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Table of Contents

 

 

UNITED STATES

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, 2011

 

[  ]

Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                     to                     

Commission File No. 1-34831

Chesapeake Midstream Partners, L.P.

(Exact Name of Registrant as Specified in Its Charter)

 

Delaware   80-0534394
(State or other jurisdiction of incorporation or organization)   (I.R.S. Employer Identification No.)

900 NW 63rd Street

Oklahoma City, Oklahoma

  73118
(Address of principal executive offices)   (Zip Code)

(405) 935-1500

(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 [X]    No [  ]

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes [X]    No [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [  ]    Accelerated filer [  ]    Non-accelerated filer [X]    Smaller reporting company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes [  ]    No [X]

As of November 7, 2011, the registrant had 69,085,038 common units outstanding.

 

 

 


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2011

 

PART I.   

Financial Information

  
         Page  
Item 1.  

Financial Statements (Unaudited):

  
 

Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010

     1   
 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010

     2   
 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010

     3   
 

Condensed Consolidated Statement of Changes in Partners’ Capital for the Nine Months Ended September 30, 2011

     4   
 

Notes to Condensed Consolidated Financial Statements

     5   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     13   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     28   
Item 4.  

Controls and Procedures

     29   
PART II.   

Other Information

  
Item 1.  

Legal Proceedings

     30   
Item 1A.  

Risk Factors

     30   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     30   
Item 3.  

Defaults Upon Senior Securities

     30   
Item 4.  

(Removed and Reserved)

     30   
Item 5.  

Other Information

     30   
Item 6.  

Exhibits

     31   


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

 

     September 30,
2011
    December 31,
2010
 
     ($ in thousands)  
ASSETS     

Current assets:

    

Cash and cash equivalents

   $ 23      $ 17,816   

Accounts receivable, including $38,478 and $88,009 from related parties at September 30, 2011 and December 31, 2010, respectively

     52,516        107,095   

Other current assets

     6,664        6,576   
  

 

 

   

 

 

 

Total current assets

     59,203        131,487   
  

 

 

   

 

 

 

Property, plant and equipment:

    

Gathering systems

     2,873,485        2,544,053   

Other fixed assets

     48,504        41,125   

Less: Accumulated depreciation

     (446,496     (358,269
  

 

 

   

 

 

 

Total property, plant and equipment, net

     2,475,493        2,226,909   
  

 

 

   

 

 

 

Intangible contracts, net

     161,446        172,481   

Deferred loan costs, net

     21,672        15,039   
  

 

 

   

 

 

 

Total assets

   $ 2,717,814      $ 2,545,916   
  

 

 

   

 

 

 
LIABILITIES AND PARTNERS’ CAPITAL     

Current liabilities:

    

Accounts payable

   $ 54,236      $ 39,619   

Accrued liabilities, including $37,504 and $42,674 to related parties at September 30, 2011 and December 31, 2010, respectively

     68,178        58,372   
  

 

 

   

 

 

 

Total current liabilities

     122,414        97,991   
  

 

 

   

 

 

 

Long-term liabilities:

    

Long-term debt

     417,300        249,100   

Other liabilities

     3,911        4,257   
  

 

 

   

 

 

 

Total long-term liabilities

     421,211        253,357   
  

 

 

   

 

 

 

Commitments and contingencies (Note 9)

    

Partners’ capital:

    

Common units (69,085,038 and 69,083,265 issued and outstanding at September 30, 2011 and December 31, 2010, respectively)

     1,275,520        1,285,619   

Subordinated units (69,076,122 issued and outstanding at September 30, 2011 and December 31, 2010)

     863,420        873,304   

General partner interest

     35,249        35,645   
  

 

 

   

 

 

 

Total partners’ capital

     2,174,189        2,194,568   
  

 

 

   

 

 

 

Total liabilities and partners’ capital

   $ 2,717,814      $ 2,545,916   
  

 

 

   

 

 

 

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

 

1


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

     Three Months Ended
September  30,
    Nine Months Ended
September  30,
 
     2011     2010     2011     2010  
     ($ in thousands, except per unit data)  

Revenues, including revenue from affiliates (Note 7)

   $ 140,105      $ 100,060      $ 396,851      $ 296,685   

Operating expenses

        

Operating expenses, including expenses from affiliates (Note 8)

     43,233        34,094        130,078        97,172   

Depreciation and amortization expense

     35,021        22,407        98,706        65,119   

General and administrative expense, including expenses from affiliates (Note 8)

     8,940        7,098        27,545        21,221   

Other operating (income) expense

     (40     323        823        256   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     87,154        63,922        257,152        183,768   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     52,951        36,138        139,699        112,917   

Other income (expense)

        

Interest expense (Note 5)

     (4,250     (2,059     (9,527     (5,876

Other income

     137        34        221        76   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     48,838        34,113        130,393        107,117   

Income tax expense

     665        699        2,361        1,772   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 48,173      $ 33,414      $ 128,032      $ 105,345   
  

 

 

   

 

 

   

 

 

   

 

 

 

Limited partner interest in net income

        

Net income

   $ 48,173      $ 19,514 (1)    $ 128,032      $ 19,514 (1) 

Less general partner interest in net income

     (964     (390     (2,560     (390
  

 

 

   

 

 

   

 

 

   

 

 

 

Limited partner interest in net income

   $ 47,209      $ 19,124      $ 125,472      $ 19,124   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income per limited partner unit – basic and diluted

        

Common units

   $ 0.34      $ 0.14      $ 0.91      $ 0.14   

Subordinated units

   $ 0.34      $ 0.14      $ 0.91      $ 0.14   

Weighted average limited partner units outstanding used for net income per unit calculation – basic and diluted (in thousands)

        

Common units

     69,359        69,083        69,268        69,083   

Subordinated units

     69,076        69,076        69,076        69,076   

 

(1) 

Reflective of general and limited partner interest in net income from closing of the Partnership’s initial public offering on August 3, 2010 through September 30, 2010. See Note 4 to the condensed consolidated financial statements.

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

 

2


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

 

     Nine Months Ended
September 30,
 
     2011     2010  
     ($ in thousands)  

Cash flows from operating activities:

    

Net income

   $ 128,032      $ 105,345   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     98,706        65,119   

Other non-cash items

     5,177        4,413   

Changes in assets and liabilities:

    

Decrease in accounts receivable

     54,579        129,592   

Increase in other assets

     (87     (1,608

Increase in accounts payable

     2,395        10,129   

Increase (decrease) in accrued liabilities

     9,692        (45,870
  

 

 

   

 

 

 

Net cash provided by operating activities

     298,494        267,120   
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Additions to property, plant and equipment

     (326,603     (156,463

Proceeds from sale of assets

     1,522        4,416   
  

 

 

   

 

 

 

Net cash used in investing activities

     (325,081     (152,047
  

 

 

   

 

 

 

Cash flows from financing activities:

    

Proceeds from credit facility borrowings

     331,400        252,300   

Payments on credit facility borrowings

     (513,200     (296,400

Proceeds from issuance of common units, net of offering costs

            475,009   

Proceeds from issuance of senior notes, net of offering costs

     343,000          

Distributions to unit holders

     (148,029       

Initial public offering costs

     (1,280       

Debt issuance costs

     (3,101     (5,113

Distributions to partners

            (231,919

Contribution from CMD

            177   

Other

     4          
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     8,794        194,054   
  

 

 

   

 

 

 

Net (decrease) increase in cash and cash equivalents

     (17,793     309,127   

Cash and cash equivalents, beginning of period

     17,816        3   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 23      $ 309,130   
  

 

 

   

 

 

 

Supplemental disclosure of non-cash investing activities:

    

Changes in accounts payable and other liabilities related to purchases of property, plant and equipment

   $ 14,142      $ 5,522   

Changes in other liabilities related to asset retirement obligations

   $ 194      $ (101

Contributions of property, plant and equipment to Chesapeake

   $      $ 11,705   

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

 

3


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

CONDENSED CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS’ CAPITAL

(Unaudited)

 

     Limited Partners     General
Partner
    Total  
     Common     Subordinated      
     ($ in thousands)  

Balance at December 31, 2010

   $ 1,285,619      $ 873,304      $ 35,645      $ 2,194,568   

Net income

     62,826        62,646        2,560        128,032   

Distribution to unitholders

     (72,539     (72,530     (2,960     (148,029

Initial public offering costs

     (1,280                   (1,280

Non-cash equity based compensation

     894                      894   

Other Adjustments

                   4        4   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 1,275,520      $ 863,420      $ 35,249      $ 2,174,189   
  

 

 

   

 

 

   

 

 

   

 

 

 

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

 

4


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

1.

Description of Business

Organization

Chesapeake Midstream Partners, L.P. (the “Partnership”), a Delaware limited partnership formed in January 2010, is principally focused on natural gas gathering, the first segment of midstream energy infrastructure that connects natural gas produced at the wellhead to third-party takeaway pipelines. The Partnership provides gathering, treating and compression services to Chesapeake Energy Corporation (“Chesapeake”) and Total Gas and Power North America, Inc. (“Total”), the Partnership’s primary customers under long-term, fixed-fee contracts, and other third-party producers under fixed-fee contracts.

Chesapeake Midstream Development, L.P. (“CMD”) is a Delaware limited partnership formed on February 29, 2008 to own, operate and develop midstream energy assets. Upon formation, gathering and treating assets of Chesapeake Energy Marketing, Inc. (“CEMI”), a wholly owned subsidiary of Chesapeake, were contributed to CMD. CEMI is the sole limited partner of CMD with a 98 percent ownership interest, and Chesapeake Midstream Management L.L.C. (“CMM”) is the general partner of CMD with a two percent ownership interest. CMM is a wholly owned subsidiary of CEMI.

On September 30, 2009, CMD formed a joint venture with Global Infrastructure Partners – A, L.P., and affiliated funds managed by Global Infrastructure Management, L.L.C., and certain of their respective subsidiaries and affiliates (“GIP”), to own and operate natural gas, natural gas liquids and oil midstream assets. As part of the transaction, CMD contributed certain natural gas gathering and treating assets to a new entity, Chesapeake Midstream Partners, L.L.C. (“CMP”), and GIP purchased a 50 percent interest in the newly formed joint venture.

The assets contributed to the joint venture and ultimately the Partnership were substantially all of CMD’s midstream assets in the Barnett Shale and certain of its midstream assets in the Arkoma, Anadarko, Delaware and Permian Basins. Subsidiaries of CMD continue to operate midstream assets outside of the Partnership. These include natural gas gathering assets primarily in the Haynesville Shale, Marcellus Shale (including other areas in the Appalachian Basin) and the Eagle Ford Shale.

On August 3, 2010, the Partnership completed its initial public offering (“IPO”) of 24,437,500 common units (including 3,187,500 common units issued pursuant to the exercise of the underwriters’ over-allotment option on August 3, 2010) at a price of $21 per unit. The common units are listed on the New York Stock Exchange under the symbol “CHKM”. Upon completion of the IPO, Chesapeake and GIP conveyed to the Partnership a 100 percent membership interest in Chesapeake MLP Operating, L.L.C.

On December 21, 2010, the Partnership acquired from Chesapeake the Springridge natural gas gathering system in the Haynesville Shale for $500.0 million. The Springridge gathering system is located in Caddo and De Soto Parishes, Louisiana. In connection with the acquisition, the Partnership entered into a 10-year, 100 percent fixed-fee gas gathering agreement with Chesapeake which includes a significant acreage dedication and annual fee redetermination. The agreement also includes an annual minimum volume commitment through December 31, 2013.

At September 30, 2011, the Partnership had outstanding 69,085,038 common units, 69,076,122 subordinated units, a two percent general partner interest and incentive distribution rights (“IDRs”). IDRs entitle the holder to specified increasing percentages of cash distributions as the Partnership’s per-unit cash distributions increase above specified levels. Common units held by the public represented 17.7 percent of all outstanding limited partner interests, and Chesapeake and GIP held 42.3 percent and 40.0 percent, respectively, of all outstanding limited partner interests. Subsequent to September 30, 2011, GIP sold 10,228,558 common units to the public in an underwritten offering. Following the offering, GIP held 32.6 percent of all outstanding limited partner interests and common units held by the public represented 25.1 percent of all outstanding limited partner interests. The limited partners, collectively, hold a 98.0 percent limited partner interest in the Partnership and the general partner, which is indirectly owned and controlled by Chesapeake and GIP, holds a two percent general partner interest in the Partnership.

 

5


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

2.

Basis of Presentation

Unless the context otherwise requires, references to our historical financial results, “our assets,” “our systems” and similar descriptions of the Partnership’s business and operations relate to the financial results, assets and systems of (i) CMP for periods prior to the closing of the IPO and (ii) the Partnership for periods after the closing of the IPO and include the financial results, assets and systems relating to the Springridge acquisition for periods after December 21, 2010.

The accompanying financial statements and related notes present the unaudited condensed consolidated balance sheets of the Partnership as of September 30, 2011 and December 31, 2010. They also include the unaudited condensed consolidated statements of operations for the three and nine-month periods ended September 30, 2011 and 2010, the unaudited condensed consolidated statements of cash flows for the Partnership for the nine-month periods ended September 30, 2011 and 2010, and unaudited changes in partners’ capital of the Partnership for the nine-month period ended September 30, 2011.

The accompanying condensed consolidated financial statements were prepared using accounting principles generally accepted in the United States (“GAAP”) for interim financial information and in accordance with the rules and regulations of the Securities and Exchange Commission (“SEC”). In the opinion of management, the interim data includes all adjustments, consisting only of normal recurring adjustments, necessary to a fair statement of the results for the interim periods. Certain footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been appropriately condensed or omitted in this quarterly report on Form 10-Q (this “Form 10-Q”). Management believes the disclosures made are adequate to make the information presented not misleading. This Form 10-Q should be read together with the Partnership’s annual report on Form 10-K for the year ended December 31, 2010.

The results of operations for the three and nine-month periods ended September 30, 2011 are not indicative of results that may be expected for the full fiscal year.

 

3.

Partnership Capital and Distributions

The partnership agreement requires that, within 45 days after the end of each quarter, the Partnership distribute its available cash (as defined in the partnership agreement) to unitholders of record on the applicable record date. During the three and nine-month periods ended September 30, 2011, the Partnership paid cash distributions to its unitholders of approximately $51.1 million and $148.0 million, respectively, representing a $0.3375 per-unit distribution for the quarter ended December 31, 2010, a $0.35 per-unit distribution for the quarter ended March 31, 2011, and a $0.3625 per-unit distribution for the quarter ended June 30, 2011. See also Note 10 — Subsequent Events, concerning distributions declared on October 28, 2011 for the three-month period ended September 30, 2011.

General Partner Interest and Incentive Distribution Rights

The general partner of the Partnership is currently entitled to two percent of all quarterly distributions that the Partnership makes. Upon the issuance of any equity by the Partnership, the general partner has the right, but not the obligation, to contribute a proportionate amount of capital to the Partnership to maintain its current general partner interest. The general partner’s two percent interest in all cash distributions will be reduced if the Partnership issues additional units in the future and the general partner does not contribute a proportionate amount of capital to the Partnership to maintain its two percent interest.

The general partner currently holds IDRs that entitle it to receive increasing percentages, up to a maximum of 50 percent, of Partnership cash distributions if any of the Partnership’s quarterly distributions exceed a specified threshold. The maximum distribution sharing percentage of 50 percent includes distributions paid to the general partner on its two percent general partner interest and assumes that the general partner maintains its general partner interest at two percent. The maximum distribution of 50 percent does not include any distributions that the general partner may receive on the limited partner units that it may hold.

 

6


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Subordinated Units

All subordinated units are held indirectly by Chesapeake and GIP. These units are considered subordinated because for a period of time (the “Subordination Period”), the subordinated units will not be entitled to receive any distributions until the common units have received the minimum quarterly distribution of $0.3375 per common unit plus any arrearages from prior quarters. Furthermore, arrearages do not apply to and therefore will not be paid on the subordinated units. The effect of the subordinated units is to increase the likelihood that, during the Subordination Period, available cash is sufficient to fully fund cash distributions on the common units in an amount equal to or greater than the minimum quarterly distribution.

The Subordination Period will lapse at such time when the Partnership has earned and paid at least $0.3375 per quarter on each common unit, subordinated unit and general partner interest for any three consecutive, non-overlapping four-quarter periods ending on or after June 30, 2013. Also, if the Partnership has earned and paid at least 150 percent of the minimum quarterly distribution on each outstanding common unit, subordinated unit and general partner interest and the related distribution on the IDRs in a four-quarter period, the Subordination Period will terminate.

 

4.

Net Income per Limited Partner Unit

The Partnership’s net income is allocated to the general partner and the limited partners, including any subordinated unitholders, in accordance with their respective ownership percentages, and, when applicable, giving effect to unvested units granted under the Chesapeake Midstream Long-Term Incentive Plan (the “LTIP”) and incentive distributions allocable to the general partner. The Partnership’s net income allocable to the limited partners is allocated between the common and subordinated unitholders by applying the provisions of the partnership agreement that govern actual cash distributions as if all earnings for the period had been distributed.

Basic and diluted net income per limited partner unit is calculated by dividing the limited partners’ interest in net income by the weighted average number of limited partner units outstanding during the period. The common units issued during the period are included on a weighted average basis for the days in which they were outstanding.

 

7


Table of Contents

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table illustrates the Partnership’s calculation of net income per unit for common and subordinated limited partner units ($ in thousands, except per-unit information):

 

     Three Months
Ended

September 30,
2011
    Nine Months
Ended

September 30,
2011
    August 3,
2010 to

September 30,
2010
 

Net income attributable to Chesapeake Midstream Partners, L.P.

   $ 48,173      $ 128,032      $ 19,514   

Less general partner interest in net income

     (964     (2,560     (390
  

 

 

   

 

 

   

 

 

 

Limited partner interest in net income

   $ 47,209      $ 125,472      $ 19,124   
  

 

 

   

 

 

   

 

 

 

Net income allocable to common units

   $ 23,653      $ 62,826      $ 9,562   

Net income allocable to subordinated units

     23,556        62,646        9,562   
  

 

 

   

 

 

   

 

 

 

Limited partner interest in net income

   $ 47,209      $ 125,472      $ 19,124   
  

 

 

   

 

 

   

 

 

 

Net income per limited partner unit – basic and diluted

      

Common units

   $ 0.34      $ 0.91      $ 0.14   

Subordinated units

     0.34        0.91        0.14   
  

 

 

   

 

 

   

 

 

 

Total

   $ 0.34      $ 0.91      $ 0.14   
  

 

 

   

 

 

   

 

 

 

Weighted average limited partner units outstanding used for basic and diluted net income per unit calculation

      

Common units

     69,358,613        69,267,825        69,083,265   

Subordinated units

     69,076,122        69,076,122        69,076,122   
  

 

 

   

 

 

   

 

 

 

Total

     138,434,735        138,343,947        138,159,387   
  

 

 

   

 

 

   

 

 

 

 

5.

Long-Term Debt

The following table presents the Partnership’s outstanding debt as of September 30, 2011 and December 31, 2010 (in thousands):

 

     September 30,
2011
     December 31,
2010
 

Revolving credit facility

   $ 67,300       $ 249,100   

5.875% Senior Notes due April 2021

     350,000         —     
  

 

 

    

 

 

 

Total long-term debt

   $ 417,300       $ 249,100   
  

 

 

    

 

 

 

Revolving Credit Facility

On June 10, 2011, the Partnership amended its senior secured revolving credit facility and extended its maturity to June 2016. As amended, the credit facility provides up to $800 million of borrowing capacity and includes a sub-limit of $50 million for same-day swing line advances and a sub-limit of $50 million for letters of credit. In addition, the credit facility contains an accordion feature that allows the Partnership to increase the available borrowing capacity under the facility up to $1 billion, subject to the satisfaction of certain closing conditions, including the identification of lenders or proposed lenders that agree to satisfy the increased commitment amounts under the credit facility. Borrowings under the credit facility are secured by all of the assets of the Partnership and its subsidiaries. Prior to the Partnership reaching investment grade status, amounts borrowed under the credit facility agreement will bear interest under a leverage-based pricing grid at the Partnership’s option at either: (i) the greater of (a) the reference rate of Wells Fargo Bank, NA, (b) the federal funds effective rate plus 0.50 percent or (c) the Eurodollar rate which is based on the London Interbank Offered Rate (LIBOR), plus 1.00 percent, each of which is subject to a margin that varies

 

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CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

from 0.75 percent to 1.50 percent per annum through December 31, 2011 and 0.625 percent to 1.50 percent per annum after December 31, 2011, according to the Partnership’s leverage ratio (as defined), or (ii) the Eurodollar rate plus a margin that varies from 1.75 percent to 2.50 percent per annum through December 31, 2011 and 1.625 percent to 2.50 percent per annum after December 31, 2011, according to the Partnership’s leverage ratio. If the Partnership reaches investment grade status, the credit facility agreement provides that the Partnership has the option to release the security under the credit facility and amounts borrowed will bear interest under a specified ratings-based pricing grid. The unused portion of the credit facility is subject to commitment fees of (a) 0.30 percent to 0.40 percent per annum through December 31, 2011 and 0.25 percent to 0.40 percent per annum after December 31, 2011 while the Partnership is subject to the leverage-based pricing grid, according to the Partnership’s leverage ratio and (b) 0.20 percent to 0.35 percent per annum while the Partnership is subject to the ratings-based pricing grid, according to the Partnership’s senior unsecured long-term debt ratings. There were $67.3 million and $249.1 million of outstanding borrowings under the credit facility at September 30, 2011 and December 31, 2010, respectively.

The credit facility agreement contains various covenants and restrictive provisions which, among other things, limit the ability of the Partnership and its subsidiaries to incur additional indebtedness, make investments or loans, create liens and pay dividends or distributions. If the Partnership fails to perform its obligations under these and other covenants, the revolving credit commitment could be terminated and any outstanding borrowings, together with accrued interest, under the credit facility could be declared immediately due and payable. The credit facility agreement also has cross default provisions that apply to any other indebtedness the Partnership has with an outstanding principal amount in excess of $15.0 million.

The credit facility agreement contains certain negative covenants that (i) limit the Partnership’s ability, as well as the ability of certain of its subsidiaries, among other things, to enter into hedging arrangements and create liens and (ii) require the Partnership to maintain a consolidated leverage ratio, and an EBITDA to interest expense ratio, in each case as described in the credit facility agreement. The credit facility agreement also provides for the discontinuance of the requirement for the Partnership to maintain the EBITDA to interest expense ratio if the Partnership reaches investment grade status. The Partnership was in compliance with all covenants under the agreement at September 30, 2011.

Senior Notes

On April 19, 2011, the Partnership and CHKM Finance Corp., a wholly owned subsidiary of Chesapeake MLP Operating, L.L.C., completed a private placement of $350.0 million in aggregate principal amount of 5.875 percent senior notes due 2021 (the “Notes”). The Partnership used a portion of the net proceeds to repay borrowings outstanding under its revolving credit facility and used the balance for general partnership purposes. Deferred loan costs of $7.8 million are being amortized over the life of the Notes.

 

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CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The Notes will mature on April 15, 2021 and interest is payable on the Notes on April 15 and October 15 of each year, beginning on October 15, 2011. The Partnership has the option to redeem all or a portion of the Notes at any time on or after April 15, 2015, at the redemption price specified in the indenture, plus accrued and unpaid interest. The Partnership may also redeem the Notes, in whole or in part, at a “make-whole” redemption price specified in the indenture, plus accrued and unpaid interest, at any time prior to April 15, 2015. In addition, the Partnership may redeem up to 35 percent of the Notes prior to April 15, 2014 under certain circumstances with the net cash proceeds from certain equity offerings. The Indenture contains covenants that, among other things, limit the Partnership’s ability and the ability of certain of its subsidiaries to: (1) sell assets including equity interests in its subsidiaries; (2) pay distributions on, redeem or purchase its units, or redeem or purchase its subordinated debt; (3) make investments; (4) incur or guarantee additional indebtedness or issue preferred units; (5) create or incur certain liens; (6) enter into agreements that restrict distributions or other payments from certain subsidiaries to the Partnership; (7) consolidate, merge or transfer all or substantially all of its assets; (8) engage in transactions with affiliates; and (9) create unrestricted subsidiaries. These covenants are subject to important exceptions and qualifications. If the Notes achieve an investment grade rating from either of Moody’s Investors Service, Inc. or Standard & Poor’s Ratings Services and no default, as defined in the Indenture, has occurred or is continuing, many of these covenants will terminate.

The Partnership has no independent assets or operations. The Partnership’s operations are conducted by its subsidiaries through its operating company subsidiary, Chesapeake MLP Operating, L.L.C. Each of Chesapeake MLP Operating, L.L.C. and the Partnership’s other subsidiaries is a guarantor, other than CHKM Finance Corp., an indirect wholly owned subsidiary of the Partnership whose sole purpose is to act as co-issuer of any debt securities. Each guarantor is a wholly owned subsidiary of the Partnership. There are no significant restrictions on the ability of the Partnership or any guarantor to obtain funds from its subsidiaries by dividend or loan. None of the assets of the Partnership or an guarantor represent restricted net assets pursuant to Rule 4-08(e)(3) of Regulation S-X under the Securities Act.

Fair Value

Estimated fair values are determined by using available market information and valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts. Based on the borrowing rates available at September 30, 2011, for debt with similar terms and maturities, the carrying value of long-term debt approximates its fair value.

Capitalized Interest

For the three-month periods ended September 30, 2011 and September 30, 2010, interest expense was net of capitalized interest of $2.7 million and $0.4 million, respectively, and $7.3 million and $1.9 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively.

 

6.

Equity-Based Compensation

Certain employees of Chesapeake have been seconded to the Partnership to provide operating, routine maintenance and other services with respect to the business under the direction, supervision and control of the Partnership’s general partner. A number of these employees receive equity-based compensation awards of Chesapeake restricted stock or Partnership restricted common units.

The fair value of the awards is initially determined based on the fair market value of the shares or units on the date of grant. For grants of Partnership restricted units, expense is based on current fair value at the vest date and recognized over the vesting period. However, expense for Chesapeake restricted stock grants is allocated based on the lesser of the value at grant date or vest date. This value is amortized over the vesting period. The vesting period for both types of awards is generally four or five years from the date of grant. To the extent compensation cost relates to employee activities directly involved in gathering or treating operations, such amounts are charged to the Partnership and are reflected as operating expenses. Included in operating expenses is equity-based compensation of $1.1 million and $0.5 million for the Partnership during the three-month periods ended September 30, 2011 and September 30, 2010, respectively, and $3.2 million and $1.4 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively. To the extent compensation cost relates to employees indirectly involved in gathering or treating operations, such amounts are charged to the Partnership through an overhead allocation and are reflected as general and administrative expenses.

 

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CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The LTIP provides for an aggregate of 3,500,000 common units to be awarded to employees, directors and consultants of the Partnership’s general partner and its affiliates through various award types, including unit awards, restricted units, phantom units, unit options, unit appreciation rights and other unit-based awards. The LTIP has been designed to promote the interests of the Partnership and its unitholders by strengthening its ability to attract, retain and motivate qualified individuals to serve as employees, directors and consultants.

The following table summarizes LTIP award activity for the nine months ended September 30, 2011:

 

     Units     Value per
Unit
 

Restricted units unvested at beginning of period

          $   

Granted

     286,748        28.51   

Vested

     (1,773     28.78   

Forfeited

     (10,476     28.51   
  

 

 

   

Restricted units unvested at end of period

     274,499      $ 28.51   
  

 

 

   

 

7.

Major Customers and Concentration of Credit Risk

CEMI accounted for $116.2 million and $80.5 million of the Partnership’s revenues for the three-month periods ended September 30, 2011 and September 30, 2010, respectively, and $331.6 million and $244.3 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively. Total accounted for $19.0 million and $15.8 million of the Partnership’s revenues for the three-month periods ended September 30, 2011 and September 30, 2010, respectively, and $53.6 million and $42.5 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively.

Financial instruments that potentially subject the Partnership to concentrations of credit risk consist principally of cash and cash equivalents and trade receivables. At September 30, 2011 and December 31, 2010, cash and cash equivalents were invested in a non-interest bearing account and money market funds with investment grade ratings.

 

8.

Transactions with Affiliates

In the normal course of business, the Partnership provides natural gas gathering and treating services to Chesapeake and its affiliates. Revenues are derived primarily from Chesapeake, which includes volumes attributable to third-party interest owners that participate in Chesapeake’s operated wells.

Chesapeake and its affiliates provide certain services including legal, accounting, treasury, human resources, information technology and administration. The employees supporting these operations are employees of CEMI or Chesapeake. The condensed consolidated financial statements for the Partnership include costs allocated from Chesapeake and CEMI for centralized general and administrative services, as well as depreciation of assets utilized by Chesapeake’s centralized general and administrative functions. The Partnership is charged a general and administrative fee from Chesapeake based on the terms of the joint venture agreement. Under the agreement, corporate overhead costs are charged to the Partnership based on actual cost of the services provided, subject to a fee per mcf cap based on volumes of natural gas gathered. The fee is calculated as the lesser of $0.03025/mcf gathered or actual corporate overhead costs, excluding those overhead costs that are billed directly to the Partnership. General and administrative charges of the Partnership were $5.6 million and $4.1 million during the three-month periods ended September 30, 2011 and September 30, 2010, respectively, and $17.4 million and $12.5 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively.

 

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CHESAPEAKE MIDSTREAM PARTNERS, L.P.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Chesapeake and its affiliates also provide compression services. The Partnership is charged for compressor rentals based on a long-term compressor rental agreement with MidCon Compression, LLC (“MidCon”), a wholly owned indirect subsidiary of Chesapeake. For the three-month periods ended September 30, 2011 and September 30, 2010, compressor rental charges from affiliates were $14.8 million and $11.9 million, respectively, and $43.2 million and $35.0 million for the nine-month periods ended September 30, 2011 and September 30, 2010, respectively. These charges are included in operating expenses in the accompanying unaudited condensed consolidated statements of operations.

See also Note 7 — Major Customers and Concentration of Credit Risk concerning revenues attributable to CEMI, an affiliate of the Partnership.

 

9.

Commitments and Contingencies

The Partnership leases certain property, equipment and operating facilities under various operating leases. Costs are also incurred associated with leased land, rights-of-way, permits and regulatory fees, the contracts for which generally extend beyond one year but can be cancelled at any time should they not be required for operations.

The Partnership from time to time is subject to various legal actions and claims incidental to its business, including those arising out of employment-related matters. Management believes that these routine legal proceedings will not have a material adverse effect on the Partnership’s financial position, results of operations or cash flows. Once information pertaining to a legal proceeding indicates that it is probable that a liability has been incurred, an accrual is established equal to the estimate of the likely exposure. There was not an accrual for legal contingencies as of September 30, 2011 or December 31, 2010.

 

10.

Subsequent Events

Distribution

On October 28, 2011, the Board of Directors of the Partnership’s general partner declared a cash distribution to the Partnership’s unitholders of $0.375 per unit, together with the corresponding distribution to the general partner. The cash distribution will be paid on November 14, 2011, to unitholders of record at the close of business on November 7, 2011, and to the general partner.

 

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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Unless the context otherwise requires, references in this report to the “Partnership,” “we,” “our,” “us” or like terms, when used in a historical context, refer to the financial results of Chesapeake Midstream Partners, L.L.C. from its inception on September 30, 2009 through the closing date of our initial public offering (“IPO”) on August 3, 2010, and to Chesapeake Midstream Partners, L.P. and its subsidiaries thereafter. “CMD” refers to Chesapeake Midstream Development, L.P. which held substantially all of our assets as well as other midstream assets prior to September 30, 2009. “Chesapeake” refers to Chesapeake Energy Corporation (NYSE: CHK) and “GIP” refers to Global Infrastructure Partners – A, L.P., and affiliated funds managed by Global Infrastructure Management, L.L.C., and certain of their respective subsidiaries and affiliates. “Total”, when discussing the upstream joint venture with Chesapeake, refers to Total E&P USA, Inc., a wholly owned subsidiary of Total S.A. (NYSE: TOT, FP: FP), and when discussing our gas gathering agreement and related matters, refers to Total E&P USA, Inc. and Total Gas & Power North America, Inc., a wholly owned subsidiary of Total S.A.

Overview

The following table sets forth certain information regarding revenues, operating expenses, other income and expenses, key performance metrics and operational data for the Partnership for the three and nine months ended September 30, 2011 (the “Current Quarter” and the “Current Period”, respectively) and the three and nine months ended September 30, 2010 (the “Prior Quarter” and the “Prior Period”, respectively):

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  
     ($ in thousands, except operational data)  

Revenues(1)

   $ 140,105      $ 100,060      $ 396,851      $ 296,685   

Operating expenses

     43,233        34,094        130,078        97,172   

Depreciation and amortization expense

     35,021        22,407        98,706        65,119   

General and administrative expense

     8,940        7,098        27,545        21,221   

Other operating (income) expense

     (40     323        823        256   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     87,154        63,922        257,152        183,768   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating income

     52,951        36,138        139,699        112,917   

Interest expense

     (4,250     (2,059     (9,527     (5,876

Other income

     137        34        221        76   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     48,838        34,113        130,393        107,117   

Income tax expense

     665        699        2,361        1,772   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 48,173      $ 33,414      $ 128,032      $ 105,345   
  

 

 

   

 

 

   

 

 

   

 

 

 

Key Performance Metrics:

        

Adjusted EBITDA(2)

   $ 88,069      $ 58,902      $ 239,449      $ 178,368   

Distributable cash flow(2)

   $ 65,588      $ 40,022      $ 175,532      $ 122,278   

Operational Data:

        

Wells connected during period

     146        121        444        301   

Wells connected at end of period

     4,799        4,065        4,799        4,065   

Throughput, bcf per day

     2.226        1.584        2.128        1.580   

Miles of pipe at end of period

     3,511        2,890        3,511        2,890   

Gas compression (horsepower) at end of period

     271,886        219,900        271,886        219,900   

 

(1) 

If either Chesapeake or Total does not meet its minimum volume commitment to the Partnership in the Barnett Shale region or Chesapeake does not meet its minimum volume commitment in the Haynesville Shale region under the relevant gas gathering agreement for specified annual periods, Chesapeake or Total is obligated to pay the Partnership a fee equal to the applicable fee for each mcf by which the applicable party’s minimum volume commitment for the year exceeds the actual volumes gathered on the Partnership’s systems. Should payments be due under the minimum volume commitment with respect to any year, we recognize the associated revenue in the fourth quarter of that year.

 

(2) 

Adjusted EBITDA and distributable cash flow are defined and reconciled to their most directly comparable financial measures calculated and presented in accordance with GAAP below under the caption How We Evaluate Our Operations within this Part I, Item 2.

 

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We are a growth-oriented, publicly traded Delaware limited partnership formed by Chesapeake and GIP to own, operate, develop and acquire natural gas, natural gas liquids and oil gathering systems and other midstream energy assets. We are principally focused on natural gas gathering, the first segment of midstream energy infrastructure that connects natural gas produced at the wellhead to third-party takeaway pipelines. We currently operate in Texas, Louisiana, Oklahoma, Kansas and Arkansas. We provide gathering, treating and compression services to Chesapeake and Total, our primary customers under long-term, fixed-fee contracts, and other third-party producers under fixed-fee contracts.

Currently, our gathering systems operate in our Barnett Shale region in north central Texas, our Haynesville Shale region in northwest Louisiana and our Mid-Continent region which includes the Anadarko, Arkoma, Delaware and Permian Basins. We generate the majority of our operating income in our Barnett Shale region, where we service approximately 2,102 wells in the core of the prolific Barnett Shale. Our Springridge gathering system services approximately 213 wells in one of the core areas of the Haynesville Shale. In our Mid-Continent region, we have an enhanced focus on the unconventional resources located in the Colony Granite Wash and Texas Panhandle Granite Wash plays of the Anadarko Basin. In total, our systems consist of approximately 3,510 miles of gathering pipelines, servicing approximately 4,799 natural gas wells. For the Current Quarter, our assets gathered approximately 2.2 billion cubic feet (“Bcf”) of natural gas per day.

For the Current Quarter, we generated approximately 62 percent of our revenues from our gathering systems in our Barnett Shale region, approximately 17 percent of our revenues from our gathering systems in our Haynesville Shale region and approximately 21 percent of our revenues from our gathering systems in our Mid-Continent region for the Current Quarter.

Acquisitions

Springridge Acquisition. On December 21, 2010, we acquired the Springridge natural gas gathering system in the Haynesville Shale and related facilities from CMD, a wholly owned subsidiary of Chesapeake, for $500 million. The Springridge gathering system is located in Caddo and De Soto Parishes, Louisiana. In connection with the acquisition, we entered into a 10-year, 100 percent fixed-fee gas gathering agreement with Chesapeake which includes a significant acreage dedication, annual fee redetermination, annual fee escalation and a three-year minimum volume commitment.

We anticipate that acquisitions of complementary companies, assets and lines of businesses will continue to play an important role in our business strategy. While there are currently no unannounced agreements for the acquisition of any material businesses or assets, such transactions can be effected quickly and may occur at any time.

Our Gas Gathering Agreements

We are party to (i) a 20-year gas gathering agreement with certain subsidiaries of Chesapeake that was entered into in connection with the joint venture transaction in September 2009, (ii) a 20-year gas gathering agreement with Total that was entered into in connection with an upstream joint venture transaction between Chesapeake and Total in January 2010, and (iii) a 10-year gas gathering agreement with certain subsidiaries of Chesapeake that was entered into concurrent with the closing of the acquisition of the Springridge gathering system in December 2010.

Future revenues under our gas gathering agreements will be derived pursuant to terms that will vary depending on the applicable operating region. The key economic provisions of our gas gathering agreements by region are outlined below.

 

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Barnett Shale Region. Under our gas gathering agreements with Chesapeake and Total, we have agreed to provide the following services in our Barnett Shale region for the fees and obligations outlined below:

 

   

Gathering, Treating and Compression Services. We gather, treat and compress natural gas for Chesapeake and Total within the Barnett Shale region in exchange for specified fees per mcf for natural gas gathered on our gathering systems that are based on the pressure at the various points where our gathering systems received our customers’ natural gas. We refer to these fees collectively as the Barnett Shale fee. Our Barnett Shale fee is subject to an annual rate escalation of two percent at the beginning of each year.

 

   

Acreage Dedication. Pursuant to our gas gathering agreements, subject to certain exceptions, each of Chesapeake and Total has agreed to dedicate all of the natural gas owned or controlled by it and produced from or attributable to existing and future wells located on natural gas and oil leases covering lands within an acreage dedication in our Barnett Shale region.

 

   

Minimum Volume Commitments. Pursuant to our gas gathering agreements, Chesapeake and Total have agreed to minimum volume commitments for each year through December 31, 2018 and for the six-month period ending June 30, 2019. Approximately 75 percent of the aggregate minimum volume commitment will be attributed to Chesapeake, and approximately 25 percent will be attributed to Total. The minimum volume commitments increase, on average, approximately three percent per year. If either Chesapeake or Total does not meet its minimum volume commitment to us, as adjusted in certain instances, for any annual period (or six-month period in the case of the six months ending June 30, 2019) during the minimum volume commitment period, Chesapeake or Total, as applicable, will be obligated to pay us a fee equal to the Barnett Shale fee for each mcf by which the applicable party’s minimum volume commitment for the year (or six-month period) exceeds the actual volumes gathered on our systems attributable to the applicable party’s production. To the extent natural gas gathered on our systems from Chesapeake or Total, as applicable, during any annual period (or six-month period) exceeds such party’s minimum volume commitment for the period, Chesapeake or Total, as applicable, will be obligated to pay us the Barnett Shale fee for all volumes gathered, and the excess volumes will be credited first against the minimum volume commitments for the six months ending June 30, 2019, and then against the minimum volume commitments for each preceding year. If the minimum volume commitment for any period is credited in full, the minimum volume commitment period will be shortened to end on the final day of the immediately preceding period.

 

   

Fee Redetermination. We and each of Chesapeake and Total, as applicable, have the right to redetermine the Barnett Shale fee during a six-month period beginning September 30, 2011 and a two-year period beginning on September 30, 2014. On September 30, 2011, we entered the initial redetermination period and are currently working with Chesapeake to determine whether a fee adjustment is required. The fee redetermination mechanism is intended to support a return on our invested capital. If a fee redetermination is requested, we will determine an adjustment (upward or downward) to our Barnett Shale fee with Chesapeake and Total based on the factors specified in our gas gathering agreements, including, but not limited to: (i) differences between our actual capital expenditures, compression expenses and revenues as of the redetermination date and the scheduled estimates of these amounts for the minimum volume commitment period forecast as of the redetermination date and scheduled estimates thereof for the minimum volume commitment period made as of September 30, 2009 and (ii) differences between the revised estimates of our capital expenditures, compression expenses and revenues for the remainder of the minimum volume commitment period forecast as of the redetermination date and scheduled estimates thereof for the minimum volume commitment period made as of September 30, 2009. The cumulative upward or downward adjustment for the Barnett Shale region is capped at 27.5 percent of the initial weighted average Barnett Shale fee (as escalated) as specified in the gas gathering agreement. If we and Chesapeake or Total, as applicable, do not agree upon a redetermination of the Barnett Shale fee within 30 days of receipt of the request for the redetermination, an industry expert will be selected to determine adjustments to the Barnett Shale fee.

 

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Well Connection Requirement. Subject to required notice by Chesapeake and Total and certain exceptions, we have generally agreed to connect new operated drilling pads and new operated wells within our Barnett Shale region acreage dedications as requested by Chesapeake and Total during the minimum volume commitment period. During the minimum volume commitment period, if we fail to complete a connection in the acreage dedication by the required date, Chesapeake and Total, as their sole remedy for such delayed connection, are entitled to a delay in the minimum volume obligations for gas volumes that would have been produced from the delayed connection.

 

   

Fuel and Lost and Unaccounted For Gas. We have agreed with Chesapeake on MMBtu-based caps on fuel and lost and unaccounted for gas on our systems, both on an individual basis and an aggregate basis, with respect to Chesapeake’s volumes. These caps do not apply to certain of our gathering systems due to their historical performance relative to the caps. These systems will be reviewed annually to determine whether changes have occurred that would make them suitable for inclusion. If we exceed a permitted cap in any covered period, we may incur significant expenses to replace the natural gas used as fuel or lost and unaccounted for in excess of such cap based on then current natural gas prices. Accordingly, this replacement obligation may subject us to direct commodity price risk.

Haynesville Shale Region. Under our gas gathering agreement with Chesapeake, we have agreed to provide the following services in our Haynesville Shale region to Chesapeake for the fees and obligations outlined below:

 

   

Gathering, Treating and Compression Services. We gather, treat and compress natural gas in exchange for fees per mcf for natural gas gathered and per mcf for natural gas compressed. We refer to these fees collectively as the Haynesville fee. The Haynesville fee for this system is subject to an annual two and a half percent rate escalation at the beginning of each year.

 

   

Minimum Volume Commitments. Pursuant to our gas gathering agreement, Chesapeake has agreed to minimum volume commitments for each year through December 31, 2013. If Chesapeake does not meet its minimum volume commitment to us, as adjusted in certain instances, for any annual period during the minimum volume commitment period, Chesapeake will be obligated to pay us a fee equal to the Haynesville fees for each mcf by which the minimum volume commitment for the year exceeds the actual volumes gathered on our system attributable to Chesapeake’s production. To the extent natural gas gathered on our system from Chesapeake during any annual period exceeds Chesapeake’s minimum volume commitment for the period, Chesapeake will be obligated to pay us the Haynesville fees for all volumes gathered, and the excess volumes will be credited first against the minimum volume commitments for the year 2013, and then against the minimum volume commitments of each preceding year. If the minimum volume commitment for any period is credited in full, the minimum volume commitment period will be shortened to end on the final day of the immediately preceding period.

 

   

Acreage Dedication. Pursuant to our gas gathering agreement, subject to certain exceptions, Chesapeake has agreed to dedicate all of the natural gas owned or controlled by it and produced from or attributable to existing and future wells located on oil, natural gas and mineral leases within the Haynesville Shale region acreage dedication.

 

   

Fee Redetermination. The Haynesville fees are subject to a redetermination mechanism. The first redetermination period extends from December 1, 2010 through December 31, 2012, and subsequent redetermination periods will be the calendar years 2013 through 2020. We and Chesapeake will determine an adjustment to fees for the gathering system in the region based on the factors specified in the gas gathering agreement, including, but not limited to, differences between our actual capital expenditures, compression expenses and revenues as of the redetermination date and the scheduled estimates of these amounts for the period ending December 31, 2020, referred to as the redetermination period, made as of November 30, 2010. The annual upward or downward fee adjustment for the Haynesville Shale region is capped at 15 percent of the then current fees at the time of redetermination.

 

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Well Connection Requirement. We have certain connection obligations for new operated drilling pads and operated wells of Chesapeake in the acreage dedications. Chesapeake is required to provide us notice of new drilling pads and wells that it operates in the acreage dedications. Subject to certain conditions specified in the gas gathering agreement, we are generally required to connect new operated drilling pads in the acreage dedication by the later of 30 days after the date the wells commence production or six months after the date of the connection notice. During the minimum volume period, if we fail to complete a connection in the Haynesville Shale acreage dedication by the required date, Chesapeake, as its sole remedy for such delayed connection, is entitled to a delay in the minimum volume obligations for gas volumes that would have been produced from the delayed connection. After the minimum volume period, we are subject to a daily penalty for such delayed connections, up to a specified cap per delayed connection. Chesapeake also is required to notify us of its wells drilled in the acreage dedications that are operated by other parties and we have the option, but not the obligation, to connect non-operated wells to our gathering system. If we decline to make a connection to a non-operated well, Chesapeake has certain rights to have the well released from the dedication under the gas gathering agreement.

 

   

Fuel and Lost and Unaccounted For Gas. We have agreed with Chesapeake on MMBtu-based caps on fuel and lost and unaccounted for gas on our system with respect to Chesapeake’s volumes. These caps do not apply to one of our compressor stations due to its historical performance relative to the caps. This station will be reviewed periodically to determine whether changes have occurred that would make it suitable for inclusion. If we exceed a permitted cap in any covered period, we may incur significant expenses to replace the natural gas used as fuel or lost and unaccounted for in excess of such cap based on then current natural gas prices. Accordingly, this replacement obligation may subject us to direct commodity price risk.

Mid-Continent Region. Under our gas gathering agreement with Chesapeake, we have agreed to provide the following services in our Mid-Continent region to Chesapeake for the fees and obligations of Chesapeake outlined below:

 

   

Gathering, Treating and Compression Services. We gather, treat and compress natural gas in exchange for system-based services fees per mcf for natural gas gathered and per mcf for natural gas compressed. We refer to these fees collectively as the Mid-Continent fee. The Mid-Continent fee for these systems is subject to an annual two and a half percent rate escalation at the beginning of each year.

 

   

Acreage Dedication. Pursuant to our gas gathering agreement, subject to certain exceptions, Chesapeake has agreed to dedicate all of the natural gas owned or controlled by it and produced from or attributable to existing and future wells located on oil, natural gas and mineral leases covering lands within the acreage dedication.

 

   

Fee Redetermination. The Mid-Continent fees are redetermined at the beginning of each year through 2019. We and Chesapeake will determine an adjustment to fees for the gathering systems in the region based on the factors specified in the gas gathering agreement, including, but not limited to, differences between our actual capital expenditures, compression expenses and revenues as of the redetermination date and the scheduled estimates of these amounts for the period ending June 30, 2019, referred to as the redetermination period, made as of September 30, 2009. The annual upward or downward fee adjustment for the Mid-Continent region is capped at 15 percent of the then current fees at the time of redetermination.

 

   

Well Connection Requirement. Subject to required notice by Chesapeake and certain exceptions, we have generally agreed to use our commercially reasonable efforts to connect new operated drilling pads and new operated wells in our Mid-Continent region acreage dedications as requested by Chesapeake through June 30, 2019.

 

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Fuel and Lost and Unaccounted For Gas. We have agreed with Chesapeake on MMBtu-based caps on fuel and lost and unaccounted for gas on our systems, both on an individual basis and an aggregate basis, with respect to Chesapeake’s volumes. These caps do not apply to certain of our gathering systems due to their historical performance relative to the caps. These systems will be reviewed annually to determine whether changes have occurred that would make them suitable for inclusion. If we exceed a permitted cap in any covered period, we may incur significant expenses to replace the natural gas used as fuel or lost and unaccounted for in excess of such cap based on then current natural gas prices. Accordingly, this replacement obligation may subject us to direct commodity price risk.

We believe the recent trend of producers moving drilling rigs from dry gas regions to liquids rich plays such as the Mid-Continent may present an opportunity for us to enter the market of gathering and transporting oil as we believe those services fit well with our current business model.

If either Chesapeake or Total sells, transfers or otherwise disposes to a third party properties within the acreage dedication in our Barnett Shale region and, solely with respect to Chesapeake in our Haynesville Shale region and our Mid-Continent region, the third party will be required to either enter into our existing gas gathering agreement with Chesapeake or Total or enter into a new gas gathering agreement with us on substantially similar terms to our existing gas gathering agreement with Chesapeake or Total.

Other Arrangements

Business Opportunities. Pursuant to our omnibus agreement with Chesapeake, Chesapeake has agreed to provide us a right of first offer with respect to three specified categories of transactions: (i) opportunities to develop or invest in midstream energy projects within five miles of our acreage dedications in our Barnett Shale and Mid-Continent regions, (ii) opportunities to succeed third parties in expiring midstream energy service contracts within five miles of the acreage dedications and (iii) opportunities with respect to future midstream divestitures outside of the acreage dedications. The consummation, if any, and timing of any such future transactions will depend upon, among other things, our ability to reach an agreement with Chesapeake and our ability to obtain financing on acceptable terms. Notwithstanding the foregoing, Chesapeake is under no obligation to accept any offer that we make with respect to such opportunities. Although we will have certain rights with respect to the potential business opportunities, we are not under any contractual obligation to pursue any such transactions.

Services Arrangements. Under our services agreement with Chesapeake, Chesapeake has agreed to provide us with certain general and administrative services and any additional services we may request. We reimburse Chesapeake for such general and administrative services in any given month subject to a cap equal to $0.03025 per mcf multiplied by the volume (measured in mcf) of natural gas that we gather, treat or compress. The fee is calculated as the lesser of $0.03025/mcf gathered or actual corporate overhead costs, excluding those overhead costs that are billed directly to the Partnership. The $0.03025 per mcf cap is subject to an annual upward adjustment on October 1 of each year equal to 50 percent of any increase in the Consumer Price Index, and, subject to receipt of requisite approvals, such cap may be further adjusted to reflect changes in general and administrative services provided by Chesapeake relating to new laws or accounting rules that are implemented. The cap contained in the services agreement does not apply to our direct general and administrative expenses.

Additionally, pursuant to an employee secondment agreement, specified employees of Chesapeake are seconded to our general partner to provide operating, routine maintenance and other services with respect to our business under the direction, supervision and control of our general partner. Our general partner, subject to specified exceptions and limitations, reimburses Chesapeake on a monthly basis for substantially all costs and expenses it incurs relating to such seconded employees. Additionally, under our employee transfer agreement, we are required to maintain certain compensation standards for seconded employees to whom we make offers for hire.

 

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Table of Contents

How We Evaluate Our Operations

Our management relies on certain financial and operational metrics to analyze our performance. These metrics are significant factors in assessing our operating results and profitability and include (i) throughput volumes, (ii) revenues, (iii) operating expenses, (iv) Adjusted EBITDA and (v) distributable cash flow.

Throughput Volumes

Although Chesapeake’s and Total’s respective minimum volume commitments generally provide us with protection if throughput volumes from Chesapeake or Total in the Barnett Shale region and Chesapeake in the Haynesville Shale region do not meet certain levels, our management analyzes our performance based on the aggregate amount of throughput volumes on our gathering systems in our Barnett Shale, Haynesville Shale and Mid-Continent regions in order to maintain or increase throughput volumes on our gathering systems as a whole. Our success in connecting additional wells is impacted by successful drilling activity on the acreage dedicated to our systems, our ability to secure volumes from new wells drilled on non-dedicated acreage, our ability to attract natural gas volumes currently gathered by our competitors and our ability to cost-effectively construct new infrastructure to connect new wells.

Revenues

Our revenues are driven primarily by our customers’ minimum volume commitments and the actual volumes of natural gas we gather, treat and compress. In the case of our Barnett Shale and Haynesville Shale volumes, our results will be supported by the minimum volume commitments contained in our gas gathering agreements with Chesapeake and Total. We contract with producers to gather natural gas from individual wells located near our gathering systems. We connect wells to gathering pipelines through which natural gas is compressed and may be delivered to a treating facility, processing plant or an intrastate or interstate pipeline for delivery to market. We treat natural gas that we gather to the extent necessary to meet required specifications of third-party takeaway pipelines. For the Current Quarter and Prior Quarter, Chesapeake accounted for approximately 83.8 percent and 78.1 percent, respectively, of the natural gas volumes on our gathering systems and 83.0 percent and 80.4 percent, respectively, of our revenues. For the Current Period and Prior Period, Chesapeake accounted for approximately 84.3 percent and 80.9 percent, respectively, of the natural gas volumes on our gathering systems and 83.6 percent and 82.4 percent, respectively, of our revenues.

Our revenues are also impacted by other aspects of our contractual agreements, including rate redetermination, and our management constantly evaluates capital spending and its impact on future revenue generation.

Operating Expenses

Our management seeks to maximize the profitability of our operations by minimizing operating expenses without compromising environmental protection and employee safety. Operating expenses consist primarily of field operating costs (which include labor, treating and chemicals, and measurement services, among other items), compression expense, ad valorem taxes and other operating costs, some of which are independent of the volumes that flow through our systems but fluctuate depending on the scale of our operations during a specific period.

Chesapeake has extensive operational, commercial, technical and administrative personnel that we utilize to enhance our operating efficiency and overall asset utilization. In some instances, these services are available to us at a low cost compared to the expense of developing these functions internally.

Adjusted EBITDA and Distributable Cash Flow

We define Adjusted EBITDA as net income (loss) before income tax expense (benefit), interest expense, depreciation and amortization expense and certain other items management believes affect the comparability of operating results.

 

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We define distributable cash flow as Adjusted EBITDA, plus interest income, less cash paid for interest expense, maintenance capital expenditures and income taxes. Distributable cash flow does not reflect changes in working capital balances. Distributable cash flow and Adjusted EBITDA are not presentations made in accordance with U.S. generally accepted accounting principles (“GAAP”).

Adjusted EBITDA and distributable cash flow are non-GAAP supplemental financial measures that management and external users of our consolidated financial statements, such as industry analysts, investors, lenders and rating agencies, may use to assess:

 

   

our operating performance as compared to other publicly traded partnerships in the midstream energy industry, without regard to historical cost basis, or in the case of Adjusted EBITDA, financing methods;

 

   

our ability to incur and service debt and fund capital expenditures;

 

   

the ability of our assets to generate sufficient cash flow to make distributions to our unitholders; and

 

   

the viability of acquisitions and other capital expenditure projects and the returns on investment of various investment opportunities.

We believe that the presentation of Adjusted EBITDA and distributable cash flow provides useful information to investors in assessing our financial condition and results of operations. The GAAP measures most directly comparable to Adjusted EBITDA and distributable cash flow are net income and net cash provided by operating activities, respectively. Our non-GAAP financial measures of Adjusted EBITDA and distributable cash flow should not be considered as an alternative to GAAP net income or net cash provided by operating activities. Each of Adjusted EBITDA and distributable cash flow has important limitations as an analytical tool because it excludes some but not all items that affect net income and net cash provided by operating activities. You should not consider either Adjusted EBITDA or distributable cash flow in isolation or as a substitute for analysis of our results as reported under GAAP. Because Adjusted EBITDA and distributable cash flow may be defined differently by other companies in our industry, our definitions of Adjusted EBITDA and distributable cash flow may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.

The following table presents a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income and a reconciliation of the non-GAAP financial measure of distributable cash flow to the GAAP financial measure cash provided by operating activities:

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2011     2010     2011     2010  
     ($ in thousands)  

Net Income

   $ 48,173      $ 33,414      $ 128,032      $ 105,345   

Interest expense

     4,250        2,059        9,527        5,876   

Income tax expense

     665        699        2,361        1,772   

Depreciation and amortization expense

     35,021        22,407        98,706        65,119   

(Gain) loss on sale of assets

     (40     323        823        256   
  

 

 

   

 

 

   

 

 

   

 

 

 

Adjusted EBITDA

   $ 88,069      $ 58,902      $ 239,449      $ 178,368   
  

 

 

   

 

 

   

 

 

   

 

 

 

Cash Provided By Operating Activities

   $ 92,506      $ 69,711      $ 298,494      $ 267,120   

Changes in assets and liabilities

     (7,906     (12,048     (66,579     (92,243

Maintenance capital expenditures

     (18,500     (17,500     (55,500     (52,500

Other non-cash items

     (512     (141     (883     (99
  

 

 

   

 

 

   

 

 

   

 

 

 

Distributable cash flow

   $ 65,588      $ 40,022      $ 175,532      $ 122,278   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Results of Operations – Three Months Ended September 30, 2011 versus September 30, 2010

Revenues. Our revenues are primarily attributable to the amount of throughput on our gathering systems and the rates charged for gathering such throughput. For the Current Quarter, revenues were $140.1 million compared to $100.1 million during the Prior Quarter, primarily as a result of volumes added through the Springridge gathering system acquisition. Revenues were positively impacted by the redetermination of Mid-Continent gathering rates that occurred January 1, 2011 and rate escalation of two percent in the Barnett Shale and two and a half percent in the Mid-Continent region. We also benefited from added revenues from the significant number of wells connected during the first half of 2011. For the Current Quarter, throughput was 2.226 Bcf per day compared to 1.584 Bcf per day for the Prior Quarter. Because we expect throughput in the Barnett Shale for the full year 2011 to be below contractual minimum volume commitment levels, we expect to recognize additional revenues related to volume shortfall in the fourth quarter of 2011. The minimum volume commitment is measured annually and the associated revenue is recognized in the fourth quarter of each year. If our estimate of minimum volume commitment for the full year of 2011 were recognized quarterly, revenues and net income would have increased $2.2 million in the Current Quarter. We connected 146 new wells during the Current Quarter compared to 121 new wells in the Prior Quarter. The following table reflects our revenues and throughput by region for the three months ended September 30, 2011 and September 30, 2010:

 

     Three Months Ended
September 30,
        
     2011      2010      % Change(1)  
     (In thousands, except percentages and throughput data)  

Revenue:

  

Barnett Shale

   $ 86,227       $ 75,411         14.3

Haynesville Shale

     24,513                 N.M.   

Mid-Continent

     29,365         24,649         19.1
  

 

 

    

 

 

    

 

 

 
   $ 140,105       $ 100,060         40.0
  

 

 

    

 

 

    

 

 

 

Throughput (bcf):

  

Barnett Shale

     98.9         94.7         4.4

Haynesville Shale

     53.2                 N.M.   

Mid-Continent

     52.7         51.0         3.3
  

 

 

    

 

 

    

 

 

 
     204.8         145.7         40.6
  

 

 

    

 

 

    

 

 

 

 

(1) 

N.M. - not meaningful

Operating Expenses. For the Current Quarter, operating expenses were $0.21 per mcf compared to $0.23 per mcf during the Prior Quarter. Despite the overall decrease, we have experienced an increase in both the Barnett Shale and Mid-Continent regions due to additional compression expense, primarily in the Barnett Shale, that has increased our overall throughput capacity and additional field personnel resulting from Partnership growth and other personnel related costs. We have also experienced an increase in ad valorem taxes due to growth and an increase in the total value of our fixed assets. The following table reflects our operating expenses and operating expenses per mcf of throughput by region for the three months ended September 30, 2011 and September 30, 2010:

 

     Three Months Ended
September 30,
        
     2011      2010      % Change(1)  
     (In thousands, except percentages and per mcf data)  

Operating Expenses:

  

Barnett Shale

   $ 25,360       $ 22,581         12.3

Haynesville Shale

     4,731                 N.M.   

Mid-Continent

     13,142         11,513         14.1
  

 

 

    

 

 

    

 

 

 
   $ 43,233       $ 34,094         26.8
  

 

 

    

 

 

    

 

 

 

Expenses ($ per mcf):

  

Barnett Shale

   $ 0.26       $ 0.24         8.3

Haynesville Shale

     0.09                 N.M.   

Mid-Continent

     0.25         0.23         8.7
  

 

 

    

 

 

    

 

 

 
   $ 0.21       $ 0.23         (8.7 )% 
  

 

 

    

 

 

    

 

 

 

 

(1) 

N.M. - not meaningful

 

 

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Depreciation and Amortization Expense. Depreciation and amortization expense for the Current Quarter was $35.0 million compared to $22.4 million during the Prior Quarter. The increase is a result of capital expenditures made in 2010 and the first half of 2011 and the acquisition of the Springridge gathering system in the Haynesville Shale.

General and Administrative Expense. During the Current Quarter, general and administrative expenses were $8.9 million compared to $7.1 million during the Prior Quarter. This increase is primarily attributable to additional expenses resulting from the acquisition of the Springridge gathering system in the Haynesville Shale.

Interest Expense. Interest expense is related to borrowings under our senior notes and revolving credit facility and commitment fees on the unused portion of our credit facility. Interest expense was $4.2 million in the Current Quarter and $2.1 million in the Prior Quarter. The increase is related to interest expense on the senior notes issued in April 2011. These amounts were net of $2.7 million and $0.4 million of capitalized interest during the Current Quarter and the Prior Quarter, respectively.

Income Tax Expense. Income tax expense is attributable to franchise taxes in the state of Texas. The Partnership and its subsidiaries are pass-through entities for federal income tax purposes. For these entities, all income, expenses, gains, losses and tax credits generated flow through to their owners and, accordingly, do not result in a provision for income taxes in the unaudited condensed consolidated financial statements, other than Texas franchise tax.

Results of Operations – Nine Months Ended September 30, 2011 versus September 30, 2010

Revenues. Our revenues are primarily attributable to the amount of throughput on our gathering systems and the rates charged for gathering such throughput. For the Current Period, revenues were $396.9 million compared to $296.7 million during the Prior Period, primarily as a result of volumes added through the Springridge gathering system acquisition. Revenues were positively impacted by the redetermination of Mid-Continent gathering rates that occurred January 1, 2011 and rate escalation of two percent in the Barnett Shale and two and a half percent in the Mid-Continent region. We also benefited from added compression revenues during the Current Period as well as additional revenues resulting from the significant number of well connects completed in late 2010 and to date in 2011. For the Current Period, throughput was 2.128 Bcf per day compared to 1.580 Bcf per day for the Prior Period. Because throughput in the Barnett Shale during the Current Period was significantly below contractual minimum volume commitment levels, we expect to recognize additional revenues related to volume shortfall in the fourth quarter of 2011. The minimum volume commitment is measured annually and the associated revenue is recognized in the fourth quarter of each year. If our estimate of minimum volume commitment for the full year of 2011 were recognized quarterly, revenues and net income would have increased $7.5 million in the Current Period. We connected 444 new wells during the Current Period compared to 301 new wells in the Prior Period. The following table reflects our revenues and throughput by region for the nine months ended September 30, 2011 and September 30, 2010:

 

     Nine Months Ended
September 30,
        
     2011      2010      % Change(1)  
     (In thousands, except percentages and throughput data)  

Revenue:

        

Barnett Shale

   $ 244,684       $ 222,951         9.7

Haynesville Shale

     69,147                 N.M.   

Mid-Continent

     83,020         73,734         12.6
  

 

 

    

 

 

    

 

 

 
   $ 396,851       $ 296,685         33.8
  

 

 

    

 

 

    

 

 

 

Throughput (bcf):

        

Barnett Shale

     281.1         279.2         0.7

Haynesville Shale

     148.9                 N.M.   

Mid-Continent

     150.9         152.0         (0.7 )% 
  

 

 

    

 

 

    

 

 

 
     580.9         431.2         34.7
  

 

 

    

 

 

    

 

 

 

 

(1) 

N.M. - not meaningful

 

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Operating Expenses. For the Current Period, operating expenses were $0.22 per mcf compared to $0.23 per mcf during the Prior Period. Despite the overall decrease, we have experienced an increase in both the Barnett Shale and Mid-Continent regions due to additional compression expense, primarily in the Barnett Shale, that has increased our overall throughput capacity and additional field personnel resulting from Partnership growth and other personnel related costs. The following table reflects our operating expenses and operating expenses per mcf of throughput by region for the nine months ended September 30, 2011 and September 30, 2010:

 

     Nine Months Ended
September  30,
        
     2011      2010      % Change(1)  
     (In thousands, except percentages and per mcf data)  

Operating Expenses:

        

Barnett Shale

   $ 75,191       $ 62,018         21.2

Haynesville Shale

     15,922                 N.M.   

Mid-Continent

     38,965         35,154         10.8
  

 

 

    

 

 

    

 

 

 
   $ 130,078       $ 97,172         33.9
  

 

 

    

 

 

    

 

 

 

Expenses ($ per mcf):

        

Barnett Shale

   $ 0.27       $ 0.22         22.7

Haynesville Shale

     0.11                 N.M.   

Mid-Continent

     0.26         0.23         13.0
  

 

 

    

 

 

    

 

 

 
   $ 0.22       $ 0.23         (4.3 )% 
  

 

 

    

 

 

    

 

 

 

 

(1) 

N.M. - not meaningful

Depreciation and Amortization Expense. Depreciation and amortization expense for the Current Period was $98.7 million compared to $65.1 million during the Prior Period. The increase is a result of capital expenditures made in 2010 and early 2011 and the acquisition of the Springridge gathering system in the Haynesville Shale.

General and Administrative Expense. During the Current Period, general and administrative expenses were $27.5 million compared to $21.2 million during the Prior Period. This increase is primarily attributable to additional expenses resulting from the acquisition of the Springridge gathering system in the Haynesville Shale.

Interest Expense. Interest expense is related to borrowings under our senior notes and revolving credit facility and commitment fees on the unused portion of our credit facility. Interest expense was $9.5 million in the Current Period and $5.9 million in the Prior Period. The increase is related to interest expense on the senior notes issued in April 2011. These amounts were net of $7.3 million and $1.9 million of capitalized interest during the Current Period and the Prior Period, respectively.

Income Tax Expense. Income tax expense is attributable to franchise taxes in the state of Texas. The Partnership and its subsidiaries are pass-through entities for federal income tax purposes. For these entities, all income, expenses, gains, losses and tax credits generated flow through to their owners and, accordingly, do not result in a provision for income taxes in the unaudited condensed consolidated financial statements, other than Texas franchise tax.

Liquidity and Capital Resources

Our ability to finance operations and fund capital expenditures will largely depend on our ability to generate sufficient cash flow to cover these expenses as well as the availability of borrowings under our revolving credit facility and our access to the capital markets. Our ability to generate cash flow is subject to a number of factors, some of which are beyond our control. See Risk Factors in Item 1A of our annual report on Form 10-K for the year ended December 31, 2010.

 

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Working Capital. Working capital, defined as the amount by which current assets exceed current liabilities, is an indication of liquidity and the potential need for short-term funding. As of September 30, 2011, we had a working capital deficit of $63.2 million and as of December 31, 2010, we had positive working capital of $33.5 million. The decrease was primarily attributable to a decrease in the accounts receivable balance, which was due to the accrual of revenue associated with the minimum volume commitment in December 2010.

Cash Flows. Net cash provided by (used in) operating activities, investing activities and financing activities of the Partnership for the nine months ended September 30, 2011 and September 30, 2010, were as follows:

 

     Nine Months Ended
September 30,
 
     2011     2010  
     ($ in thousands)  

Cash Flow Data:

  

Net cash provided by (used in):

    

Operating activities

   $ 298,494      $ 267,120   

Investing activities

   $ (325,081   $ (152,047

Financing activities

   $ 8,794      $ 194,054   

Operating Activities. Net cash provided by operating activities was $298.5 million for the Current Period compared to $267.1 million during the Prior Period. This amount was attributable to both cash flow from operations and changes in working capital. Cash flow from operations has increased as additional volumes have been brought onto our systems through both capital expenditures and acquisitions.

Investing Activities. Net cash used in investing activities for the Current Period and the Prior Period were primarily attributable to capital spending related to the expansion of gathering systems.

Financing Activities. Net cash provided by financing activities was $8.8 million for the Current Period compared to $194.1 million for the Prior Period. This change was primarily attributable to the proceeds from the issuance of senior notes in April 2011.

Sources of Liquidity

At September 30, 2011, our potential sources of liquidity included:

 

   

cash on hand;

 

   

cash generated from operations;

 

   

borrowing availability under our revolving credit facility.

We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements and long-term capital expenditure requirements and to fund our quarterly cash distributions to unitholders.

Credit Facility

On June 10, 2011, we amended our senior secured revolving credit facility and extended its maturity to June 2016. As amended, the credit facility provides up to $800 million of borrowing capacity and includes a sub-limit of $50 million for same-day swing line advances and a sub-limit of $50 million for letters of credit. In addition, the credit facility contains an accordion feature that allows us to increase the available borrowing capacity under the facility up to $1 billion, subject to the satisfaction of certain closing conditions, including the identification of lenders or proposed lenders that agree to satisfy the increased commitment amounts under the credit facility. Borrowings under the credit facility are secured by all of our and our subsidiaries’ assets. Prior to our reaching investment grade status, amounts borrowed under the credit facility agreement will bear interest under a leverage-based pricing grid at our option at either: (i) the greater of (a) the reference rate of Wells Fargo Bank, NA, (b) the federal funds effective rate plus 0.50 percent or (c) the Eurodollar rate which is based on the London Interbank Offered Rate (LIBOR), plus 1.00 percent, each of which is subject to a margin that varies from 0.75 percent to 1.50 percent per annum through December 31,

 

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Table of Contents

2011 and 0.625 percent to 1.50 percent per annum after December 31, 2011, according to the Partnership’s leverage ratio (as defined), or (ii) the Eurodollar rate plus a margin that varies from 1.75 percent to 2.50 percent per annum through December 31, 2011 and 1.625 percent to 2.50 percent per annum after December 31, 2011, according to the Partnership’s leverage ratio. If we reach investment grade status, we will have the option to release the security under the credit facility and amounts borrowed will bear interest under a specified ratings-based pricing grid. The unused portion of the credit facility is subject to commitment fees of (a) 0.30 percent to 0.40 percent per annum through December 31, 2011 and 0.25 percent to 0.40 percent per annum after December 31, 2011 while we are subject to the leverage-based pricing grid, according to the Partnership’s leverage ratio and (b) 0.20 percent to 0.35 percent per annum while we are is subject to the ratings-based pricing grid, according to our senior unsecured long-term debt ratings. There were $67.3 million and $249.1 million of outstanding borrowings under the credit facility at September 30, 2011 and December 31, 2010, respectively. The available balance at September 30, 2011 was $732.7 million.

The credit facility agreement contains various covenants and restrictive provisions which, among other things, limit our and our subsidiaries’ ability to incur additional indebtedness, make investments or loans, create liens and pay dividends or distributions. If we fail to perform our obligations under these and other covenants, the revolving credit commitment could be terminated and any outstanding borrowings, together with accrued interest, under the credit facility could be declared immediately due and payable. The credit facility agreement also has cross default provisions that apply to any of our other indebtedness with an outstanding principal amount in excess of $15.0 million.

The credit facility agreement contains certain negative covenants that (i) limit our ability, as well as the ability of certain of our subsidiaries, among other things, to enter into hedging arrangements and create liens and (ii) require us to maintain a consolidated leverage ratio, and an EBITDA to interest expense ratio, in each case as described in the credit facility agreement. The credit facility agreement also provides for the discontinuance of the requirement for us to maintain the EBITDA to interest expense ratio if we reach investment grade status. We were in compliance with all covenants under the agreement at September 30, 2011.

Senior Notes

On April 19, 2011, we and CHKM Finance Corp., a wholly owned subsidiary of Chesapeake MLP Operating, L.L.C., completed a private placement of $350.0 million in aggregate principal amount of 5.875 percent senior notes due 2021 (the “Notes”). We used a portion of the net proceeds to repay borrowings outstanding under our revolving credit facility and used the balance for general partnership purposes. Debt issuance costs of $7.8 million are being amortized over the life of the Notes.

The Notes will mature on April 15, 2021 and interest is payable on the Notes on April 15 and October 15 of each year, beginning on October 15, 2011. We have the option to redeem all or a portion of the Notes at any time on or after April 15, 2015, at the redemption price specified in the indenture, plus accrued and unpaid interest. We may also redeem the Notes, in whole or in part, at a “make-whole” redemption price specified in the indenture, plus accrued and unpaid interest, at any time prior to April 15, 2015. In addition, we may redeem up to 35 percent of the Notes prior to April 15, 2014 under certain circumstances with the net cash proceeds from certain equity offerings. The Indenture contains covenants that, among other things, limit our ability and the ability of certain of our subsidiaries to: (1) sell assets, including equity interests in our subsidiaries; (2) pay distributions on, redeem or purchase our units, or redeem or purchase our subordinated debt; (3) make investments; (4) incur or guarantee additional indebtedness or issue preferred units; (5) create or incur certain liens; (6) enter into agreements that restrict distributions or other payments from certain subsidiaries to us; (7) consolidate, merge or transfer all or substantially all of our or certain of our subsidiaries’ assets; (8) engage in transactions with affiliates; and (9) create unrestricted subsidiaries. These covenants are subject to important exceptions and qualifications. If the Notes achieve an investment grade rating from either of Moody’s Investors Service, Inc. or Standard & Poor’s Ratings Services and no default, as defined in the Indenture, has occurred or is continuing, many of these covenants will terminate.

 

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Capital Requirements

Our business is capital-intensive, requiring significant investment to grow our business as well as to maintain and improve existing assets. We categorize capital expenditures as either:

 

   

maintenance capital expenditures, which include those expenditures required to maintain our long-term operating capacity and/or operating income and service capability of our assets, including the replacement of system components and equipment that have suffered significant wear and tear, become obsolete or approached the end of their useful lives, those expenditures necessary to remain in compliance with regulatory legal requirements or those expenditures necessary to complete additional well connections to maintain existing system volumes and related cash flows; or

 

   

growth capital expenditures, which include those expenditures incurred in order to acquire additional assets to grow our business, expand and upgrade our systems and facilities, extend the useful lives of our assets, increase gathering, treating and compression throughput from current levels and reduce costs or increase revenues.

For the Current Period, growth capital expenditures totaled $271.1 million and maintenance capital expenditures totaled $55.5 million. Our future capital expenditures may vary significantly from budgeted amounts and from period to period based on the investment opportunities that become available to us.

We continually review opportunities for both organic growth projects and acquisitions that will enhance our financial performance. Because our partnership agreement requires us to distribute most of the cash generated from operations to our unitholders and our general partner, we expect to fund future capital expenditures from cash and cash equivalents on hand, cash flow generated from our operations that is not distributed to our unitholders and general partner, borrowings under our revolving credit facility and future issuances of equity and debt securities.

Distributions

On January 31, 2011, the Board of Directors of our general partner declared a cash distribution to our unitholders of $0.3375 per unit for the quarter ended December 31, 2010, or $1.35 per common unit on an annualized basis, together with the corresponding distribution to the general partner. The cash distribution was paid on February 14, 2011, to unitholders of record at the close of business on February 10, 2011, and to the general partner.

On April 26, 2011, the Board of Directors of our general partner declared a cash distribution to our unitholders of $0.35 per unit for the quarter ended March 31, 2011, or $1.40 per common unit on an annualized basis, together with the corresponding distribution to the general partner. The cash distribution was paid on May 13, 2011, to unitholders of record at the close of business on May 6, 2011, and to the general partner.

On July 26, 2011, the Board of Directors of our general partner declared a cash distribution to our unitholders of $0.3625 per unit for the quarter ended September 30, 2011, or $1.45 per common unit on an annualized basis, together with the corresponding distribution to the general partner. The cash distribution was paid on August 12, 2011, to unitholders of record at the close of business on August 5, 2011, and to the general partner.

Critical Accounting Policies and Estimates

The preparation of financial statements in conformity GAAP requires us to make estimates and assumptions that affect the reported amounts and disclosure of contingencies. We make significant estimates which impact depreciation and assumptions regarding future net cash flows. Although we believe these estimates are reasonable, actual results could differ from our estimates.

We consider depreciation and evaluation of long-lived assets for impairment to be critical policies and estimates. These policies and estimates are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in the Partnership’s annual report on Form 10-K for the year ended December 31, 2010.

 

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Forward-Looking Statements

Certain statements and information in this quarterly report on Form 10-Q may constitute forward-looking statements. The words “believe,” “expect,” “anticipate,” “plan,” “intend,” “foresee,” “should,” “would,” “could” or other similar expressions are intended to identify forward-looking statements, which are generally not historical in nature. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effect on us. While management believes that these forward-looking statements are reasonable as and when made, there can be no assurance that future developments affecting us will be those that we anticipate. All comments concerning our expectations for future revenues and operating results are based on our forecasts for our existing operations and do not include the potential impact of any future acquisitions. Our forward-looking statements involve significant risks and uncertainties (some of which are beyond our control) and assumptions that could cause actual results to differ materially from our historical experience and our present expectations or projections. Important factors that could cause actual results to differ materially from those in the forward-looking statements include, but are not limited to, those summarized below:

 

   

our dependence on Chesapeake and Total for a substantial majority of our revenues;

 

   

the impact on our growth strategy and ability to increase cash distributions if Chesapeake and Total do not increase the volume of natural gas they provide to our gathering systems;

 

   

realized oil and natural gas prices;

 

   

the termination of our gas gathering agreements with Chesapeake or Total;

 

   

our potential inability to pay the minimum quarterly distribution to our unitholders;

 

   

the limitations that Chesapeake’s and our own level of indebtedness may have on our financial flexibility;

 

   

our ability to obtain new sources of natural gas, which is dependent on factors largely beyond our control;

 

   

the availability of capital resources to fund capital expenditures and other contractual obligations, and our ability to access those resources through the debt or equity capital markets;

 

   

competitive conditions;

 

   

the unavailability of third-party pipelines interconnected to our gathering systems or the potential that the volumes we gather do not meet the quality requirement of such pipelines;

 

   

new asset construction may not result in revenue increases and will be subject to regulatory, environmental, political, legal and economic risks;

 

   

our exposure to direct commodity price risk may increase in the future;

 

   

our ability to maintain and/or obtain rights to operate our assets on land owned by third parties;

 

   

hazards and operational risks that may not be fully covered by insurance;

 

   

our dependence on Chesapeake for substantially all of our compression capacity;

 

   

our lack of industry and geographic diversification; and

 

   

legislative or regulatory changes, including changes in environmental regulations, environmental risks, regulations by FERC and liability under federal and state environmental laws and regulations.

Other factors that could cause our actual results to differ from our projected results are described elsewhere in this report and in (i) our annual report on Form 10-K for the year ended December 31, 2010, (ii) our reports and registration statements filed from time to time with the SEC and (iii) other announcements we make from time to time.

Readers are cautioned not to place undue reliance on forward-looking statements, which speak only as of the date hereof. We undertake no obligation to publicly update or revise any forward-looking statements after the date they are made, whether as a result of new information, future events or otherwise.

 

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ITEM 3. Quantitative and Qualitative Disclosures About Market Risk

We are dependent on Chesapeake and Total for substantially all of our supply of natural gas volumes and are consequently subject to the risk of nonpayment or late payment by Chesapeake and Total of gathering, treating and compression fees. Chesapeake’s debt ratings for its senior notes are below investment grade, and they may remain below investment grade for the foreseeable future. Additionally, neither of our Total counterparties under our gas gathering agreement, nor the Total guarantor of those counterparties, is rated by credit rating agencies. Accordingly, this risk may be more difficult to evaluate than it would be with an investment grade or otherwise rated contract counterparty or with a more diversified group of customers, and unless and until we significantly increase our customer base, we expect to continue to be subject to significant and non-diversified risk of nonpayment or late payment of our fees.

Commodity Price Risk

We attempt to mitigate commodity price risk by contracting our operations on a long-term fixed-fee basis and through various provisions in our gas gathering agreements with Chesapeake and Total that are intended to support the stability of our cash flows. Natural gas prices are historically impacted by changes in the supply and demand of natural gas, as well as market uncertainty. However, an actual or anticipated prolonged reduction in natural gas prices or disparity in oil and natural gas pricing could result in reduced drilling in our areas of operations and, accordingly, in volumes of natural gas gathered by our systems. Notwithstanding the minimum volume commitments in our Barnett Shale and Haynesville Shale regions and the fee redetermination provisions under our gas gathering agreements, a reduction in volumes of natural gas gathered by our systems could adversely affect both our profitability and our cash flows. Adverse effects on our cash flows from reductions in natural gas prices could adversely affect our ability to make cash distributions to our unitholders.

We have agreed with Chesapeake on MMBtu-based caps on fuel and lost and unaccounted for gas on certain of our systems with respect to Chesapeake’s volumes in our Barnett Shale and Mid-Continent regions. If we exceed a permitted cap in any covered period, we may incur significant expenses to replace the natural gas used as fuel or lost and unaccounted for in excess of such cap based on then current natural gas prices. Accordingly, this replacement obligation may subject us to direct commodity price risk.

Additionally, an increase in commodity prices could result in increased costs of steel and other products that we use in the operation of our business, as well as the cost of obtaining rights-of-way for property on which our assets are located. Accordingly, our operating expenses and capital expenditures could increase as a result of an increase in commodity prices.

 

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Table of Contents

ITEM 4. Controls and Procedures

As required by Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), we have evaluated, under the supervision and with the participation of our management, including the principal executive officer and principal financial officer of our general partner, the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this Form 10-Q. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including the principal executive officer and principal financial officer of our general partner, as appropriate, to allow timely decisions regarding required disclosure and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC. Based upon the evaluation, the principal executive officer and principal financial officer of our general partner have concluded that our disclosure controls and procedures were effective as of September 30, 2011, at the reasonable assurance level.

There was no change in our internal control over financial reporting that occurred during the Current Quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II. OTHER INFORMATION

 

ITEM 1. Legal Proceedings

We are not party to any legal proceeding other than legal proceedings arising in the ordinary course of our business. We are a party to various administrative and regulatory proceedings that have arisen in the ordinary course of our business. Management believes that there are no such proceedings for which final disposition could have a material adverse effect on our results of operations, cash flows or financial position.

 

ITEM 1A. Risk Factors

Our business has many risks. Factors that could materially adversely affect our business, financial condition, operating results or liquidity and the trading price of our common units are described under the heading “Risk Factors” in our annual report on Form 10-K for the year ended December 31, 2010. This information should be considered carefully, together with other information in this report and other reports and materials we file with the SEC.

There have been no material changes in our risk factors disclosed in Item 1A of our annual report on Form 10-K for the year ended December 31, 2010.

 

ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable.

 

ITEM 3. Defaults Upon Senior Securities

Not applicable.

 

ITEM 4. (Removed and Reserved)

 

ITEM 5. Other Information

Not applicable.

 

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ITEM 6. Exhibits

The following exhibits are filed as a part of this report:

 

            Incorporated by Reference              

Exhibit
Number

    

Exhibit Description

   Form    SEC File
Number
   Exhibit    Filing Date    Filed
Herewith
     Furnished
Herewith
 
  3.1      

Certificate of Limited Partnership of Chesapeake Midstream Partners, L.P.

   S-1    333-164905    3.1    02/16/2010      
  3.2      

First Amended and Restated Agreement of Limited Partnership of Chesapeake Midstream Partners, L.P. dated August 3, 2010.

   8-K    001-34831    3.1    08/05/2010      
  3.3      

Second Amended and Restated Limited Liability Company Agreement of Chesapeake MLP Operating, L.L.C., dated August 3, 2010.

   8-K    001-34831    3.2    08/05/2010      
  31.1      

J. Mike Stice, Chief Executive Officer, Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

                 X      
  31.2      

David C. Shiels, Chief Financial Officer, Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

                 X      
  32.1      

J. Mike Stice, Chief Executive Officer, Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                    X   
  32.2      

David C. Shiels, Chief Financial Officer, Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                    X   
 

101.INS

     

XBRL Instance Document.

                    X   
 

101.SCH

     

XBRL Taxonomy Extension Schema Document.

                    X   
 

101.CAL

     

XBRL Taxonomy Extension Calculation Linkbase Document.

                    X   
 

101.DEF

     

XBRL Taxonomy Extension Definition Linkbase Document.

                    X   
 

101.LAB

     

XBRL Taxonomy Extension Labels Linkbase Document.

                    X   
 

101.PRE

     

XBRL Taxonomy Extension Presentation Linkbase Document.

                    X   

 

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Table of Contents

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.

 

   

CHESAPEAKE MIDSTREAM PARTNERS, L.P.

   

By:    

 

Chesapeake Midstream GP L.L.C., its general partner

Date: November 10, 2011

   

By:    

 

/s/ J. MIKE STICE

     

J. Mike Stice

Chief Executive Officer

Date: November 10, 2011

   

By:    

 

/s/ DAVID C. SHIELS

     

David C. Shiels

Chief Financial Officer

 

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INDEX TO EXHIBITS

 

            Incorporated by Reference              

Exhibit
Number

    

Exhibit Description

   Form    SEC File
Number
   Exhibit    Filing Date    Filed
Herewith
     Furnished
Herewith
 
  3.1      

Certificate of Limited Partnership of Chesapeake Midstream Partners, L.P.

   S-1    333-164905    3.1    02/16/2010      
  3.2      

First Amended and Restated Agreement of Limited Partnership of Chesapeake Midstream Partners, L.P. dated August 3, 2010.

   8-K    001-34831    3.1    08/05/2010      
  3.3      

Second Amended and Restated Limited Liability Company Agreement of Chesapeake MLP Operating, L.L.C., dated August 3, 2010.

   8-K    001-34831    3.2    08/05/2010      
  31.1      

J. Mike Stice, Chief Executive Officer, Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

                 X      
  31.2      

David C. Shiels, Chief Financial Officer, Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

                 X      
  32.1      

J. Mike Stice, Chief Executive Officer, Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                    X   
  32.2      

David C. Shiels, Chief Financial Officer, Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

                    X   
 

101.INS

     

XBRL Instance Document.

                    X   
 

101.SCH

     

XBRL Taxonomy Extension Schema Document.

                    X   
 

101.CAL

     

XBRL Taxonomy Extension Calculation Linkbase Document.

                    X   
 

101.DEF

     

XBRL Taxonomy Extension Definition Linkbase Document.

                    X   
 

101.LAB

     

XBRL Taxonomy Extension Labels Linkbase Document.

                    X   
 

101.PRE

     

XBRL Taxonomy Extension Presentation Linkbase Document.

                    X   

 

33