UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

 

 

 

Form 10-Q

 

 

 

Commission File Number 001-33303

 

 

 

 

TARGA RESOURCES PARTNERS LP

(Exact name of registrant as specified in its charter)

 

 

Registrant’s telephone number, including area code:

(713) 584-1000

 

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 þ     No o

 

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

 

 

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

 

There were 32,836,000 Common Units, 11,528,231 Subordinated Units and 905,066 General Partner Units outstanding as of November 1, 2007.

 

 

As generally used in the energy industry and in this Quarterly Report on Form 10-Q, the identified terms have the following meanings:

 

 

 

Cautionary Statement About Forward-Looking Statements

 

This Quarterly Report contains “forward-looking statements” as defined in Section 21E of the Securities Exchange Act of 1934, as amended. All statements, other than statements of historical fact, included in this Quarterly Report are forward-looking statements. Forward-looking statements include, without limitation, statements regarding our future financial position, business strategy, future capital and other expenditures, plans and objectives of management for future operations. You can typically identify forward-looking statements by the use of forward-looking words such as “may,” “potential,” “project,” “plan,” “believe,” “expect,” “anticipate,” “intend,” “estimate” or similar expressions or variations on such expressions. Each forward-looking statement reflects our current view of future events and is subject to risks, uncertainties and other factors, known and unknown, which could cause our actual results to differ materially from any results expressed or implied by our forward-looking statements. These risks and uncertainties, many of which are beyond our control, include, but are not limited to:

 

 

 

Although we believe that the assumptions underlying our forward-looking statements are reasonable, any of the assumptions could be inaccurate, and, therefore, we cannot assure you that the forward-looking statements included in this Quarterly Report will prove to be accurate. Some of these and other risks and uncertainties that could cause actual results to differ materially from such forward-looking statements are more fully described under the heading Risk Factors in this Quarterly Report. Except as may be required by applicable law, we undertake no obligation to publicly update or advise of any change in any forward-looking statement, whether as a result of new information, future events or otherwise.

 

Forward-looking statements contained in this Quarterly Report and all subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by this cautionary statement.

 

PART I — FINANCIAL INFORMATION

 

 

TARGA RESOURCES PARTNERS LP

 

CONSOLIDATED BALANCE SHEETS

 

 

See notes to unaudited consolidated financial statements

TARGA RESOURCES PARTNERS LP

 

CONSOLIDATED STATEMENTS OF OPERATIONS

 

 

See notes to unaudited consolidated financial statements

TARGA RESOURCES PARTNERS LP

 

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

 

 

See notes to unaudited consolidated financial statements

TARGA RESOURCES PARTNERS LP

 

CONSOLIDATED STATEMENT OF CHANGES IN PARTNERS’ CAPITAL

 

 

See notes to unaudited consolidated financial statements

TARGA RESOURCES PARTNERS LP

 

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

 

See notes to unaudited consolidated financial statements

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements

 

 

Targa Resources Partners LP (the “Partnership”, “we”, “our”, “us”), is a Delaware limited partnership formed in October 2006. As of September 30, 2007, we operated two wholly-owned natural gas processing plants and an extensive network of integrated gathering pipelines that serve a 14 county natural gas producing region in the Fort Worth Basin in North Central Texas (the “North Texas System”) (see Note 11 — Subsequent Events). The natural gas processing facilities comprise the Chico processing and fractionating facilities and the Shackelford processing facility.

 

We closed our initial public offering (“IPO”) of 19,320,000 common units (including 2,520,000 common units sold pursuant to the full exercise by the underwriters of their option to purchase additional common units) at a price of $21.00 per unit on February 14, 2007. Proceeds from the IPO were approximately $377.5 million, net of offering costs. Concurrent with the IPO, Targa Resources, Inc. (“Targa”) contributed its interest in Targa North Texas GP LLC and Targa North Texas LP (“TNT LP”) to us. In return, Targa indirectly received a 2% general partnership interest in us (629,555 General Partner Units), incentive distribution rights and a 36.6% limited partnership interest in us (11,528,231 Subordinated Units). Our general partner is Targa Resources GP LLC (“TR GP”), a wholly owned subsidiary of Targa. See Note 3 for information related to the distribution rights of the common and subordinated unitholders and the incentive distribution rights held by the general partner.

 

The accompanying unaudited consolidated financial statements of the Partnership include historical cost-basis accounts of the assets of TNT LP, or the North Texas System, contributed to us by Targa in connection with the IPO for the periods prior to February 14, 2007, the closing date of the Partnership’s IPO, and include charges from Targa for direct costs and allocations of indirect corporate overhead and the results of contracts in force at that time. Management believes that the allocation methods are reasonable; however, these allocations are not necessarily indicative of the costs and expenses that would have resulted if the Partnership had been operated as a stand-alone entity. Both the Partnership and TNT LP are considered “entities under common control” as defined under accounting principles generally accepted in the United States of America (“GAAP”) and, as such, the transfer between entities of the assets and liabilities and operations has been recorded in a manner similar to that required for a pooling of interests, whereby the recorded assets and liabilities of TNT LP are carried forward to the consolidated partnership at their historical amounts. The Partnership as used herein refers to the consolidated financial results and operations for the North Texas System from its inception through its contribution to us and to the Partnership thereafter.

 

On February 14, 2007 the Partnership borrowed $342.5 million through its credit facility, and concurrently repaid $48.0 million under its credit facility with the proceeds from the 2,520,000 common units sold pursuant to the full exercise by the underwriters of their option to purchase additional common units. The net proceeds of $294.5 million from this borrowing, together with approximately $371.2 million of available cash from the IPO (after payment of offering and debt issue costs and necessary operating cash reserve balances), were also used to repay affiliate indebtedness that was contributed to the Partnership as part of TNT LP. See Note 6 for information related to our credit facility.

 

Targa directs our business operations through its ownership and control of our general partner. Targa and its affiliates’ employees provide administrative support to us and operate our assets.

 

These unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. The year-end balance sheet data was derived from audited financial statements, but does not include all disclosures required by GAAP. The unaudited consolidated financial statements for the three and nine month periods ended September 30, 2007 and 2006 include all adjustments, both normal and recurring, which are, in the opinion of management, necessary for a fair presentation of the results for the interim

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

periods. All significant intercompany balances and transactions have been eliminated in consolidation. Transactions between us and other Targa operations have been identified in the unaudited consolidated financial statements as transactions between affiliates (see Note 5). Financial results for the Partnership for the three and nine months ended September 30, 2007 are not necessarily indicative of the results that may be expected for the full year ended December 31, 2007. These unaudited consolidated financial statements and other information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2006.

 

 

Asset Retirement Obligations.  The Partnership accounts for asset retirement obligations (“AROs”) using Statement of Financial Accounting Standards (“SFAS”) 143, “Accounting for Asset Retirement Obligations,” as interpreted by Financial Interpretation “FIN” 47, “Accounting for Conditional Asset Retirement Obligations.” Asset retirement obligations are legal obligations associated with the retirement of tangible long-lived assets that result from the asset’s acquisition, construction, development and/or normal operation. An ARO is initially measured at its estimated fair value. Upon initial recognition of an ARO, an entity records an increase to the carrying amount of the related long-lived asset and an offsetting ARO liability. The consolidated cost of the asset and the capitalized asset retirement obligation is depreciated using a systematic and rational allocation method over the period during which the long-lived asset is expected to provide benefits. After the initial period of ARO recognition, the ARO will change as a result of either the passage of time or revisions to the original estimates of either the amounts of estimated cash flows or their timing. Changes due to the passage of time increase the carrying amount of the liability because there are fewer periods remaining from the initial measurement date until the settlement date; therefore, the present values of the discounted future settlement amount increases. These changes are recorded as a period cost called accretion expense. Upon settlement, AROs will be extinguished by the entity at either the recorded amount or the entity will recognize a gain or loss on the difference between the recorded amount and the actual settlement cost.

 

The changes in our aggregate asset retirement obligations are as follows (in thousands):

 

 

Cash and Cash Equivalents.  Targa operates a centralized cash management system whereby excess cash from most of its subsidiaries, held in separate bank accounts, is swept to a centralized account. Prior to February 14, 2007, cash distributions are deemed to have occurred through partners’ capital, and are reflected as an adjustment to partners’ capital. Prior to February 14, 2007, the cash accounts of the Partnership were part of Targa’s centralized cash management system. After this date, the Partnership maintains its own cash management system. For the period from January 1, 2007 through February 13, 2007, deemed net capital distributions from the Partnership were $0.5 million.

 

Comprehensive Income.  Comprehensive income includes net income and other comprehensive income, which includes unrealized gains and losses on derivative instruments that are designated as hedges.

 

Debt Issue Costs.  Costs incurred in connection with the issuance of long-term debt are capitalized and charged to interest expense over the term of the related debt on a straight-line basis, which approximates the interest method.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

Environmental Liabilities.  Liabilities for loss contingencies, including environmental remediation costs arising from claims, assessments, litigation, fines, and penalties and other sources are charged to expense when it is probable that a liability has been incurred and the amount of the assessment and/or remediation can be reasonably estimated.

 

Impairment of Long-Lived Assets.  Management reviews property, plant and equipment for impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. The carrying amount is deemed not recoverable if it exceeds the undiscounted sum of the cash flows expected to result from the use and eventual disposition of the asset. Estimates of expected future cash flows represent management’s best estimate based on reasonable and supportable assumptions. If the carrying amount is not recoverable, the impairment loss is measured as the excess of the asset’s carrying value over its fair value. Management assesses the fair value of long-lived assets using commonly accepted techniques, and may use more than one method, including, but not limited to, recent third party comparable sales, internally developed discounted cash flow analysis and analysis from outside advisors.

 

Income Taxes.  The Partnership is not subject to federal income taxes. As a result, our earnings or losses for federal income tax purposes are included in the tax returns of our individual partners. In May 2006, Texas adopted a margin tax, consisting generally of a 1% tax on the amount by which total revenues exceed cost of goods sold. Accordingly, we have estimated our liability for this tax and it is presently recorded as a deferred tax liability.

 

We adopted the provisions of FIN 48 “Accounting for Uncertainty in Income Taxes” on January 1, 2007. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. Based on our evaluation, we have determined that there are no significant uncertain tax positions requiring recognition in our financial statements at the date of adoption or at September 30, 2007. There are no unrecognized tax benefits that, if recognized, would affect the effective rate, and there are no unrecognized tax benefits that are reasonably expected to increase or decrease in the next twelve months. We file tax returns in the U.S. Federal and State of Texas jurisdictions, and are open to federal and state income tax examinations for years 2006 forward. Presently, no income tax examinations are underway, and none have been announced. No potential interest or penalties were recognized at September 30, 2007.

 

Inventory Imbalance.  Quantities of natural gas and/or NGLs over-delivered or under-delivered related to operational balancing agreements are recorded monthly as inventory or as a payable using weighted average prices at the time the imbalance was created. Monthly, inventory imbalances receivable are valued at the lower of cost or market; inventory imbalances payable are valued at replacement cost. These imbalances are typically settled in the following month with deliveries of natural gas or NGLs. Certain contracts require cash settlement of imbalances on a current basis. Under these contracts, imbalance cash-outs are recorded as a sale or purchase of natural gas, as appropriate.

 

Net Income per Limited Partner Unit.  Emerging Issues Task Force (“EITF”) Issue 03-6, “Participating Securities and the Two-Class Method Under FASB Statement No. 128” addresses the computation of earnings per share by entities that have issued securities other than common stock that contractually entitle the holder to participate in dividends and earnings of the entity when, and if, it declares dividends on its securities.

 

EITF 03-6 requires that securities that meet the definition of a participating security be considered for inclusion in the computation of basic earnings per unit using the two-class method. Under the two-class method, earnings per unit is calculated as if all of the earnings for the period were distributed under the terms of the partnership agreement, regardless of whether the general partner has discretion over the amount of distributions to be made in any particular period, whether those earnings would actually be distributed during a particular period from an economic or practical perspective, or whether the general partner has other legal or

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

contractual limitations on its ability to pay distributions that would prevent it from distributing all of the earnings for a particular period.

 

EITF 03-6 does not impact the Partnership’s overall net income or other financial results; however, in periods in which aggregate net income exceeds the Partnership’s aggregate distributions for such period, it will have the impact of reducing net income per limited partner unit. This result occurs as a larger portion of the Partnership’s aggregate earnings, as if distributed, is allocated to the incentive distribution rights of the general partner, even though the Partnership makes distributions on the basis of available cash and not earnings. In periods in which the Partnership’s aggregate net income does not exceed its aggregate distributions for such period, EITF 03-6 does not have any impact on the Partnership’s calculation of earnings per limited partner unit.

 

Price Risk Management (Hedging).  The Partnership accounts for derivative instruments in accordance with SFAS 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended. Under SFAS 133, all derivative instruments not qualifying for the normal purchases and normal sales exception are recorded on the balance sheet at fair value. If a derivative does not qualify as a hedge or is not designated as a hedge, the gain or loss on the derivative is recognized currently in earnings. If a derivative qualifies for hedge accounting and is designated as a hedge, the effective portion of the unrealized gain or loss on the derivative is deferred in accumulated other comprehensive income (“OCI”), a component of partners’ capital, and reclassified to earnings when the forecasted transaction occurs. Cash flows from a derivative instrument designated as a hedge are classified in the same category as the cash flows from the item being hedged.

 

The relationship between the hedging instrument and the hedged item must be highly effective in achieving the offset of changes in cash flows attributable to the hedged risk both at the inception of the contract and on an ongoing basis. Hedge accounting is discontinued prospectively when a hedge instrument becomes ineffective. Gains and losses deferred in OCI related to cash flow hedges for which hedge accounting has been discontinued remain deferred until the forecasted transaction occurs. If it is probable that a hedged forecasted transaction will not occur, deferred gains or losses on the hedging instrument are reclassified to earnings immediately.

 

The Partnership’s policy is to formally document all relationships between hedging instruments and hedged items, as well as its risk management objectives and strategy for undertaking the hedge. This process includes specific identification of the hedging instrument and the hedged item, the nature of the risk being hedged and the manner in which the hedging instrument’s effectiveness will be assessed. At the inception of the hedge and on an ongoing basis, the Partnership assesses whether the derivatives used in hedging transactions are highly effective in offsetting changes in cash flows of hedged items. Hedge effectiveness is measured on a quarterly basis. Any ineffective portion of the unrealized gain or loss is reclassified to earnings in the current period.

 

Property, Plant and Equipment.  Property, plant and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. The estimated service lives of the Partnership’s functional asset groups are as follows:

 

 

Expenditures for maintenance and repairs are expensed as incurred. Expenditures to refurbish assets that extend the useful lives or prevent environmental contamination are capitalized and depreciated over the remaining useful life of the asset. Upon disposition or retirement of property, plant, and equipment, any gain or loss is charged to operations.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

Revenue Recognition.  The Partnership’s primary types of sales and service activities reported as operating revenues include:

 

 

The Partnership recognizes revenues when all of the following criteria are met: (1) persuasive evidence of an exchange arrangement exists, if applicable, (2) delivery has occurred or services have been rendered, (3) the price is fixed or determinable and (4) collectibility is reasonably assured.

 

For processing services, the Partnership receives either fees or a percentage of commodities as payment for these services, depending on the type of contract. Under percent-of-proceeds contracts, we receive either an agreed upon percentage of the actual proceeds that we receive from our sales of the residue natural gas and NGLs or an agreed upon percentage based on index related prices for the natural gas and NGLs. Percent-of-value and percent-of-liquids contracts are variations on this arrangement. Under keep-whole contracts, we keep the NGLs extracted and return the processed natural gas or value of the natural gas to the producer. Natural gas or NGLs that the Partnership receives for services or purchase for resale are in turn sold and recognized in accordance with the criteria outlined above. Under fee-based contracts, the Partnership receives a fee based on throughput volumes.

 

The Partnership generally reports revenues gross in the consolidated statements of operations, in accordance with EITF 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent.” Except for fee-based contracts, the Partnership acts as the principal in the transactions where we receive commodities, take title to the natural gas and NGLs, and incur the risks and rewards of ownership.

 

Segment Information.  SFAS 131, “Disclosures about Segments of an Enterprise and Related Information,” establishes standards for reporting information about operating segments. The Partnership operates in one segment only, the natural gas gathering and processing segment.

 

Use of Estimates.  The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Estimates and judgments are based on information available at the time such estimates and judgments are made. Adjustments made with respect to the use of these estimates and judgments often relate to information not previously available. Uncertainties with respect to such estimates and judgments are inherent in the preparation of financial statements. Estimates and judgments are used in, among other things, (1) estimating unbilled revenues and operating and general and administrative costs (2) developing fair value assumptions, including estimates of future cash flows and discount rates, (3) analyzing tangible and intangible assets for possible impairment, (4) estimating the useful lives of assets and (5) determining amounts to accrue for contingencies, guarantees and indemnifications. Actual results could differ materially from estimated amounts.

 

Recent Accounting Pronouncements.

 

In September 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS 157, “Fair Value Measurements.” SFAS 157 defines fair value, establishes a framework for measuring fair value in GAAP, and expands disclosures about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. SFAS 157 is effective for financial statements issued for fiscal years

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

beginning after November 15, 2007, and interim periods within those fiscal years. We have not yet determined the impact this new accounting standard will have on our financial statements.

 

In February 2007, the FASB issued SFAS 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115,” which is effective for fiscal years beginning after November 15, 2007, with early adoption permitted. SFAS 159 expands opportunities to use fair value measurements in financial reporting and permits entities to choose to measure many financial instruments and certain other items at fair value. We are currently reviewing this new accounting standard and the impact, if any, it will have on our financial statements.

 

 

General.  The partnership agreement requires that, within 45 days after the end of each quarter, we distribute all of our Available Cash (defined below) to unitholders of record on the applicable record date, as determined by the general partner.

 

Definition of Available Cash.  Available Cash, for any quarter, consists of all cash and cash equivalents on hand on the date of determination of available cash for that quarter:

 

 

 

General Partner Interest and Incentive Distribution Rights.  The general partner is currently entitled to approximately 2% of all quarterly distributions that we make prior to our liquidation. The general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its current general partner interest. The general partner’s 2% interest in these distributions will be reduced if we issue additional units in the future and the general partner does not contribute a proportionate amount of capital to us to maintain its 2% general partner interest.

 

The incentive distribution rights held by the general partner entitle it to receive an increasing share of Available Cash when pre-defined distribution targets are achieved. The general partner’s incentive distribution rights are not reduced if we issue additional units in the future and the general partner does not contribute a proportionate amount of capital to us to maintain its 2% general partner interest. Please read “Distributions of Available Cash during the Subordination Period” and “Distributions of Available Cash after the Subordination Period” below for more details about the distribution targets and their impact on the general partner’s incentive distribution rights.

 

Subordinated Units.  All of the subordinated units are held by Targa GP Inc. and Targa LP Inc. The partnership agreement provides that, during the subordination period, the common units have the right to receive distributions of Available Cash each quarter in an amount equal to $0.3375 per common unit, or the “Minimum Quarterly Distribution,” plus any arrearages in the payment of the Minimum Quarterly Distribution on the common units from prior quarters, before any distributions of Available Cash may be made on the subordinated units. These units are deemed “subordinated” because for a period of time, referred to as the subordination period, the subordinated units will not be entitled to receive any distributions until the common units have received the Minimum Quarterly Distribution plus any arrearages from prior quarters. Furthermore, no arrearages will be paid on the subordinated units. The practical effect of the subordinated units is to increase the likelihood that during the subordination period there will be Available Cash to be distributed on the common units. The subordination period will end, and the subordinated units will convert to common

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

units, on a one for one basis, when certain distribution requirements, as defined in the partnership agreement, have been met. The earliest date at which the subordination period may end is April 2008.

 

Distributions of Available Cash during the Subordination Period.  Based on the general partner’s initial 2% ownership percentage, the partnership agreement requires that we make distributions of Available Cash from operating surplus for any quarter during the subordination period in the following manner:

 

 

Distributions of Available Cash after the Subordination Period.  The partnership agreement requires that we make distributions of Available Cash from operating surplus for any quarter after the subordination period in the following manner:

 

 

 

The Partnership’s net income is allocated to the general partner and the limited partners, including the holders of the subordinated units, in accordance with their respective ownership percentages, after giving effect to incentive distributions paid to the general partner. Basic and diluted net income per limited partner unit is calculated by dividing limited partners’ interest in net income, less general partner incentive distributions, by the weighted average number of outstanding limited partner units during the period.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

Basic earnings per unit is computed by dividing net earnings attributable to unitholders by the weighted average number of units outstanding during each period. However, because our IPO was completed on February 14, 2007, the number of units issued following the IPO is utilized for the 2007 period presented. Diluted earnings per unit reflects the potential dilution of common equivalent units that could occur if securities or other contracts to issue common units were exercised or converted into common units.

 

Due to the timing of our IPO, a pro-rated distribution for the first quarter of 2007 of $0.16875 per common unit was approved by the Board of Directors of our general partner on April 23, 2007. On May 15, 2007, we paid this distribution (approximately $5.3 million) to unitholders of record as of the close of business on May 3, 2007. A distribution for the second quarter of 2007 of $0.3375 per unit was approved by the Board of Directors of our general partner on July 23, 2007. On August 14, 2007, we paid this distribution (approximately $10.6 million) to unitholders of record as of the close of business on August 2, 2007.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

The following table illustrates the Partnership’s calculation of net income per limited and subordinated partner unit for the three and nine months ended September 30, 2007 (in thousands, except unit and per unit information):

 

 

The calculation of basic and diluted net income per common and subordinated unit are the same for all periods presented as distributable cash flow was greater than net income for those periods and distributions to the subordinated unitholders have been equivalent to the distribution to the common unitholders for all quarters.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

 

Targa Resources, Inc.

 

On February 14, 2007, we entered into an Omnibus Agreement with Targa, our general partner and others that addressed the reimbursement of our general partner for costs incurred on our behalf and indemnification matters. Any or all of the provisions of the Omnibus Agreement, other than the indemnification provisions described in Note 9, are terminable by Targa at its option if our general partner is removed without cause and units held by our general partner and its affiliates are not voted in favor of that removal. The Omnibus Agreement will also terminate in the event of a change of control of us or our general partner.

 

Reimbursement of Operating and General and Administrative Expense

 

Under the Omnibus Agreement, we reimburse Targa for the payment of certain operating expenses, including compensation and benefits of operating personnel, and for the provision of various general and administrative services for our benefit. With respect to the North Texas System, we reimburse Targa for the following expenses:

 

 

Pursuant to these arrangements, Targa performs centralized corporate functions for us, such as legal, accounting, treasury, insurance, risk management, health, safety and environmental, information technology, human resources, credit, payroll, internal audit, taxes, engineering and marketing. We reimburse Targa for the direct expenses to provide these services as well as other direct expenses it incurs on our behalf, such as compensation of operational personnel performing services for our benefit and the cost of their employee benefits, including 401(k), pension and health insurance benefits.

 

Sales to and purchases from affiliates.  The Partnership routinely conducts business with other subsidiaries of Targa. The related transactions result primarily from purchases and sales of natural gas and NGLs. Prior to February 14, 2007, all of the Partnership’s expenditures were paid through Targa, resulting in inter-company transactions. Prior to February 14, 2007, settlement of these inter-company transactions was through adjustments to partners’ capital accounts. Effective February 14, 2007, these transactions are settled monthly in cash.

 

NGLs and Condensate Purchase Agreement.  In connection with our IPO which closed on February 14, 2007, we entered into an NGLs and high pressure condensate purchase agreement with Targa Liquids Marketing and Trade (“TLMT”) which has an initial term of 15 years and will automatically extend for a term of five years, unless the agreement is otherwise terminated by either party, pursuant to which (i) we are obligated to sell all volumes of NGLs (other than high-pressure condensate) that we own or control to TLMT and (ii) we have the right to sell to TLMT or third parties the volumes of high-pressure condensate that we own or control, in each case at a price based on the prevailing market price less transportation, fractionation and certain other fees. Furthermore, either party may elect to terminate the agreement if either party ceases to be an affiliate of Targa.

 

Natural Gas Purchase Agreement.  In connection with our IPO which closed on February 14, 2007, we entered into a natural gas purchase agreement with Targa Gas Marketing LLC (“TGM”) at a price based on TGM’s sale price for such natural gas, less TGM’s costs and expenses associated therewith. This agreement has an initial term of 15 years and will automatically extend for a term of five years, unless the agreement is

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

otherwise terminated by either party. Furthermore, either party may elect to terminate the agreement if either party ceases to be an affiliate of Targa.

 

Allocation of costs.  The employees supporting the Partnership’s operations are employees of Targa. The Partnership’s financial statements include costs allocated to it by Targa for centralized general and administrative services performed by Targa, as well as depreciation of assets utilized by Targa’s centralized general and administrative functions. Costs allocated to the Partnership were based on identification of Targa’s resources which directly benefit the Partnership and its proportionate share of costs based on the Partnership’s estimated usage of shared resources and functions. All of the allocations are based on assumptions that management believes are reasonable; however, these allocations are not necessarily indicative of the costs and expenses that would have resulted if the Partnership had been operated as a stand-alone entity. Prior to February 14, 2007, these allocations were not settled in cash, but were settled through an adjustment to partners’ capital accounts. Effective February 14, 2007, all intercompany accounts are settled monthly in cash.

 

Allocations of long-term debt, debt issue costs, interest rate swaps and interest expense.  Prior to January 1, 2007, the Partnership’s financial statements included long-term debt, debt issue costs, interest rate swaps and interest expense allocated from Targa. The allocations were calculated in a manner similar to Targa’s purchase price allocation related to its acquisition of Dynegy Midstream Services, Limited Partnership (the “DMS Acquisition”) and were based on the fair value of acquired tangible assets plus related net working capital and unconsolidated equity interests. These allocations were not settled in cash. Settlement of these allocations occurred through adjustments to partners’ capital. On January 1, 2007, the allocated debt, debt issue costs and interest rate swaps were settled through a deemed partner contribution of $846.3 million.

 

The following table summarizes the sales to and purchases from affiliates of Targa, payments made or received by Targa on behalf of the Partnership and allocations of costs from Targa which were settled through adjustments to partners’ capital. Management believes these transactions are executed on terms that are fair and reasonable.

 

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

Other

 

Commodity hedges.  We have entered into various commodity derivative transactions with Merrill Lynch Commodities Inc. (“MLCI”), an affiliate of Merrill Lynch, Pierce, Fenner & Smith Incorporated (“Merrill Lynch”). Merrill Lynch holds an equity interest in the holding company that indirectly owns our general partner. Under the terms of these various commodity derivative transactions, MLCI has agreed to pay us specified fixed prices in relation to specified notional quantities of natural gas and condensate over periods ending in 2010, and we have agreed to pay MLCI floating prices based on published index prices of such commodities for delivery at specified locations. The following table shows our open commodity derivatives with MLCI as of September 30, 2007:

 

 

 

Pre-IPO Indebtedness.  In October 2005, Targa completed the DMS acquisition. A substantial portion of the acquisition was financed through borrowings. Following the acquisition, a significant portion of Targa’s acquisition borrowings were allocated to the North Texas System, resulting in approximately $870.1 million of allocated indebtedness and corresponding levels of interest expense. The entity holding the North Texas System provided a guarantee of this indebtedness. This indebtedness was also secured by a collateral interest in both the equity of the entity holding the North Texas System as well as its assets.

 

On January 1, 2007, Targa contributed to us affiliated indebtedness related to the North Texas System of approximately $904.5 million (including accrued interest of $88.3 million computed at 10% per anum). The Partnership recorded approximately $9.8 million in interest expense associated with this affiliated debt for the period from January 1, 2007 through February 13, 2007. On February 14, 2007, Targa contributed its interest in Targa North Texas GP LLC and Targa North Texas LP to us.

 

The stated 10% interest rate in the formal debt arrangement is not indicative of prevailing external rates of interest including that incurred under our credit facility which is secured by substantially all of our assets. On a pro forma basis, at prevailing interest rates the affiliated interest expense for the period from January 1, 2007 to February 13, 2007 would have been reduced by $3.0 million. The pro forma interest expense adjustment has been calculated by applying the weighted average rate of 6.9% that we incurred under our revolving credit facility to the affiliate debt balance for the period from January 1, 2007 to February 13, 2007.

 

Post-IPO Indebtedness.  On February 14, 2007, we entered into a credit agreement which provides for a five-year $500 million revolving credit facility with a syndicate of financial institutions. The revolving credit facility bears interest at the Partnership’s option, at the higher of the lender’s prime rate or the federal funds rate plus 0.5%, plus an applicable margin ranging from 0% to 1.25% dependent on the Partnership’s total leverage ratio, or LIBOR plus an applicable margin ranging from 1.0% to 2.25% dependent on the Partnership’s total leverage ratio. The Partnership initially borrowed $342.5 million under its credit facility, and concurrently repaid $48.0 million under its credit facility with the proceeds from the 2,520,000 common

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

units sold pursuant to the full exercise by the underwriters of their option to purchase additional common units. The net proceeds of $294.5 million from this borrowing, together with approximately $371.2 million of available cash from the IPO (after payment of offering and debt issue costs and necessary operating cash reserve balances), were used to repay approximately $665.7 million of affiliate indebtedness. In connection with our IPO, the guarantee of indebtedness from the entity holding the North Texas System was terminated,the related collateral interest was released and the remaining affiliate indebtedness was retired and treated as a capital contribution to the Partnership. Our credit facility is secured by substantially all of our assets. Our weighted average interest rate on outstanding borrowings under our credit facility for the period from February 14, 2007 to September 30, 2007 was 6.7%.

 

The credit agreement restricts our ability to make distributions of available cash to unitholders if we are in any default or an event of default (as defined in the credit agreement) exists. The credit agreement requires us to maintain a leverage ratio (the ratio of consolidated indebtedness to our consolidated EBITDA, as defined in the credit agreement) of no more than 5.00 to 1.00 on the last day of any fiscal quarter ending on or after September 30, 2007. The credit agreement also requires us to maintain an interest coverage ratio (the ratio of our consolidated EBITDA to our consolidated interest expense, as defined in the credit agreement) of no less than 2.25 to 1.00 determined as of the last day of each quarter for the four-fiscal quarter period ending on the date of determination. In addition, the credit agreement contains various covenants that may limit, among other things, our ability to:

 

 

The credit facility matures on February 14, 2012, at which time all unpaid principal and interest is due.

 

As of September 30, 2007, we had approximately $205.2 million available under our revolving credit facility, after giving effect to our outstanding borrowings of $294.5 million and the issuance of $0.3 million of letters of credit.

 

 

At September 30, 2007 and December 31, 2006, OCI included $9.9 million of unrealized net losses and $30.5 million ($30.2 million, net of tax) of unrealized net gains, respectively, on commodity hedges. For the three and nine months ended September 30, 2007, deferred net gains on commodity hedges of $1.1 million and $6.1 million were reclassified from OCI and credited to income as revenues. For the three and nine months ended September 30, 2006, deferred net gains on commodity hedge of $0.3 million and $0.3 million, respectively, were reclassified from OCI and credited to income as revenues. There were no adjustments for hedge ineffectiveness during the first nine months of 2007 or 2006.

 

At December 31, 2006, OCI also included $0.6 million of unrealized gains on interest rate hedges allocated from Targa. In connection with our IPO, all allocated debt was repaid or retired, and the associated allocated interest rate swaps were also retired. For the three and nine months ended September 30, 2006, deferred net gains on interest rate hedges of $0.2 million and $0.2 million, respectively, were reclassified from OCI to net interest expense. There were no adjustments for hedge ineffectiveness during the first nine months of 2007 or 2006.

 

At September 30, 2007, deferred net gains of $4.6 million on commodity hedges recorded in OCI are expected to be reclassified to earnings during the next twelve months.

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

At September 30, 2007, we had the following hedge arrangements which will settle during three months ended December 31, 2007 and the years ended December 31, 2008 thru 2012:

 

Natural Gas

 

 

Targa Resources Partners LP

 

Notes to Consolidated Financial Statements — (Continued)

 

NGLs