Item 8. Financial Statements and Supplementary Data

 

Report of Independent Registered Public Accounting Firm

Report of Independent Registered Public Accounting Firm

 

The Partners
Crosstex Energy, L.P.:

 

We have audited Crosstex Energy, L.P.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Partnership’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Partnership’s internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of the Partnership as of December 31, 2008 and 2007, and the related consolidated statements of operations, stockholders’ equity, comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated March 2, 2009 expressed an unqualified opinion on those consolidated financial statements.

 

 

Dallas, Texas

March 2, 2009

CROSSTEX ENERGY, L.P.

 

Consolidated Balance Sheets

 

 

See accompanying notes to consolidated financial statements.

CROSSTEX ENERGY, L.P.

 

Consolidated Statements of Operations

 

 

See accompanying notes to consolidated financial statements.

 

CROSSTEX ENERGY, L.P.

 

Consolidated Statements of Changes in Partners’ Equity
Years ended December 31, 2008, 2007 and 2006

 

 

See accompanying notes to consolidated financial statements.

 

CROSSTEX ENERGY, L.P.

 

Consolidated Statements of Comprehensive Income

 

 

See accompanying notes to consolidated financial statements.

CROSSTEX ENERGY, L.P.

 

Consolidated Statements of Cash Flows

 

 

See accompanying notes to consolidated financial statements.

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements
December 31, 2008 and 2007

 

 

 

Crosstex Energy, L.P., a Delaware limited partnership formed on July 12, 2002, is engaged in the gathering, transmission, processing and marketing of natural gas and natural gas liquids (NGLs). The Partnership connects the wells of natural gas producers in the geographic areas of its gathering systems in order to gather for a fee or purchase the gas production, processes natural gas for the removal of NGLs, transports natural gas and NGLs and ultimately provides natural gas and NGLs to a variety of markets. In addition, the Partnership purchases natural gas and NGLs from producers not connected to its gathering systems for resale and markets natural gas and NGLs on behalf of producers for a fee.

 

 

Crosstex Energy GP, L.P., the general partner of the Partnership, is an indirect wholly-owned subsidiary of Crosstex Energy, Inc. (CEI). As of December 31, 2008, CEI owns 16,414,830 common units in the Partnership through its wholly-owned subsidiaries. As of December 31, 2008, CEI owned 34.0% of the limited partner interests in the Partnership and officers and directors owned 1.02% of the limited partnership interests. The remaining units are held by the public.

 

 

The accompanying consolidated financial statements include the assets, liabilities, and results of operations of the Partnership and its wholly-owned subsidiaries. The Partnership proportionately consolidates its undivided 59.27% interest in a gas processing plant acquired by the Partnership in November 2005 (23.85%) and May 2006 (35.42%). In January 2004, the Partnership adopted FASB ASC 810-10-05-8 and began consolidating its joint venture interest in Crosstex DC Gathering, J.V. (CDC) as discussed more fully in Note 5. The consolidated operations are hereafter referred to herein collectively as the “Partnership.” All material intercompany balances and transactions have been eliminated. Certain reclassifications have been made to the consolidated financial statements for the prior years to conform to the current presentation.

 

 

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management of the Partnership 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 revenues and expenses during the period. Actual results could differ from these estimates.

 

 

The Partnership considers all highly liquid investments with an original maturity of three months or less to be cash equivalents.

 

 

The Partnership’s inventories of products consist of natural gas and NGLs. The Partnership reports these assets at the lower of cost or market.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

 

Property, plant and equipment consist of intrastate gas transmission systems, gas gathering systems, industrial supply pipelines, NGL pipelines, natural gas processing plants and NGL fractionation plants.

 

Other property and equipment is primarily comprised of computer software and equipment, furniture, fixtures, leasehold improvements and office equipment. Property, plant and equipment are recorded at cost. Gas required to maintain pipeline minimum pressures is capitalized and classified as property, plant and equipment. Repairs and maintenance are charged against income when incurred. Renewals and betterments, which extend the useful life of the properties, are capitalized. Interest costs are capitalized to property, plant and equipment during the period the assets are undergoing preparation for intended use. Interest costs totaling $2.7 million, $4.8 million, and $5.4 million were capitalized for the years ended December 31, 2008, 2007 and 2006, respectively.

 

Depreciation is provided using the straight-line method based on the estimated useful life of each asset, as follows:

 

 

Depreciation expense of $76.1 million, $57.0 million and $43.2 million was recorded for the years ended December 31, 2008, 2007 and 2006, respectively.

 

Financial Accounting Standards Board Accounting Standards Codification (ASC) 360-10-05-4 requires long-lived assets to be reviewed whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In order to determine whether an impairment has occurred, the Partnership compares the net book value of the asset to the undiscounted expected future net cash flows. If an impairment has occurred, the amount of such impairment is determined based on the expected future net cash flows discounted using a rate commensurate with the risk associated with the asset.

 

When determining whether impairment of one of our long-lived assets has occurred, the Partnership must estimate the undiscounted cash flows attributable to the asset. The Partnership’s estimate of cash flows is based on assumptions regarding the purchase and resale margins on natural gas, volume of gas available to the asset, markets available to the asset, operating expenses, and future natural gas prices and NGL product prices. The amount of availability of gas to an asset is sometimes based on assumptions regarding future drilling activity, which may be dependent in part on natural gas prices. Projections of gas volumes and future commodity prices are inherently subjective and contingent upon a number of variable factors. Any significant variance in any of the above assumptions or factors could materially affect our cash flows, which could require us to record an impairment of an asset.

 

The Partnership recorded impairments to long-lived assets of $24.6 million during the year ending December 31, 2008. See Note 3(c) for further details on the long-lived assets impaired. No impairments were incurred during the years ended December 31, 2007 and 2006.

 

FASB ASC 360-10-05-4 also requires long-lived assets being held for sale or disposed of to be presented in the financial statements separately. During the third quarter of 2008 the Partnership held for sale its undivided 12.4% interest in the Seminole gas processing plant. The sale was finalized on November 17, 2008. All operating results for the Seminole plant are recorded in discontinued operating income and the gain on the disposition of the plant is recorded in gain on sale of discontinued operations. See Note 3(d) for further

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

information on discontinued operations related to the Seminole plant. Details related to other discontinued operations and assets and liabilities held for sale are disclosed in Note 3(d).

 

 

The Partnership had approximately $4.9 million of goodwill at December 31, 2007. Goodwill created in the formation of the Partnership of $4.9 million net book value associated with the Midstream assets was impaired during the year ending December 31, 2008. See Note 4 for further details on the impairment of goodwill on the Midstream assets.

 

Intangible assets consist of customer relationships and the value of the dedicated and non-dedicated acreage attributable to pipeline, gathering and processing systems. The Chief acquisition, as discussed in Note 3(a), included $395.6 million of such intangibles, including the Devon Energy Corporation (Devon) gas gathering agreement. Intangible assets other than the intangibles associated with the Chief acquisition are amortized on a straight-line basis over the expected period of benefits of the customer relationships, which range from three to 15 years. The intangible assets associated with the Chief acquisition are being amortized using the units of throughput method of amortization. The weighted average amortization period for intangible assets is 17.7 years. Amortization of intangibles was approximately $31.4 million, $26.4 million and $13.2 million for the years ended December 31, 2008, 2007 and 2006, respectively.

 

The following table summarizes the Company’s estimated aggregate amortization expense for the next five years (in thousands):

 

 

 

Unamortized debt issuance costs totaling $11.7 million and $9.6 million as of December 31, 2008 and 2007, respectively, are included in other assets, net. Debt issuance costs are amortized into interest expense using the effective-interest method over the term of the debt for the senior secured notes. Debt issuance costs are amortized using the straight-line method over the term of the debt for the bank credit facility because borrowings under the bank credit facility cannot be forecasted for an effective-interest computation.

 

 

Quantities of natural gas and NGLs over-delivered or under-delivered related to imbalance agreements are recorded monthly as receivables or payables using weighted average prices at the time of the imbalance. These imbalances are typically settled with deliveries of natural gas or NGLs. The Partnership had imbalance payables of $7.1 million and $9.4 million at December 31, 2008 and 2007, respectively, which approximate the fair value of these imbalances. The Partnership had imbalance receivables of $3.9 million at December 31, 2008 and 2007, which are carried at the lower of cost or market value.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

 

FASB ASC 410-20-25-16 was issued March 2005 which became effective at December 31, 2005. FASB ASC 410-20-25-16 clarifies that the term “conditional asset retirement obligation” as used in FASB ASC 410-20 refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Since the obligation to perform the asset retirement activity is unconditional, FASB ASC 410-20-25-16 provides that a liability for the fair value of a conditional asset retirement activity should be recognized if that fair value can be reasonably estimated, even though uncertainty exists about the timing and/or method of settlement. FASB ASC 410-20-25-16 also clarifies when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation under FASB ASC 410-20. The Partnership did not provide any asset retirement obligations as of December 31, 2008 or 2007 because it does not have sufficient information as set forth in FASB ASC 410-20-25-16 to reasonably estimate such obligations and the Partnership has no current intention of discontinuing use of any significant assets.

 

 

The Partnership recognizes revenue for sales or services at the time the natural gas, or NGLs are delivered or at the time the service is performed. The Partnership generally accrues one to two months of sales and the related gas purchases and reverses these accruals when the sales and purchases are actually invoiced and recorded in the subsequent months. Actual results could differ from the accrual estimates. The Partnership’s purchase and sale arrangements are generally reported in revenues and costs on a gross basis in the statements of operations in accordance with FASB ASC 605-45-45-1. Except for fee based arrangements and the Partnership’s energy trading activities related to its “off-system” gas marketing operations discussed in Note 2(k), the Partnership acts as the principal in these purchase and sale transactions, has the risk and reward of ownership as evidenced by title transfer, schedules the transportation and assumes credit risk.

 

The Partnership accounts for taxes collected from customers attributable to revenue transactions and remitted to government authorities on a net basis (excluded from revenues).

 

 

The Partnership uses derivatives to hedge against changes in cash flows related to product price and interest rate risks, as opposed to their use for trading purposes. FASB ASC 815 requires that all derivatives be recorded on the balance sheet at fair value. We generally determine the fair value of futures contracts and swap contracts based on the difference between the derivative’s fixed contract price and the underlying market price at the determination date. The asset or liability related to the derivative instruments is recorded on the balance sheet in fair value of derivative assets or liabilities.

 

Realized and unrealized gains and losses on derivatives that are not designated as hedges, as well as the ineffective portion of hedge derivatives, are recorded as gain or loss on derivatives in the consolidated statement of operations. Unrealized gains and losses on effective cash flow hedge derivatives are recorded as a component of accumulated other comprehensive income. When the hedged transaction occurs, the realized gain or loss on the hedge derivative is transferred from accumulated other comprehensive income to earnings. Realized gains and losses on commodity hedge derivatives are recognized in revenues, and realized gains and losses on interest hedge derivatives are recorded as adjustments to interest expense. Settlements of derivatives are included in cash flows from operating activities.

 

 

The Partnership conducts “off-system” gas marketing operations as a service to producers on systems that the Partnership does not own. The Partnership refers to these activities as its energy trading activities. In

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

some cases, the Partnership earns an agency fee from the producer for arranging the marketing of the producer’s natural gas or NGLs. In other cases, the Partnership purchases the natural gas or NGLs from the producer and enters into a sales contract with another party to sell the natural gas or NGLs. The revenue and cost of sales for energy trading activities are shown net in the consolidated statement of operations.

 

The Partnership manages its price risk related to future physical purchase or sale commitments for its energy trading activities by entering into either corresponding physical delivery contracts or financial instruments with an objective to balance the Partnership’s future commitments and significantly reduce its risk to the movement in natural gas and NGL prices. However, the Partnership is subject to counter-party risk for both the physical and financial contracts. The Partnership’s energy trading contracts qualify as derivatives, and accordingly, the Partnership continues to use mark-to-market accounting for both physical and financial contracts of its energy trading activities. Accordingly, any gain or loss associated with changes in the fair value of derivatives and physical delivery contracts relating to the Partnership’s energy trading activities are recognized in earnings as gain or loss on derivatives immediately.

 

Net margins earned on settled contracts from the Partnership’s energy trading activities included in profit on energy trading activities in the consolidated statement of operations were $3.4 million, $4.1 million and $2.5 million for the years ended December 31, 2008, 2007 and 2006, respectively.

 

Energy trading contract volumes that were physically settled were as follows (in MMBtus):

 

 

 

Comprehensive income includes net income (loss) and other comprehensive income, which includes, but is not limited to, unrealized gains and losses on marketable securities, foreign currency translation adjustments, minimum pension liability adjustments and unrealized gains and losses on derivative financial instruments.

 

Pursuant to FASB ASC 815, the Partnership records deferred hedge gains and losses on its derivative financial instruments that qualify as cash flow hedges as other comprehensive income.

 

 

Legal costs incurred in connection with a loss contingency are expensed as incurred.

 

 

Financial instruments, which potentially subject the Partnership to concentrations of credit risk, consist primarily of trade accounts receivable and derivative financial instruments. Management believes the risk is limited since the Partnership’s customers represent a broad and diverse group of energy marketers and end users. In addition, the Partnership continually monitors and reviews credit exposure to its marketing counter-parties and letters of credit or other appropriate security are obtained as considered necessary to limit the risk of loss. The Partnership records reserves for uncollectible accounts on a specific identification basis since there is not a large volume of late paying customers. The Partnership had a reserve for uncollectible receivables as of December 31, 2008, 2007 and 2006 of $3.7 million, $1.0 million and $0.6 million, respectively. The increase in reserve in 2008 primarily relates to SemStream, L.P. See Note 16(e) for a discussion of the bankruptcy filing of SemStream, L.P. and related subsidiaries.

 

During 2008, 2007 and 2006 Dow Hydrocarbons accounted for 11.0%, 11.8% and 13.4%, respectively, of the consolidated revenue of the Partnership including discontinued operations. As the Partnership

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

continues to grow and expand, the relationship between individual customer sales and consolidated total sales is expected to continue to change. While this customer represents a significant percentage of revenues, the loss of this customer would not have a material adverse impact on the Partnership’s results of operations.

 

 

Environmental expenditures are expensed or capitalized as appropriate, depending on the nature of the expenditures and their future economic benefit. Expenditures that related to an existing condition caused by past operations that do not contribute to current or future revenue generation are expensed. Liabilities for these expenditures are recorded on an undiscounted basis (or a discounted basis when the obligation can be settled at fixed and determinable amounts) when environmental assessments or clean-ups are probable and the costs can be reasonably estimated. For the years ended December 31, 2008, 2007 and 2006, such expenditures were not significant.

 

 

Effective January 1, 2006, the Partnership adopted the provisions of FASB ASC 718 which requires compensation related to all stock-based awards, including stock options, be recognized in the consolidated financial statements.

 

The Partnership elected to use the modified-prospective transition method for adopting ASC 718. Under the modified-prospective method, awards that are granted, modified, repurchased, or canceled after the date of adoption are measured and accounted for under ASC 718. The unvested portion of awards that were granted prior to the effective date are also accounted for in accordance with ASC 718. Under ASC 718, the Partnership is required to estimate forfeitures in determining periodic compensation cost. The cumulative effect of the adoption of ASC 718 recognized on January 1, 2006 was an increase in net income of $0.7 million due to the reduction in previously recognized compensation costs associated with the estimation of forfeitures.

 

The Partnership and CEI each have similar unit or share-based payment plans for employees, which are described below. Share-based compensation associated with the CEI share-based compensation plans awarded to officers and employees of the Partnership are recorded by the Partnership since CEI has no operating activities other than its interest in the Partnership. Amounts recognized in the consolidated financial statements with respect to these plans are as follows (in thousands):

 

 

The fair value of each option is estimated on the date of grant using the Black Scholes option-pricing model as disclosed in Note 11 — Employee Incentive Plans.

 

 

The Consolidated Statements of Operations and related earnings per unit have been revised to segregate income related to assets sold in 2009 to discontinued operations and reclassify letter of credit fees from purchased gas expense to interest expense. Discontinued operations as originally reported consisted of the financial activities

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

of the Seminole Gas Processing Plant. During 2009 the Partnership disposed of additional assets and the financial activities of these assets have now been included in discontinued operations in the recast Consolidated Statements of Operations for all periods presented (see Note 3(d)). These assets were held for sale and the final sale concluded during 2009. Additionally, letter of credit fees of $1.5 million, $1.3 million and $0.6 million for the years ended December 31, 2008, 2007, and 2006 respectively, were reclassified from purchased gas expense to interest expense in the Consolidated Statements of Operations to more clearly reflect the cost of financing.

 

 

The Partnership has recast its consolidated financial statements as of December 31, 2008, 2007 and 2006 for the adoption of FASB ASC 260-10-45-60 issued June 2008 which requires unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents to be treated as participating securities as defined in FASB ASC 260-10-20 and for the adoption of FASB ASC 810-10-65-1 issued December 2007 which requires non-controlling interests to be treated as a separate component of equity, not as a liability or other item outside of permanent equity.

 

In addition, FASB ASC 260-10-55-102 addresses the consensus reached by the Task Force that incentive distribution rights (IDRs) in a typical master limited partnership are participating securities under FASB ASC 260, but earnings in excess of the partnership’s “available cash” should not be allocated to the IDR holders for purposes of calculating earnings-per-share using the two-class method when “available cash” represents a specified threshold that limits participation. The consensus only applies when payments to IDR holders are accounted for as equity distributions. The consensus is effective for fiscal years beginning after December 15, 2008 and applied retrospectively to all periods presented. Under our partnership agreement, “available cash” is a specified threshold that limits participation for IDR holders. Therefore earnings in excess of our “available cash” during the periods presented were not allocated to IDR holders.

 

 

As a result of the recent credit crisis, FASB ASC 820-10-35-15A was issued October 2008 and clarifies the application of FASB ASC 820 in a market that is not active and provides guidance on how observable market information in a market that is not active should be considered when measuring fair value, as well as how the use of market quotes should be considered when assessing the relevance of observable and unobservable data available to measure fair value. FASB ASC 820-10-35-15A is effective upon issuance, for companies that have adopted FASB ASC 820. The Partnership has evaluated FASB ASC 820-10-35-15A and determined that this standard has no impact on its results of operations, cash flows or financial position for this reporting period.

 

FASB ASC 260-10-45-60 was issued June 2008 and requires unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents to be treated as participating securities as defined in FASB ASC 260-10-20 and, therefore, included in the earnings allocation in computing earnings per share under the two-class method described in FASB ASC 260. FASB ASC 260-10-45-60 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. Upon adoption, the Partnership will consider restricted shares with nonforfeitable dividend rights in the calculation of earnings per share and will adjust all prior reporting periods retrospectively to conform to the requirements, although the impact should not be material.

 

FASB ASC 825-10-05-5 was issued February 2007 and permits entities to choose to measure many financial assets and financial liabilities at fair value. Changes in the fair value on items for which the fair value option has been elected are recognized in earnings each reporting period. FASB ASC 825-10-05-5 also establishes presentation and disclosure requirements designed to draw comparisons between the different measurement attributes elected for similar types of assets and liabilities. FASB ASC 825-10-05-5 was adopted effective January 1, 2008 and did not have a material impact on our financial statements.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

FASB ASC 805 and FASB ASC 810-10-65-1 were issued December 2007. FASB ASC 805 requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value.” The Statement applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under FASB ASC 805 all business combinations will be accounted for by applying the acquisition method. FASB ASC 805 is effective for periods beginning on or after December 15, 2008. FASB ASC 810-10-65-1 will require noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. The statement applies to the accounting for noncontrolling interests and transactions with noncontrolling interest holders in consolidated financial statements. FASB ASC 810-10-65-1 is effective for periods beginning on or after December 15, 2008 and will be applied prospectively to all noncontrolling interests, including any that arose before the effective date, except that comparative period information must be recast to classify noncontrolling interests in equity, attribute net income and other comprehensive income to noncontrolling interests and provide other disclosures required by FASB ASC 810-10-65-1.

 

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States of America. SFAS No. 162 is effective for fiscal years beginning after November 15, 2008. The Partnership is currently evaluating the potential impact, if any, of the adoption of SFAS No. 162 on our consolidated financial statements.

 

FASB ASC 815-10-65-1 was issued March 2008 and requires entities to provide greater transparency about how and why the entity uses derivative instruments, how the instruments and related hedged items are accounted for under FASB ASC 815 and how the instruments and related hedged items affect the financial position, results of operations and cash flows of the entity. FASB ASC 815-10-65-1 is effective for fiscal years beginning after November 15, 2008. The principal impact to the Partnership will be to require expanded disclosure regarding derivative instruments.

 

 

 

On June 29, 2006, the Partnership expanded its operations in the north Texas area through the acquisition of the natural gas gathering pipeline systems and related facilities of Chief Holdings, LLC or Chief in the Barnett Shale for $475.3 million. The acquired systems, which we refer to in conjunction with the NTP and other facilities in the area as the north Texas assets, included gathering pipeline, a 125 MMcf/d carbon dioxide treating plant and compression facilities with 26,000 horsepower.

 

The Partnership financed the Chief acquisition with borrowings of approximately $105.0 million under its bank credit facility, net proceeds of approximately $368.3 million from the private placement of senior subordinated series C units, including approximately $9.0 million of equity contributions from Crosstex Energy GP, L.P., the general partner of the Partnership and an indirect subsidiary of CEI, and $6.0 million of cash.

 

Simultaneously with the Chief acquisition, the Partnership entered into a gas gathering agreement with Devon Energy Corporation (Devon) whereby the Partnership has agreed to gather, and Devon has agreed to dedicate and deliver, the future production on acreage that Devon acquired from Chief (approximately 160,000 net acres). Under the agreement, Devon has committed to deliver all of the production from the dedicated acreage into the gathering system, including production from current wells and wells that it drills in the future. The Partnership will expand the gathering system to reach the new wells as they are drilled. The

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

agreement has a 15-year term and provides for fixed gathering fees over the term. In addition to the Devon agreement, approximately 60,000 additional net acres were dedicated to the NTG Assets under agreements with other producers.

 

 

In November 2008, the Partnership sold a contract right for firm transportation capacity on a third party pipeline to an unaffiliated third party for $20.0 million. The entire amount of such proceeds is reflected in other income in the consolidated statement of operations.

 

 

Impairments of $24.6 million were recorded in the year ended December 31, 2008 related to long-lived assets. The impairments are comprised of:

 

 

 

As part of the Partnership’s strategy to increase liquidity in response to the tightening financial markets, the Partnership began marketing a non-strategic asset for sale in late September 2008. In early October 2008, the Partnership entered into an agreement to sell its undivided 12.4% interest in the Seminole gas processing plant to a third party for $85.0 million. The transaction was completed on November 17, 2008. This asset was previously presented in the Partnership’s Treating segment. The consolidated balance sheets at December 31, 2008 and 2007 do not reflect the asset held for sale due to the fact that the decision to dispose of the asset occurred after December 31, 2007, and the sale was completed prior to December 31, 2008.

 

During 2009, the Partnership sold certain non-strategic assets and used the proceeds from such sales to reduce long-term indebtedness.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

The Partnership sold its Midstream assets in Alabama, Mississippi and south Texas for net proceeds of $218.4 million (after final purchase price adjustments) in August 2009. Sales proceeds, net of transaction costs and other obligations associated with the sale, of $212.0 million were used to repay long-term indebtedness and the Partnership recognized a gain on sale of $97.2 million. On October 1, 2009, the Partnership sold its Treating assets for net proceeds of $265.4 million (after final purchase price adjustments). Sales proceeds, net of transaction costs and other obligations associated with the sale, of $258.1 million were used to repay long-term indebtedness and the Partnership recognized a gain on sale of $86.3 million.

 

The revenues, operating expenses, general and administrative expenses associated directly with the sold assets, depreciation and amortization expense, allocated Texas margin tax and an allocated interest expense related to the operations of the sold assets have been segregated from continuing operations and reported as discontinued operations for all periods. No corporate office general and administrative expenses have been allocated to income from discontinued operations. Following are revenues and income from discontinued operations (in thousands):

 

 

 

 

 

As of December 31, 2006 and 2007, the carrying amount of goodwill was considered recoverable. In the fourth quarter of 2008, the Partnership determined that the carrying amount of goodwill attributable to the Midstream segment was impaired because of the significant decline in its Midstream operations due to the significant declines in natural gas and NGL prices during the last half of 2008 coupled with the global economic decline. The Partnership determined the estimated fair value of the Midstream reporting unit by calculating the present value of its estimated future cash flows. The Partnership determined the implied fair value of goodwill associated with the Midstream reporting unit by subtracting the estimated fair value of the tangible assets and intangible assets associated with the Midstream reporting unit from the estimated fair value of the unit. The Partnership recognized an impairment loss of $4.9 million in the Midstream segment for the year ended December 31, 2008.

 

 

The Partnership owns a majority interest in Crosstex Denton County Joint Venture (CDC) and consolidates its investment in CDC pursuant to FASB ASC 810-10-05-8. The Partnership manages the business affairs of CDC. The other joint venture partner (the CDC partner) is an unrelated third party who owns and operates a natural gas field located in Denton County, Texas.

 

In connection with the formation of CDC, the Partnership agreed to loan the CDC partner up to $1.5 million for its initial capital contribution. The loan bears interest at an annual rate of prime plus 2%. CDC makes payments directly to the Partnership attributable to CDC partner’s share of distributable cash flow to repay the loan. The balance remaining on the note of $0.4 million is included in current notes receivable as of December 31, 2008.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

 

As of December 31, 2008 and 2007, long-term debt consisted of the following (in thousands):

 

 

Credit Facility.  In September 2007, the Partnership increased borrowing capacity under the bank credit facility to $1.185 billion. The bank credit facility matures in June 2011. As of December 31, 2008, $850.4 million was outstanding under the bank credit facility, including $66.4 million of letters of credit, leaving approximately $334.6 million available for future borrowing.

 

Obligations under the bank credit facility are secured by first priority liens on all of the Partnership’s material pipeline, gas gathering and processing assets, all material working capital assets and a pledge of all of the Partnership’s equity interests in substantially all of its subsidiaries, and rank pari passu in right of payment with the senior secured notes. The bank credit facility is guaranteed by the Partnership’s material subsidiaries. The Partnership may prepay all loans under the credit facility at any time without premium or penalty (other than customary LIBOR breakage costs), subject to certain notice requirements.

 

On November 7, 2008, the Partnership entered into the Fifth Amendment and Consent (the “Fifth Amendment”) to its credit facility with Bank of America, N.A., as administrative agent, and the banks and other parties thereto (the “Bank Lending Group”). The Fifth Amendment amended the agreement governing its credit facility to, among other things, (i) increase the maximum permitted leverage ratio it must maintain for the fiscal quarters ending December 31, 2008 through September 30, 2009, (ii) lower the minimum interest coverage ratio it must maintain for the fiscal quarter ending December 31, 2008 and each fiscal quarter thereafter, (iii) permit it to sell certain assets, (iv) increase the interest rate it pays on the obligations under the credit facility and (v) lower the maximum permitted leverage ratio it must maintain if the Partnership or its subsidiaries incur unsecured note indebtedness.

 

Due to the continued decline in commodity prices and the deterioration in the processing margins, the Partnership determined that there was a significant risk that the amended terms negotiated in November 2008 would not be sufficient to allow it to operate during 2009 without triggering a covenant default under our bank facility and the senior secured note agreement. On February 27, 2009, the Partnership entered into the Sixth Amendment to the Fourth Amended and Restated Credit Agreement and Consent (the “Sixth Amendment”) to its credit facility with Bank Lending Group. Under the Sixth Amendment, borrowings will bear interest at its option at the administrative agent’s reference rate plus an applicable margin or London Interbank Offering Rate (LIBOR) plus an applicable margin. The applicable margins for the Partnership’s interest rate and letter of credit fees vary quarterly based on the Partnership’s leverage ratio as defined by the credit facility (the “Leverage Ratio” generally being computed as total funded debt to consolidated earnings

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

before interest, taxes, depreciation, amortization and certain other non-cash charges) and are as follows beginning February 27, 2009:

 

 

 

 

The Sixth Amendment also sets a floor for the LIBOR interest rate of 2.75% per annum, which means, effective as of February 27, 2009, borrowings under the bank credit facility accrue interest at the rate of 6.75% based on the LIBOR rate in effect on such date and our current leverage ratio. Based on the Partnership’s forecasted leverage ratios for 2009, it expects the applicable margins to be at the high end of these ranges for its interest rate and letter of credit fees.

 

Pursuant to the Sixth Amendment, the Partnership must pay a leverage fee if it does not prepay debt and permanently reduce the banks’ commitments by the cumulative amounts of $100.0 million on September 30, 2009, $200.0 million on December 31, 2009 and $300.0 million on March 31, 2010. If it fails to meet any de-leveraging target, it must pay a leverage fee on such date, equal to the product of the aggregate commitments outstanding under its bank credit facility and the outstanding amount of senior secured note agreement on such date, and 1.0% on September 30, 2009, 1.0% on December 31, 2009 and 2.0% on March 31, 2010. This leverage fee will accrue on the applicable date, but not be payable until the Partnership refinances its bank credit facility.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

Under the Sixth Amendment, the maximum Leverage Ratio (measured quarterly on a rolling four-quarter basis) is as follows:

 

 

The minimum cash interest coverage ratio (as defined in the agreement, measured quarterly on a rolling four-quarter basis) is as follows under the Sixth Amendment:

 

 

Under the Sixth Amendment, no quarterly distributions may be paid to partners unless the PIK notes have been repaid and the Leverage Ratio is less than 4.25 to 1.00. If the Leverage Ratio is between 4.00 to 1.00 and 4.25 to 1.00, the Partnership may make the minimum quarterly distribution of up to $0.25 per unit if the PIK notes have been repaid. If the Leverage Ratio is less than 4.00 to 1.00, the Partnership may make quarterly distributions to partners from available cash as provided by its partnership agreement if the PIK notes have been repaid. The PIK notes are due six months after the earlier of the refinancing or maturity of its bank credit facility. Based on its forecasted leverage ratios for 2009 and its near term ability to refinance its bank credit facility, the Partnership does not anticipate making quarterly distributions during 2009 other than the distribution paid in February 2009 related to fourth quarter 2008 operating results. The Partnership will not be able to make distributions to its unitholders in future periods if its leverage ratio does not improve.

 

The Sixth Amendment also limits the Partnership’s annual capital expenditures (excluding maintenance capital expenditures) to $120.0 million in 2009 and $75.0 million in 2010 and each year thereafter (with unused amounts in any year being carried forward to the next year). It is unlikely that the Partnership will be able to make any acquisitions based on the terms of our credit facility and the current condition of the capital markets because it may only use a portion of the proceeds from the incurrence of unsecured debt and the issuance of equity to make such acquisitions.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

The Sixth Amendment also eliminated the accordion in the Partnership’s bank credit facility, which previously had permitted it to increase commitments thereunder by certain amounts if any bank was willing to undertake such commitment increase.

 

The Sixth Amendment also revised the terms for mandatory repayment of outstanding indebtedness from asset sales and proceeds from incurrence of unsecured debt and equity issuances. Proceeds from debt issuances and from equity issuances not required to prepay indebtedness are considered to be “Excess Proceeds” under the amended bank credit agreement. The Partnership may retain all Excess Proceeds. The following table sets forth the amended prepayment terms:

 

 

 

 

The prepayments are to be applied pro rata based on total debt (including letter of credit obligations) outstanding under the bank credit agreement and the total debt outstanding under the note agreement described below. Any prepayments of advances on the bank credit facility from proceeds from asset sales, debt or equity issuances will permanently reduce the borrowing capacity or commitment under the facility in an amount equal to 100% of the amount of the prepayment. Any such commitment reduction will not reduce the banks’ $300.0 million commitment to issue letters of credit.

 

In addition, the bank credit facility contains various covenants that, among other restrictions, limit the Partnership’s ability to:

 

 

Each of the following will be an event of default under the bank credit facility:

 

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

 

 

If an event of default relating to bankruptcy or other insolvency events occurs, all indebtedness under our bank credit facility will immediately become due and payable. If any other event of default exists under the bank credit facility, the lenders may accelerate the maturity of the obligations outstanding under the bank credit facility and exercise other rights and remedies.

 

The Partnership is subject to interest rate risk on its credit facility and has entered into interest rate swaps to reduce this risk. See Note 13 to the financial statements for a discussion of interest rate swaps.

 

Senior Secured Notes.  The Partnership entered into a master shelf agreement with an institutional lender in 2003 that was amended in subsequent years to increase availability under the agreement, pursuant to which it issued the following senior secured notes (dollars in thousands):

 

 

 

 

On November 7, 2008, the Partnership amended our senior secured note agreement governing its senior secured notes to, among other things, (i) modify the maximum permitted leverage ratio and lower the minimum interest coverage ratio it must maintain consistent with the ratios under the Fifth Amendment to the bank credit facility, (ii) permit it to sell certain assets and (iii) increase the interest rate it pays on the senior secured notes. The interest rate the Partnership paid on the senior secured notes increased by 1.25% for the fourth quarter of 2008 due to this amendment.

 

The covenants and terms of default for the senior secured notes are substantially the same as the covenants and default terms under the Partnership’s bank credit facility, and therefore the agreements governing the senior secured notes also required amendment in 2009. On February 27, 2009, the Partnership

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

amended its senior note agreements to (i) increase the maximum permitted leverage ratio and to lower the minimum interest coverage ratio it must maintain consistent with the ratios under the Sixth Amendment to the bank credit facility, (ii) revise the mandatory prepayment terms consistent with the terms under the Sixth Amendment to the bank credit facility, (iii) increase the interest rate it pays on the senior secured notes and (iv) provide for the payment of a leverage fee consistent with the terms of bank credit facility. Commencing February 27, 2009 the interest rate the Partnership pays in cash on all of the senior secured notes will increase by 2.25% per annum for each of the fiscal quarters commencing with the quarter ending March 31, 2009 over the comparative interest rates under the senior note agreements prior to the November and February amendments. As a result of this rate increase, the weighted average interest rate on the outstanding balance on the senior secured notes is approximately 9.25% as of February 2009.

 

Under the amended senior secured note agreement, the senior secured notes will accrue additional interest of 1.25% per annum of the senior secured notes (the “PIK notes”) in the form of an increase in the principal amount unless our leverage ratio is less than 4.25 to 1.00 as of the end of any fiscal quarter. All PIK notes will be payable six months after the maturity of our bank credit facility, which is currently scheduled to mature in June 2011, or six months after refinancing of such indebtedness if prior to the maturity date.

 

Per the terms of the amended senior note agreement, commencing on the date we refinance our bank credit facility, the interest rate payable in cash on our senior secured notes will increase by 1.25% per annum for any quarter if our leverage ratio as of the most recently ended fiscal quarter was greater than or equal to 4.25 to 1.00. In addition, commencing on June 30, 2012, the interest rate payable in cash on our senior secured notes will increase by 0.50% per annum for any quarter if our leverage as of the most recently ended fiscal quarter was greater than or equal to 4.00 to 1.00, but this incremental interest will not accrue if we are paying the incremental 1.25% per annum of interest described in the preceding sentence.

 

These notes represent the Partnership’s senior secured obligations and will rank pari passu in right of payment with the bank credit facility. The notes are secured, on an equal and ratable basis with the Partnership’s obligations under the credit facility, by first priority liens on all of its material pipeline, gas gathering and processing assets, all material working capital assets and a pledge of all its equity interests in substantially all of its subsidiaries. The senior secured notes are guaranteed by the Partnership’s material subsidiaries.

 

The senior secured notes issued in 2003 are redeemable, at the Partnership’s option and subject to certain notice requirements, at a purchase price equal to 100% of the principal amount together with accrued interest, plus a make-whole amount determined in accordance with the senior secured note agreement. The senior secured notes issued 2004, 2005 and 2006 provide for a call premium of 103.5% of par beginning three years after issuance at rates declining from 103.5% to 100.0%. The notes are not callable prior to three years after issuance.

 

If an event of default resulting from bankruptcy or other insolvency events occurs, the senior secured notes will become immediately due and payable. If any other event of default occurs and is continuing, holders of at least 50.1% in principal amount of the outstanding notes may at any time declare all the notes then outstanding to be immediately due and payable. If an event of default relating to the nonpayment of principal, make-whole amounts or interest occurs, any holder of outstanding notes affected by such event of default may declare all the notes held by such holder to be immediately due and payable.

 

The senior secured note agreement relating to the notes contains substantially the same covenants and events of default as our bank credit facility.

 

The Partnership was in compliance with all debt covenants at December 31, 2008 and 2007 and expects to be in compliance with debt covenants for the next twelve months.

 

CROSSTEX ENERGY, L.P.

 

Notes to Consolidated Financial Statements — (Continued)

 

Intercreditor and Collateral Agency Agreement.  In connection with the execution of the senior secured note agreement, the lenders under our bank credit facility and the purchasers of the senior secured notes have entered into an Intercreditor and Collateral Agency Agreement, which has been acknowledged and agreed to by the Partnership and its subsidiaries. This agreement appointed Bank of America, N.A. to act as collateral agent and authorized Bank of America to execute various security documents on behalf of the lenders under our bank credit facility and the purchasers of the senior secured notes. This agreement specifies various rights and obligations of lenders under our bank credit facility, holders of our senior secured notes and the other parties thereto in respect of the collateral securing the Partnership’s obligations under our bank credit facility and the senior secured note agreement. On February 27, 2009, the holders of the Partnership’s senior secured notes and a majority of the banks under its bank credit facility entered into an amendment to the Intercreditor and Collateral Agency Agreement, which provides that the PIK notes and certain treasury management obligations will be secured by the collateral for its bank credit facility and the senior secured notes, but only paid with proceeds of collateral after obligations under its bank credit facility and the senior secured notes are paid in full.

 

Maturities.  Maturities for the long-term debt as of December 31, 2008 are as follows (in thousands):

 

 

 

The Partnership entered into 9 and 10-year capital leases for certain compressor equipment. Assets under capital leases are summarized as follows (in thousands):