CURRENT ASSETS:

Cash

Accounts receivable

Prepaid assets

 

Total current assets

 

 

PROPERTY AND EQUIPMENT

Less- accumulated depreciation

 

Property and equipment, net

 

 

DEFERRED LOAN COSTS, net

 

INTANGIBLE ASSETS, net

 

OTHER LONG-TERM ASSETS

 

 

Total assets

 

 

CURRENT LIABILITIES:

Accounts payable

Amounts due to related parties

Other liabilities, current

Current portion of capital leases

 

Total current liabilities

 

LONG-TERM DEBT

 

CAPITAL LEASES

 

COMMITMENTS AND CONTINGENCIES (Note H)

 

MEMBERS’ EQUITY, per accompanying statement

 

 

Total liabilities and members’ equity

 

REVENUES:

Gas sales

Natural gas liquids sales

Gathering

Compression and other

Condensate sales

 

Total revenues

 

 

EXPENSES:

Gas purchases

Operating

General and administrative

Depreciation and amortization

 

Total expenses

 

 

OPERATING INCOME (LOSS)

 

OTHER INCOME (EXPENSE):

Gain on business combination

Interest income

Interest expense

 

Total other income

 

 

NET INCOME (LOSS)

 

BALANCE, January 1, 2008

CONTRIBUTIONS

NET LOSS

 

BALANCE, December 31, 2008

CONTRIBUTIONS

NET LOSS

 

BALANCE, December 31, 2009

CONTRIBUTIONS

NET INCOME

 

BALANCE, December 31, 2010

 

CASH FLOWS FROM OPERATING ACTIVITIES:

Net income (loss)

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

Depreciation and amortization

Noncash general and administrative expenses

Amortization of loan costs

Gain on business combination

Change in operating assets and liabilities:

Accounts receivable

Prepaid assets

Accounts payable

Other current liabilities

Amounts due to related parties

 

Net cash provided by operating activities

 

CASH FLOWS FROM INVESTING ACTIVITIES:

Additions to property and equipment

Cash paid for acquisition

 

Net cash used in investing activities

 

CASH FLOWS FROM FINANCING ACTIVITIES:

Contributions

Borrowings on long-term debt

Payments of loan costs

Payments on capital leases

Payment on FES line of credit

Borrowings on FES line of credit

 

Net cash provided by financing activities

 

NET (DECREASE) INCREASE IN CASH

 

CASH, beginning of year

 

 

CASH, end of year

 

 

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:

Cash paid for interest, net of interest capitalized of $0, $0 and $45,510

 

NONCASH INVESTING AND FINANCING ACTIVITES:

Purchase of fixed assets on capital lease

 

Accrued purchases of property and equipment

 

Frontier Gas Services, LLC (“Gas” or the “Company”), a Delaware limited liability company is engaged in the acquisition, enhancement, operations and divesting of gathering, processing, transportation and other midstream assets, including product marketing. The Company is headquartered in Tulsa, Oklahoma.

Frontier Gas Services is a subsidiary of Frontier Midstream, LLC (“Midstream”). Midstream was formed in 2006 as a wholly owned subsidiary of Frontier Energy Services, LLC (“FES”). On February 25, 2008, a majority interest in Midstream was acquired by Energy Spectrum Partners V LP (“ESP”), an equity investment group located in Dallas, Texas with a capital contribution of $18,000,000. Gas was formed on July 17, 2009. In August 2009, Midstream contributed its Indian Creek System to Gas in conjunction with a $5,000,000 cash contribution from TPF II Gas Services, LLC (“TPF”). Midstream’s other gathering systems, Wilson Creek and Rose Bud, were later contributed to Gas in November 2009. The contribution of the gathering systems from Midstream to Gas was accounted for as a combination of entities under common control, which is similar to the pooling of interest method of accounting for business combinations. Accordingly, these financial statements give retrospective effect to these transactions; and therefore, the Company’s results from January 1, 2008 through the dates contributed include all operations and transactions of the contributed gathering systems.

The Company currently has six gathering systems. The Rose Bud System was constructed and brought online in 2007. The Wilson Creek System was constructed and brought online in 2008. Both are located in the Fayetteville Shale Play in Arkansas. The Indian Creek System was acquired in January 2009 from Indian Creek Gas Processing, L.P. and Central Plains Pipeline Company, L.L.C. and is located in Roberts County, Texas. In 2010, the Company purchased two systems (Note C) and constructed the Woolly Hollow System. The Twin Groves, Prairie Creek and Woolly Hollow systems are located in the Fayetteville Shale Play in Arkansas.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, if any, at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Although management believes the estimates are appropriate, actual results could differ from those estimates.

The Company places its cash with high-quality institutions. At times, such balances may be in excess of the Federal Deposit Insurance Corporation insurance limit. The Company derives its revenue from customers in the natural gas industry. This industry concentration has the potential to impact the Company’s overall exposure to credit risk, either positively or negatively, in that its customers could be affected by similar changes in economic, industry or other conditions. However, the Company believes that the credit risk posed by this industry concentration is offset by the creditworthiness of its customer base. The Company’s portfolio of accounts receivable is comprised primarily of mid-size to large domestic corporate entities. At December 31, 2010 and 2009, four and three customers accounted for approximately 100% of total accounts receivable, respectively. Approximately 95%, 81%, and 95% of the Company’s net sales were provided by four, two and three customers in 2010, 2009 and 2008, respectively.

Accounts receivable are recorded at amounts billed to customers. Credit is extended based on an evaluation of a customer’s financial condition and generally, collateral is not required. Amounts outstanding longer than the contractual terms are considered past due. An allowance for doubtful accounts, if necessary, is based on management’s assessment of the realizability of customer accounts. Management’s assessment is based on the overall creditworthiness of the Company’s customers and specific disputes, if any. Management believes that no allowance for doubtful accounts was necessary at December 31, 2010 and 2009.

Property and equipment are stated at cost, net of accumulated depreciation except when obtained through business combination (Note C). The Company charges repairs and maintenance expense against income when incurred and capitalizes renewals and betterments that extend the useful life or expand the capacity of the existing assets. Depreciation on property and equipment is calculated using the straight-line method over the estimated useful lives (ranging from 4 to 20 years) of the respective assets. Additionally, the Company capitalizes interest directly related to the construction of assets.

The cost of property and equipment sold or otherwise disposed of, and the related accumulated depreciation is removed from the accounts, and any gain or loss is reflected in current operations.

The Company reviews long-lived assets for impairment upon the occurrence of events or changes in circumstances that indicate that the carrying amount of such assets may not be recoverable. If such a review should indicate that the carrying amount of long-lived assets is not recoverable, the carrying amount of such assets is reduced to fair value. No impairment of long-lived assets was required during the periods presented.

Intangible assets consist of gas contracts. The gas contracts were acquired by the Company during acquisitions - See Note C. These contracts are amortized over the contract lives using the straight-line method.

The Company’s natural gas sales and purchase arrangements are accounted for on a gross basis in the statement of operations as sales and purchases, respectively. These transactions are contractual arrangements that establish the terms of the purchase of natural gas at a specified location and the sale at a different location at the specified date. Both sale and purchase transactions require physical delivery of the natural gas and the risk and reward of ownership are evidenced by title transfer, assumption of environmental risk, transportation scheduling, credit risk and counterparty nonperformance risk.

Service revenues generated include fee-based arrangements for natural gas gathering or compressing, treating or processing of those volumes of natural gas that flow through the gathering systems. The service revenues are recognized in the period when the service is provided.

The Company is structured as a limited liability company. Therefore, no provision for income taxes has been recorded in the Company’s financial statements. The Company’s earnings and losses for federal and state income tax purposes are included in the tax returns for the individual members.

The Company evaluates uncertain tax positions for recognition and measurement in the financial statements. To recognize a tax position, the Company determines whether it is more likely than not that the tax positions will be sustained upon examination, including resolution of any related appeals or litigation, based on the technical merits of the position. A tax position that meets the more likely than not threshold is measured to determine the amount of benefit to be recognized in the financial statements. The amount of tax benefit recognized with respect to any tax position is measured as the largest amount of benefit that is greater than 50% likely of being realized upon settlement. The Company had no uncertain tax positions that required recognition in the financial statements at December 31, 2010 and 2009. Any interest or penalties would be recognized as a component of income tax expense.

The Company accounts for equity-based compensation to employees at fair value. The cost of employee services received in exchange for equity instruments is measured based on the grant-date fair value of those instruments. That cost is recognized as compensation expense over the requisite service period (often the vesting period). Awards subject to performance criteria vest when it is probable that the performance criteria will be met. Generally, no compensation cost is recognized for equity instruments that do not vest.

Property and equipment

Construction in progress

Pipeline systems

Trucks

Furniture and fixtures

 

 

Accumulated depreciation

 

 

 

For the years ended December 31, 2010, 2009 and 2008, the Company recorded depreciation expense of $7,244,057, $1,307,056 and $489,560, respectively. Interest in the amount of $0, $0 and $45,510 was capitalized to pipeline systems for the years ended December 31, 2010, 2009 and 2008, respectively.

At December 31, 2010, the construction in progress represents costs incurred in the ongoing construction of the Company’s gathering systems. Accordingly, no depreciation expense was recorded for these costs.

During 2010, the Company leased certain compressors which are accounted for as capital leases. The total capitalized cost of the leases is $11,313,497 with accumulated depreciation of $2,468,399.

On January 1, 2010, the Company entered into an asset sale agreement with Arkansas Midstream Gas Services, Corp., to acquire 100% of the natural gas gathering systems located in Conway and Faulkner counties in Arkansas for $49.4 million. The Company assumed no liabilities in the transaction. As part of the transaction, the Company executed a 10 year contractual arrangement, with a renewal option, for which they receive monthly gathering fees. The acquisition was funded through capital contributions and was accounted for using the purchase method of accounting. Accordingly, the assets acquired were recorded at their fair values. The tangible assets were valued utilizing the cost approach and the intangible asset was valued using the income approach. The assumptions used to estimate the fair values reflect the best estimate of how the Company believes market participants would benefit from the use of the assets being valued. The Company did utilize an expert in valuation techniques to assist in the formulation of the fair value estimates. The resulting valuation resulted in the Company recognizing a gain of approximately $11.2 million for the excess of the fair value of assets acquired compared to the consideration paid.

There were several factors that the Company believes contributed to the $11.2 million gain recognized in the acquisition including: seller’s business strategy and capital requirements, limited potential buyers in the region, and the historical business relationship created between the seller and the Company. The operating results of the business acquired have been included in the Company’s results of operations from the date of acquisition.

The value of the Twin Groves and Prairie Creek acquisition has been allocated to the assets acquired at the date of the acquisition as summarized in the table below:

Property and equipment

Gas contracts

 

Total fair value

 

 

Gain recognized on business combination

 

On January 9, 2009, the Company purchased certain assets of Indian Creek natural gas processing plant and related gathering system, and the Central Plains gas liquids pipeline, which are located in Roberts County, Texas, for $25,000,000. The acquisition was primarily funded through capital contributions from ESP, which totaled $24,000,000. The acquisition was accounted for using the purchase method of accounting, and the operating results of the business acquired have been included in the Company’s results of operations from the date of acquisition.

The cost of the Indian Creek acquisition has been allocated to the assets acquired at the date of the acquisition as summarized in the table below:

Property and equipment

Gas contracts

 

Total fair value

 

Intangible assets, gross

Accumulated amortization

 

Intangible assets, net of amortization

 

 

Amortization expense recorded for the year ended

 

Future amortization expense for intangible assets is currently expected to be: $1.4 million in each of the years 2011 - 2015; and $14.9 million cumulatively in 2016 and beyond. The intangible assets have useful lives of 15 to 20 years.

On October 7, 2010, the Company entered into a revolving credit agreement and note agreement with a bank. The initial line of credit is $50.0 million and has a maturity date of October 7, 2014. Interest is paid quarterly at either the “Daily Adjusting LIBOR Rate” or the “Prime-based Rate” plus an applicable margin as defined in the agreement (5.0% at December 31, 2010). The Company had $6.0 million outstanding on the revolving credit agreement at December 31, 2010.

Substantially all of the Company’s fixed assets serve as collateral under the agreement. The Company is subject to certain financial and nonfinancial covenants including, but not limited to, maintenance of an interest coverage ratio and debt to consolidated EBITDA ratio. The Company was in compliance with its debt covenants at December 31, 2010.

The Company had a $10,000,000 line of credit agreement with FES that was terminated in March 2008 upon receipt of the capital contribution from ESP. Under the agreement, amounts borrowed were charged interest at a rate plus .5% for the first $5,000,000 borrowed and at the Bank of Oklahoma financial corporation prime rate less .5% for the second $5,000,000. Prior to termination of the agreement, the base rate charged was 7.75%.

As discussed in Note B, the Company entered into several new leases for compressors during the year which are accounted for as capital leases. The total liability outstanding at December 31, 2010 related to these leases was $8.8 million.

2011

2012

2013

2014

 

Total payments

Imputed interest

 

Present value of future payments

 

The approximate fair values of all the financial instruments, including cash, accounts receivable and accounts payables approximate their carrying values, due to their short-term nature. Additionally, the estimated fair value of borrowings under the revolving credit facility approximates its carrying value due to the debt agreements being so recent in nature.

In addition to the capital leases discussed above, the Company entered into operating leases during 2010 and 2009 for operating equipment, specifically compressors.

Future minimum lease payments for all non-cancelable operating leases at December 31, 2010 are $3,591,700 in 2011; $1,694,160 in 2012 and $141,024 in 2013.

For the years ended December 31, 2010, 2009 and 2008, rent expense was $5.5 million, $1.0 million, and $138,662, respectively.

At December 31, 2010, the Company had a commitment to purchase a cryogenic unit for $6,029,295. Milestone payments under the commitment are due upon completion of certain steps in the production process for the cryogenic unit. Production of the unit is expected to be completed by August 2011. As of December 31, 2010, the Company had made payments under the commitment of $602,930. Cancellation fees apply if the Company cancels the commitment prior to completion.

From time to time, the Company may be a party to various legal and/or regulatory proceedings incidental to its business. Certain claims, suits and complaints arising in the ordinary course of business have been filed or are pending against the Company from time to time. The Company cannot predict with certainty the outcome or effect of the pending matters. However, in the opinion of management, such pending matters would not have a significant effect on the financial position or results of operations of the Company.

As provided by the limited liability company agreement, Midstream and Gas have management agreements with FES whereby FES agreed to provide management, general and administrative services to the Company. To the extent the Company has cash to reimburse FES, FES is reimbursed by the Company for all direct general and administrative expenses, including office equipment and other necessary office expenses. Expenses that are not reimbursed are deemed to be capital contributions by FES. During the years ended December 31, 2010, 2009 and 2008, the Company incurred $0, $535,256 and $1,826,187 of unreimbursed expenses under this agreement, respectively. This amount is included in general and administrative expenses in the statement of operations. At December 31, 2010 and 2009, $59,398 and $173,083 was payable to FES and there were no receivables from FES, respectively.

The Company also had sales of gas to Tenaska Marketing Ventures, an affiliate of TPF of $18.0 million and $11.6 million for the years ended December 31, 2010 and 2009, respectively. Receivables from TPF at December 31, 2010 and 2009 were $1.6 million and $1.5 million, respectively.

On February 18, 2011, the Company entered into an agreement with Crestwood Midstream Partners LP to sell all of its pipeline systems and related assets for $338.0 million and an additional $15.0 million to be paid to the Company if certain operational objectives are met within six-months of the closing date.

Management has evaluated subsequent events through February 22, 2011, the date the financial statements were available to be issued. No additional subsequent events were identified requiring recognition or disclosure in the accompanying financial statements.