facilities and our current cost of credit.
55
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
CASH FLOWS FROM INVESTING ACTIVITIES
Net cash used in investing activities totaled $5.3 million in the first
nine months of 2003 as compared to $30.1 million during the same period in 2002.
Cash additions to property, plant, and equipment of $5.5 million in 2003
primarily include $4.8 million for pipeline, storage tank and related facility
improvements and $0.3 million related to the Morgan's Point Facility. Cash
additions to property, plant, equipment and turnaround costs of $31.7 million in
2002 primarily include $15.8 million related to a pipeline expansion project in
Mississippi, a new pipeline, truck and rail facility for the West Coast
operations and $7.1 million related to turnaround costs for the MTBE Plant.
Proceeds from asset sales were $0.2 million during the nine months ended
September 30, 2003 and $1.6 million during the comparable period in 2002.
We estimate that capital expenditures necessary to maintain the existing
asset base at current operating levels will be approximately $10 million to $13
million each year. The level of additional capital expenditures by us will vary
depending upon cash from operations, availability of financing, prevailing
energy markets, general economic conditions and the current regulatory
environment. Our credit facilities prohibit us from making capital expenditures
outside of our present businesses, and further place monetary limitations on
capital expenditures.
CASH FLOWS FROM FINANCING ACTIVITIES
Net cash used in financing activities totaled $26.6 million in the first
nine months of 2003 as compared to $30.2 million in the first half of 2002. The
2003 amount primarily represents a decrease in the amount outstanding under our
receivables financing. The 2002 amount represents decreases in short term debt
and repurchase agreements offset in part by an increase in receivable financing.
We suspended distribution payments to unitholders in April 2002 and are not
permitted to make any cash distributions to unitholders pursuant to the terms of
our exit credit facilities so long as we have any indebtedness or other
obligations outstanding under the exit credit facilities and certain
requirements are met under the indenture governing our 9% senior notes.
SUMMARY OF DEBTOR IN POSSESSION ("DIP") FINANCING
On October 18, 2002, we entered into agreements with Standard Chartered,
SCTS, Lehman and other lending institutions for $575 million in DIP financing
facilities. The DIP facilities provided (i) $500 million of credit and financing
facilities through Standard Chartered and SCTS, which included up to $325
million for letters of credit and $175 million of inventory repurchase/accounts
receivable financing through SCTS, and (ii) $75 million of term loans through
Lehman and other lending institutions. The credit facilities were subject to a
borrowing base and were secured by a first-priority lien on all, or
substantially all, of our real and personal property. As of February 28, 2003,
we had outstanding approximately $313.1 million of letters of credit, $125.0
million of inventory repurchase/accounts receivable financing, and $75 million
of term loans. The DIP financing facilities contained certain restrictive
covenants that, among other things, limited distributions, other debt, and
certain asset sales. On February 28, 2003, the DIP financing facilities were
refinanced by the same institutions as we emerged from bankruptcy. The following
discussion provides an overview of our post-bankruptcy debt.
SUMMARY OF EXIT CREDIT FACILITIES, SENIOR NOTES, AND OTHER DEBT
EOTT LLC's emergence from bankruptcy as of March 1, 2003, was financed
through a combination of exit credit facilities, senior notes and other debt
associated with settlement of claims during our bankruptcy proceedings. The
table below provides a summary of these financing arrangements as of September
30, 2003.
56
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
SUMMARY OF FINANCING ARRANGEMENTS
(IN MILLIONS)
COMMITMENT/ AMOUNT
FACE AMOUNT OUTSTANDING MATURITY
----------- ----------- --------
Exit Credit Facilities:
Letter of Credit Facility................. $ 325.0(1) $ 244.8 August 30, 2004
Trade Receivables Agreement............... 100.0(2) 23.0 March 1, 2004(4)
Commodity Repurchase Agreement............ 75.0(3) 75.0(3) March 1, 2004(4)
Term Loans................................ 75.0 75.0 August 30, 2004
Senior Notes...................................... 109.2 104.3 March 1, 2010(5)(6)
Other Debt:
Enron Note................................ 6.4 7.1 October 1, 2005(5)
Big Warrior Note.......................... 2.6 2.3 March 1, 2007(5)
Ad Valorem Tax Liability.................. 7.2 7.2 March 1, 2009
(1) Subsequent to September 30, 2003, the maximum commitment was reduced to
$290 million.
(2) $50 million of this commitment is unavailable ten days each month.
(3) On October 1, 2003, net proceeds of $25 million from the disposition of
assets (see Note 6) were used to reduce the amount outstanding to $50
million and the maximum amount of the commitment under the Commodity
Repurchase Agreement was reduced to $50 million.
(4) We have the option to extend these arrangements for an additional 6
months. Such an extension would be subject to the payment of extension
fees of $875,000.
(5) These notes were adjusted to fair value pursuant to the adoption of fresh
start reporting required by SOP 90-7.
(6) On September 1, 2003, we issued an additional senior note in the amount of
$5.2 million in lieu of the first semi-annual payment of interest on our
senior notes.
The following is a summary of certain contractual obligations at September
30, 2003 (in millions):
After
2003 2004 2005 2006 2007 2007 Total
-------- -------- -------- -------- -------- -------- --------
Operating Leases $ 1.5 $ 4.7 $ 3.6 $ 2.7 $ 0.5 $ 0.6 $ 13.6
9% Senior Notes -- -- -- -- -- 109.2 109.2
Term Loans(2) -- 75.0 -- -- -- -- 75.0
Commodity Repurchase Agreement (1)(2) -- 75.0 -- -- -- -- 75.0
Trade Receivables Agreement(2) -- 23.0 -- -- -- -- 23.0
Enron Note 1.0 1.0 4.4 -- -- -- 6.4
Big Warrior Note 0.1 0.3 0.4 0.4 1.4 -- 2.6
Ad Valorem Tax Liability 0.6 1.2 1.3 1.4 1.5 1.2 7.2
-------- -------- -------- -------- -------- -------- --------
$ 3.2 $ 180.2 $ 9.7 $ 4.5 $ 3.4 $ 111.0 $ 312.0
======== ======== ======== ======== ======== ======== ========
(1) On October 1, 2003, net proceeds of $25 million from the disposition of
assets (see Note 6) were used to reduce the amount outstanding to $50
million.
(2) See Previous discussion of covenant violations, cross defaults and the
waivers obtained.
We provide certain purchasers with irrevocable letters of credit to secure
our obligations to purchase crude oil or feedstocks for our crude oil or liquids
marketing activities. Liabilities with respect to these purchase obligations are
recorded in accounts payable on our balance sheet in the month the crude oil or
feedstock is purchased. These letters of credit are generally issued for up to
sixty-day periods and are cancelled upon the payment of the purchase obligation.
At September 30, 2003, we had outstanding letters of credit of approximately
$244.8 million.
57
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Exit Credit Facilities
On February 11, 2003, we entered into our exit credit facilities with the
same lenders and under substantially the same terms in the DIP financing
facilities. These new facilities were effective March 1, 2003 and $2.9 million
of facility and extension fees were paid in connection with these new
facilities. Such fees are being amortized as interest expense over the terms of
the facilities.
Letter of Credit Facility
The Letter of Credit Facility, as amended, with Standard Chartered
provides $290 million of financing until August 30, 2004 and is subject to
defined borrowing base limitations. The borrowing base is (as of the date of
determination) the sum of cash equivalents, specified percentages of eligible
receivables, deliveries, fixed assets, inventory, margin deposits and undrawn
product purchase letters of credit, minus (i) first purchase crude payables,
other priority claims, aggregate net amounts payable by the borrowers under
certain hedging contracts and certain eligible receivables arising from future
crude oil obligations, (ii) the principal amount of loans outstanding and any
accrued and unpaid fees and expenses under the Term Loans, and (iii) all
outstanding amounts under the Amended and Restated Commodity Repurchase
Agreement and the Amended and Restated Receivables Purchase Agreement ("SCTS
Purchase Agreements"). Pursuant to a scheduled advance rate reduction, effective
July 31, 2003, the specified percentages of eligible receivables and fixed
assets in the borrowing base were reduced. The impact of this reduction at July
31, 2003 was to lower our borrowing base by approximately $17 million. Standard
Chartered has the right to reduce these same percentages in the borrowing base
at October 31, 2003.
The Letter of Credit Facility required an upfront facility fee of $1.25
million that was paid at closing. An additional reduction fee of $2.5 million
will be payable on March 29, 2004, if Standard Chartered's exposure is not
reduced to $200 million or less by that date. Letter of credit fees range from
2.25% to 2.75% per annum depending on usage. The commitment fee is 0.5% per
annum of the unused portion of the Letter of Credit Facility. Additionally, we
agreed to a fronting fee, which is the greater of 0.25% per annum times the face
amount of the letter of credit or $250. An annual arrangement fee of 1% per
annum times the average daily maximum commitment amount, as defined in the
Letter of Credit Facility, is payable on a monthly basis.
The exit credit facilities include various financial covenants that we
must adhere to on a monthly basis discussed above in "-Factors Affecting
Liquidity" and set forth below:
- Minimum Consolidated Tangible Net Worth. At the end of each month,
from March 31, 2003 to December 31, 2003, we are required to
maintain a minimum consolidated tangible net worth, subject to
certain adjustments, as defined ("Minimum Consolidated Tangible Net
Worth"), of $8.5 million. From January 31, 2004 to September 30,
2004, we are required to maintain a Minimum Consolidated Tangible
Net Worth of $10 million.
- Current Ratio. We must maintain a ratio of consolidated current
assets, subject to certain adjustments to consolidated current
liabilities less funded debt, as defined, of 0.90 to 1.00 for the
term of the exit credit facilities.
At September 30, 2003, we were in compliance with the Minimum Consolidated
Tangible Net Worth and Current Ratio covenants.
For purposes of determining the financial information used in the
financial covenants set forth, we are required to exclude all items directly
attributable to our Liquids Assets and the West Coast natural gas liquids assets
("Designated Assets") for the first five months ended May 31, 2003 and to make
"permitted adjustments" (changes due to fresh start reporting, income and
expenses attributable to the Designated Assets during the first five months
ended May 31, 2003, changes due to the cumulative affect of changes in GAAP,
which are approved by the bank, gains or losses from the sales of assets or
Designated Assets and any write-downs on Designated Assets), as defined.
58
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In connection with the sale of the West Coast Assets and the ArkLaTex
assets, the Letter of Credit Facility was amended to allow the net proceeds from
these asset sales to be used to repay amounts outstanding under the Commodity
Repurchase Agreement.
In addition, there are certain restrictive covenants that, among other
things, limit other debt, certain asset sales, mergers and change in control
transactions. Additionally, the exit credit facilities prohibit us from making
any distributions, or purchases, acquisitions, redemptions or retirement of our
LLC units so long as we have any indebtedness, liabilities or other obligations
outstanding to Standard Chartered, SCTS, Lehman, or any other lenders under
these facilities.
SCTS Purchase Agreements
We have an agreement with SCTS similar to our pre-bankruptcy inventory
repurchase agreement, which provides for the financing of purchases of crude oil
inventory utilizing a forward commodity repurchase agreement ("Commodity
Repurchase Agreement"). The maximum commitment under the Commodity Repurchase
Agreement was $75 million. It required an upfront facility fee of approximately
$378,000 and carried an interest rate of LIBOR plus 3%. On October 1, 2003, net
proceeds of $25 million from the disposition of assets were used to repay
amounts outstanding under the Commodity Repurchase Agreement and the maximum
commitment amount was reduced to $50 million. The Commodity Repurchase Agreement
had an initial term of six months to August 30, 2003, at which time we had the
option to extend for an additional twelve months. In August 2003, we amended the
Commodity Repurchase Agreement to provide us the option to (1) extend the
maturity date to March 1, 2004 and (2) prior to March 1, 2004, extend the
maturity date to August 30, 2004. The election of each option will require the
payment of an extension fee of $375,000. We elected to extend the maturity date
to March 1, 2004, which required the payment of an extension fee of $375,000 and
the interest rate increased to LIBOR plus 7%.
In addition, we also have an agreement with SCTS similar to our
pre-bankruptcy trade receivables agreement, which provides for the financing of
up to an aggregate amount of $100 million of certain trade receivables ("Trade
Receivables Agreement") outstanding at any one time. The discount fee was LIBOR
plus 3% and an upfront facility fee of approximately $504,000 was paid. The
Trade Receivables Agreement had an initial term of six months to August 30,
2003, at which time we had the option to extend for an additional twelve months.
In August 2003, we amended the Trade Receivable Agreement to provide us the
option to (1) extend the maturity date to March 1, 2004 and (2) prior to March
1, 2004, extend the maturity date to August 30, 2004. The election of each
option will require the payment of an extension fee of $0.5 million. We elected
to extend the maturity date to March 1, 2004, which required the payment of an
extension fee of $0.5 million and the interest rate increased to LIBOR plus 7%.
Term Loan Agreement
We entered into an agreement with Lehman, as Term Lender Agent, and other
lenders (collectively, "Term Lenders"), which provides for term loans in the
aggregate amount of $75 million (the "Term Loans"). The Term Loans mature on
August 30, 2004.
The financing included two term notes. The Tier-A Term Note is for $50
million with a 9% per annum interest rate. The Tier-B Term Note is for $25
million with a 10% per annum interest rate. Interest is payable monthly on both
notes. An upfront fee of $750,000 was paid and we agreed to pay a deferred
financing fee in the aggregate amount of $2 million on the maturity date of the
Term Loans. This latter fee was fully accrued as of February 28, 2003.
The Term Loans are collateralized and have certain repayment priorities
with respect to collateral proceeds pursuant to the Intercreditor and Security
Agreement that is discussed below. Under the Term Loan Agreement, term loan debt
outstanding is subject to a borrowing base as defined in the Letter of Credit
59
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Agreement. Further, the Term Loan Agreement contains financial covenants that
mirror those outlined above in the discussion of the Letter of Credit Facility.
Intercreditor and Security Agreement
In connection with the Letter of Credit Facility, the Term Loans and the
SCTS Purchase Agreements, we entered into the Intercreditor and Security
Agreement ("Intercreditor Agreement"), with Standard Chartered, Lehman, SCTS and
various other secured parties ("Secured Parties"). This agreement provides for
the sharing of collateral among the Secured Parties and prioritizes the
application of collateral proceeds which provides for repayment of the Tier-A
Term Note and the Standard Chartered Letter of Credit exposure above $300
million prior to other secured obligations.
In addition, to the extent that drawings are made on any letters of
credit, Standard Chartered, as collateral agent, may distribute funds from our
debt service payment account to itself (as letter of credit issuer agent on
behalf of the letter of credit issuer) as needed to allow Link LLC to reimburse
Standard Chartered, as letter of credit issuer, for such drawings.
Senior Notes
On October 1, 1999, we issued to the public $235 million of 11% senior
notes. The senior notes were due October 1, 2009, and interest was paid
semiannually on April 1 and October 1. The senior notes were fully and
unconditionally guaranteed by all of our operating limited partnerships but were
otherwise unsecured. On October 1, 2002, we did not make the interest payment of
$12.9 million on our $235 million 11% senior notes. These notes were cancelled
effective March 1, 2003 as a result of our Restructuring Plan and the holders of
these notes, along with our general unsecured creditors with allowed claims,
will receive a pro rata share of $104 million of 9% senior unsecured notes, plus
new Link LLC units as discussed below.
Link LLC Senior Notes 2010
In February 2003, we issued the $104 million of 9% senior unsecured notes
to the Bank of New York, as depositary agent, which will be subsequently
allocated by the depositary agent to former holders of the 11% senior notes
described above and our general unsecured creditors with allowed claims.
However, the exact pro rata allocation of the senior notes cannot be determined
until the precise amount of each allowed claim is determined. This process is
underway in the EOTT Bankruptcy Court as part of our Restructuring Plan. The
Bank of New York, as depositary agent, distributed approximately 90% of the
senior unsecured notes in August 2003 and the final allocation of notes is
expected to be completed by December 2003. The senior notes are due in March
2010, and interest will be paid semiannually on September 1 and March 1. Under
the terms of the indenture governing our senior notes, we are allowed to pay
interest payments in kind by issuing additional senior notes on the first two
interest payment dates. If we make payments in kind, we must make the payments
as if interest were being charged at 10% per annum instead of 9% per annum. On
September 1, 2003, we issued an additional senior note in the amount of $5.2
million to the Bank of New York in lieu of the first interest payment. We may
not optionally redeem the notes. The notes are subject to mandatory redemption
or sinking fund payments if we sell assets and use the money for certain
purposes or if we have a change of control. Provisions of the indenture could
limit additional borrowings, sale and lease back transactions, affiliate
transactions, purchases of our own equity, payments on debt subordinated to the
senior notes, distributions to members, sale of assets if certain financial
performance ratios are not met, or certain merger, consolidation or change in
control transactions.
Enron Note and Big Warrior Note
In connection with our settlement with Enron as part of the Restructuring
Plan, we executed a $6.2 million note payable to Enron ("Enron Note") that is
guaranteed by our subsidiaries. The Enron Note is
60
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
secured by an irrevocable letter of credit and bears interest at 10% per annum.
Interest is paid semiannually on April 1 and October 1, beginning on April 1,
2003 and we are allowed to pay interest payments in kind on the first two
interest payment dates. Principal payments of $1 million are payable in October
2003 and October 2004 with the remaining principal due in October 2005. On
October 1, 2003, we paid our first principal payment of $1 million and elected
to pay our interest payment of $0.3 million in kind, which increases the
principal balance of the Enron Note.
In connection with a settlement with Big Warrior Corporation ("Big
Warrior") during our bankruptcy, we executed a $2.7 million note payable to Big
Warrior, which is secured by a second lien position in one of our Mississippi
pipelines. The four-year note is payable in quarterly installments which began
June 1, 2003 based on a seven-year amortization schedule, at an interest rate of
6% per annum. A final balloon payment is due March 1, 2007. Effective July 31,
2003, Farallon Capital Partners, L.P. ("Farallon") and Tinicum Partners, L.P.
("Tinicum") purchased this note from Big Warrior. Farallon and Tinicum are Term
Lenders and holders of allowed claims, which will allow them to receive a pro
rata allocation of our 9% senior unsecured notes and LLC units from the
depositary agent.
Ad Valorem Tax Liability
In conjunction with our Restructuring Plan, we agreed to pay accrued but
unpaid 2002 ad valorem taxes over six years from the effective date of our
Restructuring Plan. This debt bears interest at 6% with quarterly principal and
interest payments, with the first payment made on June 1, 2003.
Link LLC Equity Units and Warrants
Under our Restructuring Plan, the MLP's common units were eliminated. We
issued 12,317,340 new LLC units to be allocated to former equity holders, former
note holders, and holders of allowed general unsecured claims. We also issued to
former equity holders 957,981 warrants to purchase additional LLC units. As with
the issuance of our 9% senior unsecured notes, the allocation of 11,947,820 of
these new LLC units to former note holders and holders of allowed general
unsecured claims cannot be determined until the precise amount of each allowed
claim is determined. The Bank of New York, as depositary agent, distributed
approximately 90% of the LLC units in August 2003 and the final allocation of
units is expected to be completed by December 2003. Until the final allocation
is made we will not know how many units each of our unitholders is entitled to
vote. We do not expect to make distributions to our unit holders in the
foreseeable future due to restrictions in our exit credit facilities.
NEW ACCOUNTING STANDARDS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
SFAS No. 143, "Accounting for Asset Retirement Obligations." This statement
requires entities to record the fair value of a liability for legal obligations
associated with the retirement obligations of tangible long-lived assets in the
period in which it is incurred. When the liability is initially recorded, a
corresponding increase in the carrying value of the related long-lived asset
would be recorded. Over time, accretion of the liability is recognized each
period, and the capitalized cost is depreciated over the useful life of the
related asset. Upon settlement of the liability, an entity either settles the
obligation for its recorded amount or incurs a gain or loss on settlement. We
adopted the accounting principle required by the new statement effective January
1, 2003. Determination of the fair value of the retirement obligation is based
on numerous estimates and assumptions including estimated future third-party
costs, future inflation rates and the future timing of settlement of the
obligations.
Our long-lived assets consist primarily of our crude oil gathering and
transmission pipelines and associated field storage tanks, our liquids
processing and facilities at Morgan's Point, our underground storage facility
and associated pipeline grid system, handling and transportation facilities at
Mont Belvieu and our gas processing and fractionation plant and related storage
and distribution facilities on the West Coast.
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LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
We identified asset retirement obligations that are within the scope of
the new statement, including contractual obligations included in certain
right-of-way agreements, easements and surface leases associated with our crude
oil gathering, transportation and storage assets and obligations pertaining to
closure and/or removal of facilities and other assets associated with our
Morgan's Point, Mont Belvieu and West Coast facilities. We have estimated the
fair value of asset retirement obligations based on contractual requirements
where the settlement date is reasonably determinable. We cannot currently make
reasonable estimates of the fair values of certain retirement obligations,
principally those associated with certain right-of-way agreements and easements
for our pipelines, our Morgan's Point, Mont Belvieu and West Coast facilities,
because the settlement dates for the retirement obligations cannot be reasonably
determined. We will record retirement obligations associated with these assets
in the period in which sufficient information exists to reasonably estimate the
settlement dates of the respective retirement obligations.
As a result of the adoption of SFAS 143 on January 1, 2003, we recorded a
liability of $1.7 million, property, plant and equipment, net of accumulated
depreciation of $0.1 million and a cumulative effect of a change in accounting
principle of $1.6 million. The effect of adoption of the new accounting
principle was not material to the results of operations for the one month ended
March 31, 2003, the two months ended February 28, 2003 nor would it have had a
material impact on our net income for the three and nine months ended September
30, 2002. The asset retirement obligation as of January 1, 2002 was not
material.
In September 2003, we recorded additional asset retirement obligations
resulting from the planned reduction in our operations at the Morgan's Point
Facility to phase out the production of MTBE.
The following is a rollforward of our asset retirement obligations for the
nine months ended September 30, 2003:
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -------------------
SEVEN MONTHS | TWO MONTHS
ENDED | ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003
------------------ | -----------------
|
Balance at beginning of period........................ $ 1,678 | $ --
Additions to liability................................ 1,525 | 1,675
Accretion expense..................................... 9 | 3
Liabilities settled................................... -- | --
Revisions to estimates................................ -- | --
------------------ | --------------------
Balance at end of period.............................. $ 3,212 | $ 1,678
================== | ====================
In October 2002, the Emerging Issues Task Force ("EITF") reached a
consensus in EITF Issue 02-03, "Issues Involved in Accounting for Derivative
Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and
Risk Management Activities." The EITF reached a consensus to rescind Issue
98-10, and related interpretive guidance, and preclude mark to market accounting
for energy trading contracts that are not derivative instruments pursuant to
SFAS 133. The consensus requires that gains and losses (realized and unrealized)
on all derivative instruments held for trading purposes be shown net in the
income statement, whether or not the instrument is settled physically. The
consensus to rescind Issue 98-10 eliminated our basis for recognizing physical
inventories at fair value. The consensus to rescind Issue 98-10 was effective
for all new contracts entered into (and physical inventory purchased) after
October 25, 2002. For energy trading contracts and physical inventories that
existed on or before October 25, 2002, that remained at December 31, 2002, the
consensus was effective January 1, 2003 and was reported as a cumulative effect
of a change in accounting principle. The cumulative effect of the accounting
change on January 1, 2003 was a loss of approximately $2.4 million. With the
rescission of Issue 98-10, inventories purchased after October 25, 2002, have
been valued at average cost.
62
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
In January 2003, the FASB issued Financial Interpretation No. 46,
"Consolidation of Variable Interest Entities - an interpretation of ARB No. 51"
("FIN 46"). FIN 46 is an interpretation of Accounting Research Bulletin 51,
"Consolidated Financial Statements", and addresses consolidation by business
enterprises of variable interest entities ("VIE"). FIN 46 requires an enterprise
to consolidate a VIE if that enterprise has a variable interest that will absorb
a majority of the entity's expected losses if they occur, receive a majority of
the entity's expected residual returns if they occur, or both. This guidance
applies immediately to VIE's created after January 31, 2003, and to VIE's in
which an enterprise obtains an interest after that date. We implemented FIN 46
effective with the adoption of fresh start reporting on March 1, 2003. This
statement did not have any impact on our financial statements.
In April 2003, the FASB issued SFAS 149, "Amendment of Statement 133
on Derivative Instruments and Hedging Activities." The statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
133. The new statement is effective for contracts entered into or modified after
June 30, 2003 (with certain exceptions) and for hedging relationships designated
after June 30, 2003. The accounting guidance in the new statement is to be
applied prospectively. We implemented SFAS 149 effective with the adoption of
fresh start reporting. The adoption of this statement did not have any impact on
our financial statements.
In May 2003, the FASB issued SFAS 150, "Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities and Equity." This
statement establishes standards for how a company classifies and measures
certain financial instruments with characteristics of both liabilities and
equity. This statement is effective for financial instruments entered into or
modified after May 31, 2003 and otherwise is effective at the beginning of the
first interim period beginning after June 15, 2003. The statement will be
implemented by reporting the cumulative effect of a change in accounting
principle for financial instruments created before the issuance date of the
statement and still existing at the beginning of the period of adoption. We
implemented SFAS 150 effective with the adoption of fresh start reporting on
March 1, 2003. The adoption of this statement did not have any impact on our
financial statements.
LINK ENERGY LLC EQUITY INCENTIVE PLAN
In August 2003, the Board of Directors of Link Energy LLC adopted
the Link Energy LLC Equity Incentive Plan ("Equity Plan"), which authorizes 1.2
million restricted units to be issued to certain key employees and directors.
The Equity Plan has a ten-year term, beginning June 1, 2003. Each award of
restricted units under the Equity Plan will be evidenced by an Award Agreement,
which will set forth the number of restricted units granted, the vesting period
and other material terms of the restricted unit award.
On October 1, 2003, 865,000 restricted units were awarded to certain
key employees. The restricted units awarded will vest 50% on June 1, 2004, 25%
on June 1, 2005 and 25% on June 1, 2006. Based on the market value of the LLC
units on October 1, 2003, compensation expense of $13.0 million will be recorded
against earnings over the three-year vesting period.
CERTAIN LITIGATION AND ENVIRONMENTAL MATTERS
We are subject to federal, state and local laws and regulations
governing the discharge of materials into the environment or otherwise relating
to environmental protection. At the federal level, such laws include, among
others, the Clean Air Act, the Clean Water Act, the Oil Pollution Act, the
Resource Conservation and Recovery Act, the Comprehensive Environmental
Response, Compensation and Liability Act, and the National Environmental Policy
Act, as each may be amended from time to time. Failure to comply with these laws
and regulations may result in the assessment of administrative, civil, and
criminal penalties or the imposition of an
63
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
injunctive relief. Moreover, compliance with such laws and regulations in the
future could prove to be costly, and there can be no assurance that we will not
incur such costs in material amounts. For a more thorough discussion of certain
environmental matters that do or may impact us, see Note 12 to the Condensed
Consolidated Financial Statements. The clear trend in environmental regulation
is to place more restrictions and limitations on activities that may impact the
environment, such as emissions of pollutants, generation and disposal of wastes
and use and handling of chemical substances.
In connection with extensive asset purchases in 1998 and 1999, we
instituted a pipeline integrity management program in 1999. This program was
expanded in December of 2001 with a pipeline integrity assurance program to
comply with certain regulatory and legislative changes. Under this program, the
integrity of a pipeline is evaluated to avoid operating a pipeline that poses
significant risk of crude oil spills. Our written Link Pipeline Integrity
Program, which was intended to comply with the U.S. Department of Transportation
Office of Pipeline Safety ("OPS") Integrity Management regulations issued in
2001, was formally implemented in January 2002 and further expanded in January
2003. Anticipated operating expenses and capital expenditures to comply with
that program are budgeted annually; however, actual future expenditures may be
different from the amounts currently anticipated.
John H. Roam, et al. vs. Texas-New Mexico Pipe Line Company and EOTT
Energy Pipeline Limited Partnership, Cause No. CV43296, In the District Court of
Midland County, Texas, 238th Judicial District (Kniffen Estates Suit). The
Kniffen Estates Suit was filed on March 2, 2001, by certain residents of the
Kniffen Estates, a residential subdivision located outside of Midland, Texas.
The allegations in the petition state that free crude oil products were
discovered in water wells in the Kniffen Estates area, on or about October 3,
2000. The plaintiffs claim that the crude oil products are from a 1992 release
from a pipeline then owned by the Texas-New Mexico Pipe Line Company ("Tex-New
Mex"). We purchased that pipeline from Tex-New Mex in 1999. The plaintiffs have
alleged that Tex-New Mex was negligent, grossly negligent, and malicious in
failing to accurately report and remediate the spill. With respect to us, the
plaintiffs were seeking damages arising from any contamination of the soil or
groundwater since we acquired the pipeline in question. No specific amount of
money damages was claimed in the Kniffen Estate Suit, but the plaintiffs did
file proofs of claim in our bankruptcy proceeding totaling $62 million. In
response to the Kniffen Estates Suit, we filed a cross-claim against Tex-New
Mex. In the cross-claim, we claimed that, in relation to the matters alleged by
the plaintiffs, Tex-New Mex breached the Purchase and Sale Agreement between the
parties dated May 1, 1999, by failing to disclose the 1992 release and by
failing to undertake the defense and handling of the toxic tort claims, fair
market value claims, and remediation claims arising from the release. On April
5, 2002, we filed an amended cross-claim which alleges that Tex-New Mex
defrauded us as part of Tex-New Mex's sale of the pipeline systems to us in
1999. The amended cross-claim also alleges that various practices employed by
Tex-New Mex in the operation of its pipelines constitute gross negligence and
willful misconduct and void our obligation to indemnify Tex-New Mex for
remediation of releases that occurred prior to May 1, 1999. In the Purchase and
Sale Agreement, we agreed to indemnify Tex-New Mex only for certain remediation
obligations that arose before May 1, 1999, unless these obligations were the
result of the gross negligence or willful misconduct of Tex-New Mex prior to May
1, 1999. EOTT Energy Pipeline Limited Partnership ("PLP") and the plaintiffs
agreed to a settlement during our bankruptcy proceedings. The settlement
provides for the plaintiffs' release of their claims filed against PLP in this
proceeding and in the bankruptcy proceedings, in exchange for an allowed general
unsecured claim in our bankruptcy of $3,252,800 (as described above, the
plaintiffs filed proofs of claim in our bankruptcy proceedings totaling $62
million). The allowed general unsecured claim was accrued at December 31, 2002.
On April 1, 2003, we filed a second amended cross-claim in this matter. In
addition to the claims filed in the previous cross-claims, we requested (i)
injunctive relief for Tex-New Mex's refusal to honor its indemnity obligations;
(ii) injunctive relief requiring Tex-New Mex to identify, investigate and
remediate sites where the conduct alleged in our cross-claim occurred; and (iii)
restitution damages of over $125,000,000. Tex-New Mex filed a motion to compel
arbitration of these issues. The motion to compel arbitration was denied at a
hearing held on April 11, 2003. At the April 11, 2003 hearing, the court also
severed into a separate action EOTT's cross-claims against Tex-New Mex that
extend beyond the crude oil release and groundwater contamination in the Kniffen
Estates subdivision ("EOTT's
64
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Over-Arching Claim"). Prior to the trial of the plaintiff's claims against
Tex-New Mex and EOTT's original cross-claim against Tex-New Mex arising from the
crude oil release and groundwater contamination in the Kniffen Estates
subdivision ("EOTT's Kniffen Claims"), Tex-New Mex reached a settlement with the
plaintiffs that provided for the release of the plaintiffs' claims. The trial of
EOTT's Kniffen Claims commenced on June 16, 2003, and the jury returned its
verdict on July 2, 2003. The jury found that Tex-New Mex's gross negligence and
willful misconduct caused the contamination in the Kniffen Estates. The jury
also found that Tex-New Mex committed fraud against us with respect to the
Kniffen Estates site. The jury awarded us actual damages equal to the expenses
we have incurred to date in remediating the Kniffen Estates site (approximately
$6.1 million) and punitive damages in the amount of $50 million. On August 29,
2003, the court entered its final judgment based on the jury verdict. The final
judgment provides for the award to us of (i) actual damages in the amount of
$7,701,938, (ii) attorney's fees in the amount of $1,400,000, (iii) prejudgment
interest in the amount of $953,774, and (iv) punitive damages in the amount of
$20,111,424. The punitive damages were reduced from the jury's award of $50
million in accordance with Texas' statutory caps on punitive damages awards. The
final judgment also contains a finding that Tex-New Mex is obligated to
indemnify us for future remediation costs incurred at the Kniffen Estates site.
On September 26, 2003, Tex-New Mex filed a motion for new trial and a motion
seeking modification of the judgment. At a hearing held on November 10, 2003,
the court denied Tex-New Mex's motion for new trial but partially granted
Tex-New Mex's motion to modify the judgment. The court ruled that prejudgment
interest should not be included in the calculation for determining the statutory
cap on punitive damages. Accordingly, our punitive damages award will be reduced
further by approximately $1.9 million. A judgment reflecting the modification
ordered by the court is being prepared and will be submitted for entry by the
court on November 24, 2003. We cannot predict the outcome of Tex-New Mex's
appellate efforts.
Bankruptcy Issues related to Claims Made by Texas-New Mexico Pipeline
Company and its affiliates. Tex-New Mex, Shell Oil Company and Equilon filed
proofs of claim in our bankruptcy, each filing the same claim in the amount of
$112 million. Equilon Pipeline Company LLC guaranteed, under certain
circumstances, the obligations of Tex-New Mex under the Purchase and Sale
Agreement dated May 1, 1999. According to Shell Oil Company's 2002 Annual
Report, in 2002, Shell became the sole owner of Equilon, which was merged into
Shell Oil Products US. The three claims filed each included the same supporting
information, consisting of indemnity claims under the Purchase and Sale
Agreement. In essence, there is only one claim of $112 million filed by three
entities and we have objected in our bankruptcy court to having the same claim
filed three times. The amount of the $112 million claim is equivalent to the sum
of the total amount of the proofs of claim filed in our bankruptcy proceedings
by owners of property on which the Tex-New Mex system is located and the
attorneys fees incurred by Tex-New Mex in defending the Kniffen Estates Suit and
other lawsuits (including our bankruptcy proceedings) with respect to the
Tex-New Mex system. The majority of these owners were plaintiffs in the Kniffen
Estates Suit and a group of New Mexico environmental claimants, with whom we
settled during our bankruptcy proceeding and accrued the allowed general
unsecured claim at December 31, 2002. In July of 2003 we entered into an
agreement with Shell, Tex-New Mex and Equilon whereby all of their claims were
either withdrawn, estimated or allowed, leaving the value of the claims
estimated for distribution purposes at $56,924.52. We are currently working to
fully resolve these claims in the bankruptcy claims resolution process.
Environmental Matters
We may experience future releases of crude oil, or other substances into
the environment or discover releases that were previously unidentified. While an
inspection program is maintained on our pipelines to prevent and detect such
releases, and operational safeguards and contingency plans are in place for the
operation of our processing facilities, damages and liabilities incurred due to
any future environmental releases could affect our business. We believe that our
operations and facilities are in substantial compliance with applicable
environmental laws and regulations and that there are no outstanding potential
liabilities or claims relating to safety and environmental matters that we are
currently aware of, the resolution of which, individually or in the aggregate,
would have a materially adverse effect on our financial position or results of
65
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
operations. However, we could be significantly adversely impacted by additional
repair or remediation costs related to the pipeline assets we acquired from
Tex-New Mex if the need for any additional repair or remediation arises and we
do not obtain reimbursement for any such costs as a result of the pending
litigation concerning those assets. Our environmental expenditures include
amounts spent on permitting, compliance and response plans, monitoring and spill
cleanup and other remediation costs. In addition, we could be required to spend
substantial sums to ensure the integrity of and upgrade our pipeline systems,
and in some cases, we may take pipelines out of service if we believe the cost
of upgrades will exceed the value of the pipelines. See Note 12 to the Condensed
Consolidated Financial Statements for further discussion of environmental
matters affecting us.
No assurance can be given as to the ultimate amount or timing of future
expenditures for environmental remediation or compliance, and actual future
expenditures may be different from the amounts currently estimated. In the event
of future increases in costs, we may be unable to pass on those increases to our
customers.
Tax Status
In order for us to be classified as a partnership for federal income tax
purposes, at least 90% of our gross income for every taxable year must consist
of "qualifying income" within the meaning of the Internal Revenue Code. In 2002
and 2003, we recognized income from our settlement with Enron and discharge of
indebtededness in excess of 10% of our gross income for each of those years.
Based on discussions in late 2002 with our outside advisors, and as disclosed in
more detail in our Third Amended Joint Chapter 11 Plan which is incorporated by
reference into our Annual Report on Form 10-K for the year ended December 31,
2002, we concluded that income from our settlement with Enron and our debt
discharge income constituted "qualifying income", although the matter was not
free from doubt.
We believe that to access the capital markets we need a higher degree of
certainty as to our classification for federal income tax purposes. We therefore
have decided to seek a private letter ruling from the Internal Revenue Service
either that the income from our settlement with Enron and the debt discharge
income is qualifying income or that the recognition of such income should be
disregarded for purposes of the qualifying income test because it was an
inadvertent result of our bankruptcy.
We are unable to predict how or when the Internal Revenue Service will
rule. If the ruling is favorable, we will continue to be treated as a
partnership for federal income tax purposes for so long as we satisfy the
qualifying income test. If we are unable to obtain a favorable ruling and are
unsuccessful in litigating the matter should we choose to do so, we will be
taxable as a corporation for the year in which we failed to meet the qualifying
income test and every year thereafter. Any classification of us as a corporation
could result in a material reduction in the value of our units.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America ("GAAP") requires
management to make 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 actual revenues
and expenses during the reporting period. Although we believe these estimates
are reasonable, actual results could differ from those estimates. The
significant accounting policies summarized in Note 2 to the Consolidated
Financial Statements included in our Annual Report on Form 10-K for the year
ended December 31, 2002 were:
- Revenues and Expenses;
- Depreciation and Amortization;
- Impairment of Assets; and
- Contingencies.
66
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
Additional critical accounting policies or changes to existing policies
that occurred since December 31, 2002 are discussed below.
Fresh Start Reporting
We adopted fresh start reporting required by SOP 90-7 as of February 28,
2003 (the date chosen for accounting purposes). In accordance with the
principles of fresh start reporting, we have adjusted our assets and liabilities
to their fair values. We used independent third party financial advisors and
valuation specialists to assist in the determination of the enterprise value of
EOTT, the allocation of our reorganization value to our tangible and
identifiable intangible assets and the fair value of our long-term liabilities.
The valuations were based on a number of estimates and assumptions such as
annual volumes and cash flows, terminal values and discount rates, which are
inherently subject to significant uncertainties and contingencies beyond our
control. Accordingly, there can be no assurance that the valuations will be
realized and actual results could vary significantly. See further discussion in
Note 3 to our Condensed Consolidated Financial Statements.
Energy Trading and Derivative Activities
Prior to the adoption of EITF 02-03, substantially all of our gathering,
marketing and trading activities were accounted for on a fair value basis under
EITF 98-10 or SFAS 133 with changes in fair value included in earnings. EITF
02-03 precludes mark to market accounting for energy trading contracts that are
not derivative instruments pursuant to SFAS 133. See further discussion in Note
13 to the Condensed Consolidated Financial Statements regarding the impact of
adopting EITF 02-03.
Crude Oil Linefill Estimates
Measuring the physical volumes of crude oil linefill in certain of the
pipelines we operate in the West Texas and New Mexico area is inherently
difficult. Because these pipelines are operated under very little pressure,
unlike the vast majority of our other pipelines, we cannot use traditional
engineering based methods to estimate the physical volumes in the system but
instead have utilized certain operational assumptions and topographical
information which take into consideration the measurement limitations. See
further discussion in Note 7 to the Condensed Consolidated Financial Statements.
67
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information contained in Item 3 should be read in conjunction with
information set forth in Part II, Item 7a in our Annual Report on Form 10-K for
the year ended December 31, 2002, in addition to the interim Condensed
Consolidated Financial Statements and accompanying Notes presented in Part I of
this Form 10-Q.
COMMODITY PRICE RISK
We have performed a value at risk analysis of our financial derivative
commodity instruments. Value at risk incorporates numerous variables that could
impact the fair value of our investments, including commodity prices, as well as
correlation within and across these variables. We estimate value at risk
commodity exposures using a parametric model, which captures the exposure
related to open futures contracts. The value at risk method utilizes a one-day
holding period and a 95% confidence level.
Our value at risk for commodity price risk was $0.2 million at September
30, 2003 and less than $0.1 million at December 31, 2002. The value at risk
amount represents financial derivative commodity instruments, primarily
commodity futures contracts, entered into to hedge future physical crude oil
purchase and sale commitments. The commitments to purchase and sell physical
crude oil have not been included in the value at risk computation. At September
30, 2003, we had crude oil futures contracts to purchase 1.3 million barrels of
crude oil and to sell 1.1 million barrels of crude oil, with the majority of
these contracts maturing in the fourth quarter of 2003. At December 31, 2002, we
had crude oil future contracts to purchase 0.3 million barrels of crude oil and
to sell 0.6 million barrels of crude oil, with the majority of these contracts
maturing in the first quarter of 2003.
COMMODITY DERIVATIVE TRANSACTIONS ACCOUNTED FOR AT FAIR VALUE
Generally, as we purchase crude oil, we enter into corresponding sales
transactions involving physical delivery of crude oil to third party users or
corresponding sales transactions on the NYMEX. This process enables us to
minimize our exposure to price risk until we take physical delivery of the crude
oil. In 2002, substantially all of our crude oil and refined products marketing
and trading operations were accounted for on a fair value basis pursuant to SFAS
No. 133 or EITF Issue 98-10. Effective January 1, 2003, energy trading contracts
that are not derivative instruments pursuant to SFAS No. 133 are no longer
accounted for at fair value. Prior to the rescission of EITF 98-10, we accounted
for inventories used in our energy trading activities at fair value.
The following table indicates fair values and changes in fair value of our
commodity derivative transactions (in thousands):
SUCCESSOR COMPANY | PREDECESSOR COMPANY
----------------- | -----------------------------------
|
|
SEVEN MONTHS ENDED | TWO MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, 2003 | FEBRUARY 28, 2003 SEPTEMBER 30, 2002
------------------ | ----------------- ------------------
|
Fair value of contracts at beginning of period.............. $ 1,254 | $ (844) $ (5,597)
Cumulative effect of accounting change...................... -- | (2,389) --
Change in realized and unrealized value..................... (2,614) | 4,114 14,563
Fair value of new contracts entered into during year........ 1,304 | 373 (10,437)
-------------- | ------------- --------------
Fair value of contracts at end of period.................... $ (56) | $ 1,254 $ (1,471)*
============== | ============= ==============
* Approximately $0.4 million of the fair value loss at September 30, 2002
related to physical sales transactions or sales transactions on the NYMEX
entered into to hedge physical inventory. The fair value of inventory is
not included in the table above.
68
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
FAIR VALUE OF COMMODITY DERIVATIVE INSTRUMENTS AT SEPTEMBER 30, 2003
MATURITY GREATER
MATURITY OF 90 THAN 90 DAYS BUT LESS
DAYS OR LESS THAN ONE YEAR TOTAL FAIR VALUE
SOURCE OF FAIR VALUE -------------- --------------------- ----------------
Prices Actively Quoted........................... $ (818) $ (48) $ (866)
*Prices Provided by Other
External Source.............................. 771 39 810
-------------- --------------------- ----------------
Total........................................ $ (47) $ (9) $ (56)
============== ===================== ================
* In determining the fair value of certain contracts, adjustments may be
made to published posting data, for location differentials and quality
basis adjustments.
ITEM 4. CONTROLS AND PROCEDURES
DISCLOSURE CONTROLS AND PROCEDURES
Our management, with the participation of our Chief Executive Officer and
Chief Financial Officer, has evaluated the effectiveness of our disclosure
controls and procedures (as such term is defined in Rules 13a-15(e) and
15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange
Act")) as of the end of the period covered by this report. Based on such
evaluation and except as described below, our Chief Executive Officer and Chief
Financial Officer have concluded that, as of the end of such period, our
disclosure controls and procedures were effective in recording, processing,
summarizing and reporting, on a timely basis, information required to be
disclosed by us in the reports that we file or submit under the Exchange Act.
INTERNAL CONTROL OVER FINANCIAL REPORTING
Except as described below, there have not been any changes in our internal
control over financial reporting (as such term is defined in Rules 13-15(f) and
15d-15(f) under the Exchange Act) during the fiscal quarter to which this report
relates that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
We recently discovered that inventory reconciliations for certain of our
pipelines were not being completed in a timely manner and that reconciling items
were not being appropriately resolved. Upon discovery of this control
deficiency, we undertook a review of our inventory reconciliation controls for
all our Pipeline and Liquids operations. This expanded review identified
additional control deficiencies with inventory and accounts payable
reconciliation procedures in our Liquids operations.
Management has disclosed the foregoing deficiencies in our internal
control over financial reporting to the Audit Committee and to our auditors. We
have implemented and continue to implement changes to our internal control over
financial reporting to address these issues. We have also performed additional
procedures designed to provide reasonable assurance that these control
deficiencies did not lead to a material misstatement in our consolidated
financial statements.
Specifically in response to these issues, we have implemented or plan to
implement the following corrective actions:
- establishing monitoring controls over inventory and accounts payable
reconciliations requiring quarterly supervisory review and approval
of all reconciliations and the disposition of reconciling items;
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LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- evaluating skills of accounting personnel, which could result in
realignment or changes in personnel or supplementing our accounting
and financial reporting resources;
- initiating an internal peer-auditing process of our inventory
reconciliations in our pipeline and liquids accounting group; and
- retaining a major independent accounting firm to assist with the
design and implementation of an internal audit function.
We continue to evaluate methods to improve our internal control over
financial reporting.
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PART II. OTHER INFORMATION
LINK ENERGY LLC
(A LIMITED LIABILITY COMPANY)
ITEM 1. LEGAL PROCEEDINGS
See Part I. Item 1, Note 13 to the Condensed Consolidated Financial
Statements entitled "Commitments and Contingencies," which is incorporated
herein by reference.
In addition to other matters discussed elsewhere in this report, you
should consider the following risk factors, which could cause actual results or
outcomes to differ materially from what is expected:
ITEM 5. OTHER MATTERS
RISK FACTORS RELATING TO OUR BUSINESS
OUR ABILITY TO CONTINUE AS A GOING CONCERN.
We are highly leveraged and have shown no substantive improvement in our
financial performance since emerging from bankruptcy in March 2003. Our
pre-bankruptcy customers and business partners have been less willing to do
business with us than we anticipated and our marketing volumes have not improved
as originally assumed in our Restructuring Plan. Due to these and other factors,
we recently breached various covenants under our credit facilities with respect
to period ended September 30, 2003. Although these breaches have been waived, we
expect to be in default under our credit facilities at November 30, 2003,
December 31, 2003 and perhaps beyond those dates unless our results of
operations show an unexpected significant improvement. There can be no assurance
that our lenders will waive any future breaches under our credit facilities. For
more information, please read Note 2 to our Condensed Consolidated Financial
Statements included elsewhere herein.
The Condensed Consolidated Financial Statements included in this report
have been prepared assuming we will continue as a going concern, which
contemplates the realization of assets and settlement of liabilities in the
normal course of business. The factors discussed above raise substantial doubt
about our ability to continue as a going concern. The Condensed Consolidated
Financial Statements do not include any adjustments that might result from the
outcome of this uncertainty.
WE HAVE RECENTLY EMERGED FROM BANKRUPTCY AND MAY NOT BE ABLE TO RE-ESTABLISH
MARKET CREDIBILITY OR EXECUTE OUR RESTRUCTURING PLAN. CONTINUING LIMITATIONS ON
OUR ABILITY TO OBTAIN CREDIT SUPPORT AND FINANCING FOR OUR WORKING CAPITAL
NEEDS, AS WELL AS OUR HIGH COST OF CREDIT, HAVE RESTRICTED AND ARE EXPECTED TO
CONTINUE TO RESTRICT OUR CRUDE OIL GATHERING AND MARKETING ACTIVITIES.
As a former Enron affiliate, our market credibility has been adversely
affected since Enron's bankruptcy filing and our bankruptcy filing. While we
settled our issues with Enron in our Restructuring Plan, in the near term we
expect continued pressure on our gross profits until we are able to re-establish
our market credibility. Our ability to obtain letters of credit to support our
purchases of crude oil is fundamental to our crude oil gathering and marketing
activities. As a result of the Enron Bankruptcy and our bankruptcy, as well as
the tighter overall energy industry credit environment, our trade creditors have
been less willing to extend credit to us on an unsecured basis. Additionally,
our high cost of credit has affected our ability to compete for additional
volumes. The amount of letters of credit we are required to post has also
increased as a result of the rise in crude oil prices. The amount of letters of
credit is primarily based on volume and crude oil prices. If volumes remain
constant and crude oil prices increase, the dollar amount of letters of credit
will increase. We can give no assurance that we will not be required to further
reduce or restrict our gathering and marketing activities because of continuing
limitations on our ability to obtain credit support and financing for our
working capital needs, as well as the high cost of such support. Any significant
decrease in our financial strength, regardless of the reason for such decrease,
may also increase the number of transactions requiring letters of credit or
other financial support, may make it more difficult for us to obtain such
letters of credit, and/or may increase the cost of obtaining them. This could in
turn adversely affect our ability to maintain our level of purchasing and
marketing activities or otherwise adversely affect our profitability.
WE MAY BE UNABLE TO ARRANGE FUTURE FINANCINGS ON ACCEPTABLE TERMS, WHICH WOULD
LIMIT OUR ABILITY TO REFINANCE OUR EXISTING INDEBTEDNESS, REDUCE OUR CURRENT
DEBT LEVELS, AND FUND OUR FUTURE CAPITAL REQUIREMENTS.
As described in "Management's Discussion and Analysis of Financial
Condition and Results of Operations - Overview - Liquidity/Capital Resources"
and "- Factors Affecting our Liquidity," for the four month period ended
September 30, 2003, we were in violation of two covenants in our Letter of
Credit Facility and Term Loan. In addition, as of September 30, 2003, we
breached the minimum inventory provision of our Commodity Repurchase Agreement.
Our covenant requirements under the Letter of Credit Facility and the Term Loan
Agreement become increasingly stringent each month and we expect we will be in
default under our exit facilities at the end of each month at least through
December 31, 2003 unless our results of operations show an unexpected
significant improvement. A default under one of our exit facilities, which
includes the Letter of Credit Facility, the Term Loan, the Trade Receivables
Agreement and the Commodity Repurchase Agreement, will cause a cross-default
under all the other exit facilities. Any breaches, unless waived, could severely
limit our access to liquidity and result in our being required to repay all
outstanding debt under these debt agreements as well as our 9% senior note
indenture all of which totals approximately $277 million as of September 30,
2003. Although our lenders provided a waiver for our breach of the covenants as
of September 30, 2003 and for our expected breach of these covenants as of
October 31, 2003, there can be no assurance they will provide waivers for any
subsequent period or that any amendment to our credit facilities required to
obtain such waiver will not adversely affect our liquidity.
In addition, our Trade Receivables Agreement and Commodity Repurchase
Agreement mature on March 1, 2004 (although we have an option to extend the
maturity to August 30, 2004) and our Term Loan and Letter of Credit Facility
mature on August 30, 2004. As of September 30, 2003, we had $23 million of
outstanding borrowings under our Trade Receivables Agreement, $75 million of
outstanding borrowings under our Commodity Repurchase Agreement, and $75 million
of borrowings under our Term Loan Agreement. We can provide no assurance that
our lenders will renew these facilities at maturity or that we will be able to
refinance such facilities on more favorable terms. If we are unable to obtain
external financing to refinance this indebtedness on terms that are acceptable
to us, our financial condition and future results of operations could be
adversely affected. In addition, any future indebtedness may include terms that
are more restrictive or burdensome than those of our current indebtedness. These
terms may negatively impact our ability to operate our business.
In order to improve our liquidity, we must reduce our debt and attract new
volumes. We will likely not be able to achieve volume and earnings growth
without reducing our debt by at least $100 million. As part of our efforts to
improve our liquidity, we are evaluating alternatives for raising additional
equity capital, both publicly and privately. Our efforts to raise additional
equity will be limited by a number of factors, including the following:
o Under the terms of our LLC Agreement, we are prohibited from issuing
additional equity without a vote of two-thirds of our unitholders.
o We are unable to issue equity in a public offering or in an offering
pursuant to Regulation D of the Securities Act until we have
satisfied the requirement to have three years of audited financial
statements by completing an audit of our financial statements for
the year ending December 31, 2003.
o We have recognized income from our settlement with Enron and
discharge of indebtedness from our bankruptcy in excess of 10% of
our gross income. We concluded, as disclosed in our Third Amended
Disclosure Statement, that this income constituted "qualifying
income" under the Internal Revenue Code, although the matter was not
free from doubt. We believe that we may not be able to access the
capital markets without a higher degree of certainty of whether this
income is qualifying income and, therefore, we have decided to seek
a private letter ruling from the Internal Revenue Service.
Due to the absence of volume growth in our core business and the amount of
additional equity required to achieve debt reduction of at least $100 million,
if we are able to issue additional equity, we expect we will be required to do
so at prices significantly less than the current trading prices of our units and
warrants.
OUR MARKETING VOLUMES HAVE NOT RETURNED TO PREVIOUSLY EXPECTED LEVELS.
Even though we have the capacity to issue letters of credit to secure
additional volumes, our pre-bankruptcy customers and business partners have been
less willing to do business with us than we anticipated as a result of our being
highly leveraged and having shown no substantive improvement in our financial
performance. Although we assumed that our marketing volumes would increase to
approximately 350,000 barrels per day by the end of 2003, our marketing volumes
were approximately 250,000 barrels per day in September 2003, and we do not
anticipate an appreciable increase in volumes for the remainder of 2003. The
anticipated quick return of volume growth in 2003 contemplated by our
Restructuring Plan has not occurred given the heightened sensitivity to credit
risk in the energy industry and our high credit costs. If we are unable to
improve our future marketing volumes, our results of operations and financial
condition could be adversely affected.
ECONOMIC AND INDUSTRY FACTORS BEYOND OUR CONTROL CAN ADVERSELY AFFECT OUR GROSS
PROFITS.
Historically, our business has been very competitive with thin and
volatile profit margins. The ability to generate margins in the crude oil
marketing business is not tied to the absolute price of crude oil but is
generated by the difference between the price at which crude oil is sold and the
price paid and other costs incurred in the purchase and transportation of the
crude oil. Pipeline tariff revenues are dependent on volumes primarily from our
marketing business. Additionally, gross profits could be affected by the change
in fair value of positions taken, if any. Our gross profits are also affected by
factors beyond our control, including, without limitation:
- the performance of the U.S. and world economies;
- volumes of crude oil produced in the areas we serve;
- demand for oil by refineries and other customers;
- prices for crude oil at various lease locations;
- prices for crude oil futures contracts on the New York Mercantile
Exchange;
- the competitive position of alternative energy sources; and
- the availability of pipeline and other transportation facilities
that may make crude oil production from other producing areas
competitive with crude oil production that we purchase at the lease.
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OUR ABILITY TO MAINTAIN OUR VOLUMES OF CRUDE OIL PURCHASED AT THE LEASE MAY ALSO
BE ADVERSELY AFFECTED BECAUSE OF REDUCED DRILLING AND PRODUCTION ACTIVITY.
Our profitability depends in part on our ability to offset volumes lost
because of natural declines in crude oil production from depleting wells or
volumes lost to competitors. This is particularly difficult in the current
environment of reduced drilling activity and discontinued production operations.
The amount of drilling and production will depend in large part on crude oil
prices. To the extent that low crude oil prices result in lower volumes of lease
crude oil available for purchase, we may experience lower per barrel margins, as
competition for available lease crude oil on the basis of price intensifies. It
is possible that domestic crude oil producers may further reduce or discontinue
drilling and production operations. In addition, a sustained depression in crude
oil prices could result in the bankruptcy of some producers.
OUR ABILITY TO MAINTAIN OR INCREASE OUR GROSS PROFITS IS DEPENDENT ON THE
SUCCESS OF OUR PRICE RISK MANAGEMENT STRATEGIES.
Price risk management strategies, including those involving price hedges
using NYMEX futures contracts, are very important in maintaining or increasing
our gross profits. Hedging techniques require significant resources dedicated to
the management of futures positions and physical inventories. We cannot assure
you that our price risk management strategies will be successful in protecting
us from risks or in maintaining our gross profits at desirable levels.
Furthermore, we have certain basis risks (the risk that price relationships
between delivery points, grades of crude oil or delivery periods will change)
that cannot be completely hedged, and from time to time we enter into
transactions providing for purchases and sales in future periods in which the
volumes of crude oil are balanced, but where either the purchase or the sale
prices are not fixed at the time the transactions are entered into. In these
cases, we are subject to the risk that prices may change or that price changes
will not occur as anticipated.
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OUR PERFORMANCE DEPENDS ON OUR ABILITY TO MINIMIZE BAD DEBTS AND LEGAL LIABILITY
WHEN EXTENDING CREDIT TO OPERATORS AND CUSTOMERS.
When we purchase crude oil at the lease, we often make payment to an
operator who is responsible for the correct payment and distribution of the
proceeds to other parties. If the operator does not have sufficient resources to
indemnify and defend us in case of a protest, action or complaint by those other
parties, our costs could rise. In addition, because we may extend credit to some
customers in large amounts, it is important that our credit review, evaluation
and control mechanisms work properly. Even if our mechanisms work properly, we
cannot assure you that our customers will not experience losses in dealings with
other parties, in which case we could be adversely affected.
ENVIRONMENTAL AND OTHER REGULATORY COSTS AND LIABILITIES COULD AFFECT OUR CASH
FLOW.
Our business is heavily regulated by federal, state and local agencies
with respect to environmental, safety and other matters. This regulation
increases our cost of doing business. We may be subject to substantial penalties
if we fail to comply with any regulation. We cannot assure you that changes
enacted by regulatory agencies that have jurisdiction over us will not increase
our cost of conducting business or otherwise negatively impact our
profitability, cash flow and financial condition. If an accidental leak or spill
occurs from one of our pipelines, at a storage facility or from one of our
operating units, we may have to pay a significant amount to clean up the leak or
spill. The resulting costs and liabilities, net of insurance recovery, if any,
could negatively affect the level of cash available to pay amounts due on our
debt. Although we believe we are in compliance in all material respects with all
applicable environmental laws and regulations, we could be adversely affected by
environmental costs and liabilities that may be incurred or increased costs
resulting from failure to obtain all required regulatory consents and approvals.
As to all of our properties, we cannot assure you that past operating practices,
including those that were state of the art at the time employed, will not result
in significant future environmental liabilities. In particular, we could be
significantly adversely impacted by additional repair or remediation costs
related to the pipeline assets we acquired from Tex-New
73
Mex if the need for any additional repairs or remediation arises and we do not
obtain reimbursement for any such costs as a result of the pending litigation
concerning those assets. See Item 1. "Business - Environmental Matters,"
"Regulation," and Item 3. "Legal Proceedings."
The uncertainty and risk of future terrorist activity may impact our
results of operations and financial condition in unpredictable ways. These
developments have resulted in adverse changes in the insurance markets and
insurance premiums could be increased further or coverages may be unavailable in
the future.
DIFFICULTY IN ATTRACTING QUALIFIED DRIVERS COULD ADVERSELY AFFECT OUR
PROFITABILITY AND OUR ABILITY TO TRANSPORT OUR PRODUCTS TO MARKET.
We rely on qualified drivers to operate our fleet of trucks to transport
our products to market. Periodically, we experience substantial difficulty in
attracting and retaining qualified drivers to transport our products. If we are
unable to attract qualified drivers, our ability to utilize our truck fleet to
transport our products to market may be severely hindered, which could adversely
affect our growth and profitability. We anticipate that the competition for
qualified drivers will continue to be high and we cannot predict whether we will
experience shortages of qualified drivers in the future.
RISK FACTORS RELATING TO OUR LIMITED LIABILITY COMPANY STRUCTURE
OUR UNITS MAY BE SUBJECT TO RESTRAINTS ON LIQUIDITY.
Although we are a public company required to file public reports under the
Securities Exchange Act of 1934, we are not currently listed on any stock
exchange or automated quotation system. As of November 19, 2003, our LLC Units
were being traded over-the-counter and are listed in the Pink Sheets. It is not
our current intention to become listed on a national stock exchange or the
NASDAQ quotation system in the near future, but we may elect to do so at an
appropriate time, assuming we meet any applicable listing requirements.
Consequently, and because of the nature of over-the-counter trading, trading in
our units may be limited, the price of our units could be volatile, and as a
result holders of units may not be able to sell significant quantities of units
at prices posted in the Pink Sheets or in the quantities desired.
WE COULD BE TREATED AS A CORPORATION FOR UNITED STATES INCOME TAX PURPOSES.
In order for us to be classified as a partnership for federal income tax
purposes, at least 90% of our gross income for every taxable year must consist
of "qualifying income" within the meaning of the Internal Revenue Code. We may
not find it possible, regardless of our efforts, to meet this income requirement
or may inadvertently fail to meet this income requirement. Current law may
change to cause us to be treated as a corporation for United States income tax
purposes without regard to our sources of income or otherwise subject us to
entity-level taxation.
In 2002 and 2003, we recognized income from our settlement with Enron and
discharge of indebtededness in excess of 10% of our gross income for each of
those years. Based on discussions in late 2002 with our outside advisors, and as
disclosed in more detail in our Third Amended Joint Chapter 11 Plan and
Disclosure Statement, which is incorporated by reference into our Annual Report
on Form 10-K for the year ended December 31, 2002, we concluded that income from
our settlement with Enron and our debt discharge income constituted "qualifying
income," although the matter was not free from doubt. We believe that we may not
be able to access the capital markets without a higher degree of certainty as to
our classification for federal income tax purposes. We, therefore, have decided
to seek a private letter ruling from the Internal Revenue Service either that
the income from our settlement with Enron and the debt discharge income is
qualifying income or that the recognition of such income should be disregarded
for purposes of the qualifying income test because it was an inadvertent result
of our bankruptcy. We are unable to predict how or when the Internal Revenue
Service will rule. If we are unable to obtain a favorable ruling and are
unsuccessful in litigating the matter should we choose to do so, we will be
taxable as a corporation for the year in which we failed to meet the qualifying
income test and every year thereafter.
74
If we were to be treated as a corporation for United States income tax
purposes, we would pay United States income tax on our income at the corporate
tax rate, which is currently a maximum of 35%, and would pay state income taxes
at varying rates. Distributions to unitholders would generally be taxed as a
corporate dividend. Because a tax would be imposed upon us as a corporation, the
cash available for distribution to a unitholder would be substantially reduced.
Any classification of us as a corporation could result in a material reduction
in the value of our units.
THE LLC STRUCTURE IS RELATIVELY NEW AND COULD BE CHALLENGED.
Because most LLC statutes were only recently enacted, there is little or
no judicial guidance as to their interpretation. This could create uncertainty
regarding the rights and obligations of and among our unitholders, directors and
officers. Also, some doubt as to liability under state law of LLC members in
certain states, combined with absence of case law on the point, creates some
uncertainty as to the possibility of such liability to our unitholders in such
states.
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ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits.
Exhibit 3.1 Certificate of Formation of EOTT Energy LLC, dated as of November 13, 2002 (Incorporated by reference
to Exhibit 3.1 to the Annual Report on Form 10-K of EOTT Energy LLC for the year ended December 31, 2002,
SEC file Number 000-50195).
Exhibit 3.2 Amended and Restated Limited Liability Company Agreement of EOTT Energy LLC, dated as of March 1, 2003
(Incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K of EOTT Energy LLC for the
year ended December 31, 2002, SEC File Number 000-50195).
* Exhibit 3.3 Certificate of Amendment to Certificate of Formation, of EOTT Energy LLC, effective as of October 1, 2003.
* Exhibit 3.4 Amendment No. 1 to Amended and Restated Limited Liability Company Agreement of EOTT Energy LLC, effective as
of October 1, 2003.
* Exhibit 3.5 Certificate of Amendment to Certificate of Formation of EOTT Energy General Partner, L.L.C., effective as of
October 1, 2003.
* Exhibit 3.6 Amendment No. 2 to Limited Liability Company Agreement of EOTT Energy General Partner, L.L.C., effective as of
October 1, 2003.
* Exhibit 3.7 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Operating Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.8 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Operating Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.9 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Canada Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.10 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Canada Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.11 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Pipeline Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.12 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Pipeline Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.13 Certificate of Amendment of Certificate of Incorporation of EOTT Energy Finance Corp., effective as of
October 1, 2003.
+ Exhibit 10.2 Executive Employment Agreement between EOTT Energy LLC and Thomas M. Matthews, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
+ Exhibit 10.3 Executive Employment Agreement between EOTT Energy LLC and H. Keith Kaelber, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
+ Exhibit 10.4 Executive Employment Agreement between EOTT Energy LLC and Dana R. Gibbs, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
* Exhibit 10.5 Amendment No. 1 dated September 29, 2003 to the Letter of Credit Agreement among EOTT Energy Operating
Limited Partnership, EOTT Energy Canada Limited Partnership, EOTT Energy Liquids, L.P., and EOTT Energy
Pipeline Limited Partnership, as joint and several Borrowers, EOTT Energy LLC and EOTT Energy General Partner,
L.L.C., as Guarantors, Standard Chartered Bank, as LC Agent, LC Issuer, and Collateral Agent and the
LC Participants thereto, dated as of February 11, 2003 (the "Letter of Credit Agreement").
* Exhibit 10.7 Amendment No. 1 dated August 29, 2003 to the Second Amended and Restated Commodities Repurchase Agreement,
by and among EOTT Energy Operating Limited Partnership, Standard Chartered Trade Services Corporation,
Standard Chartered Bank, as collateral agent, dated as of February 11, 2003.
* Exhibit 10.8 Amendment No. 1 dated August 29, 2003 to the Second Amended and Restated Receivables Purchase Agreement,
by and among EOTT Energy Operating Limited Partnership, Standard Chartered Trade Services, Standard
Chartered as collateral agent, dated as of February 11, 2003.
*+ Exhibit 10.9 EOTT Energy LLC Equity Incentive Plan.
* Exhibit 31.1 Section 302 Certification of Thomas M. Matthews
* Exhibit 31.2 Section 302 Certification of H. Keith Kaelber
* Exhibit 32.1 Section 906 Certification of Thomas M. Matthews and H. Keith Kaelber
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-Q by Item 601(b)(10)(iii) of
Regulation S-K.
(b) Reports on Form 8-K.
Current Report on Form 8-K filed by EOTT Energy LLC on July 9, 2003
pursuant to Item 5. Other Events regarding its press release dated July 7, 2003
announcing James Allred as new EOTT Energy Vice President and Treasurer.
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Current Report on Form 8-K filed by EOTT Energy LLC on July 10, 2003
pursuant to Item 5. Other Events regarding its press release dated July 9, 2003
announcing the jury award related to litigation against Texas New Mexico
Pipeline Company.
Current Report on Form 8-K filed by EOTT Energy LLC on August 28, 2003
pursuant to Item 5. Other Events regarding its press release dated August 28,
2003 announcing that EOTT Energy restructuring plan was upheld in court and the
Shell Oil appeal was denied.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
LINK ENERGY LLC
(A Delaware Limited Liability Company)
Date: November 19, 2003
/s/ H. KEITH KAELBER
H. Keith Kaelber
Executive Vice President and
Chief Financial Officer
78
INDEX TO EXHIBITS
EXHIBIT NUMBER DESCRIPTION
Exhibit 3.1 Certificate of Formation of EOTT Energy LLC, dated as of November 13, 2002 (Incorporated by reference
to Exhibit 3.1 to the Annual Report on Form 10-K of EOTT Energy LLC for the year ended December 31, 2002,
SEC file Number 000-50195).
Exhibit 3.2 Amended and Restated Limited Liability Company Agreement of EOTT Energy LLC, dated as of March 1, 2003
(Incorporated by reference to Exhibit 3.2 to the Annual Report on Form 10-K of EOTT Energy LLC for the
year ended December 31, 2002, SEC File Number 000-50195).
* Exhibit 3.3 Certificate of Amendment to Certificate of Formation, of EOTT Energy LLC, effective as of October 1, 2003.
* Exhibit 3.4 Amendment No. 1 to Amended and Restated Limited Liability Company Agreement of EOTT Energy LLC, effective as
of October 1, 2003.
* Exhibit 3.5 Certificate of Amendment to Certificate of Formation of EOTT Energy General Partner, L.L.C., effective as of
October 1, 2003.
* Exhibit 3.6 Amendment No. 2 to Limited Liability Company Agreement of EOTT Energy General Partner, L.L.C., effective as of
October 1, 2003.
* Exhibit 3.7 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Operating Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.8 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Operating Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.9 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Canada Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.10 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Canada Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.11 Certificate of Amendment to Certificate of Limited Partnership of EOTT Energy Pipeline Limited Partnership,
effective as of October 1, 2003.
* Exhibit 3.12 Amendment No. 3 to Amended and Restated Agreement of Limited Partnership of EOTT Energy Pipeline Limited
Partnership, effective as of October 1, 2003.
* Exhibit 3.13 Certificate of Amendment of Certificate of Incorporation of EOTT Energy Finance Corp., effective as of
October 1, 2003.
+ Exhibit 10.2 Executive Employment Agreement between EOTT Energy LLC and Thomas M. Matthews, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.2 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
+ Exhibit 10.3 Executive Employment Agreement between EOTT Energy LLC and H. Keith Kaelber, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.3 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
+ Exhibit 10.4 Executive Employment Agreement between EOTT Energy LLC and Dana R. Gibbs, effective as of July 1, 2003
(Incorporated by reference to Exhibit 10.4 to the Quarterly Report on Form 10-Q of EOTT Energy LLC for the
quarterly period ended June 30, 2003, SEC File Number 000-50195).
* Exhibit 10.5 Amendment No. 1 dated September 29, 2003 to the Letter of Credit Agreement among EOTT Energy Operating
Limited Partnership, EOTT Energy Canada Limited Partnership, EOTT Energy Liquids, L.P., and EOTT Energy
Pipeline Limited Partnership, as joint and several Borrowers, EOTT Energy LLC and EOTT Energy General Partner,
L.L.C., as Guarantors, Standard Chartered Bank, as LC Agent, LC Issuer, and Collateral Agent and the
LC Participants thereto, dated as of February 11, 2003 (the "Letter of Credit Agreement").
* Exhibit 10.7 Amendment No. 1 dated August 29, 2003 to the Second Amended and Restated Commodities Repurchase Agreement,
by and among EOTT Energy Operating Limited Partnership, Standard Chartered Trade Services Corporation,
Standard Chartered Bank, as collateral agent, dated as of February 11, 2003.
* Exhibit 10.8 Amendment No. 1 dated August 29, 2003 to the Second Amended and Restated Receivables Purchase Agreement,
by and among EOTT Energy Operating Limited Partnership, Standard Chartered Trade Services, Standard
Chartered as collateral agent, dated as of February 11, 2003.
*+ Exhibit 10.9 EOTT Energy LLC Equity Incentive Plan.
* Exhibit 31.1 Section 302 Certification of Thomas M. Matthews
* Exhibit 31.2 Section 302 Certification of H. Keith Kaelber
* Exhibit 32.1 Section 906 Certification of Thomas M. Matthews and H. Keith Kaelber
* Filed herewith.
+ Management contract or compensatory plan or arrangement required to be
filed as an exhibit to this Form 10-Q by Item 601(b)(10)(iii) of
Regulation S-K.
82