| • JUNE 30, 2012 FORM 10-Q • THIRD SUPPLEMENTAL INDENTURE • CERTIFICATION OF PRESIDENT AND CFO • SECTION 1350 CERTIFICATION OF PRESIDENT AND CFO • XBRL INSTANCE DOCUMENT • XBRL TAXONOMY EXTENSION SCHEMA DOCUMENT • XBRL TAXONOMY EXTENSION CALCULATION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION DEFINITION LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION LABEL LINKBASE DOCUMENT • XBRL TAXONOMY EXTENSION PRESENTATION LINKBASE DOCUMENT | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q
For the quarterly period ended June 30, 2012 or
Commission file number 1-32740 ENERGY TRANSFER EQUITY, L.P. (Exact name of registrant as specified in its charter)
3738 Oak Lawn Avenue, Dallas, Texas 75219 (Address of principal executive offices) (zip code) (214) 981-0700 (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 ý 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 ý 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.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No ý At August 1, 2012, the registrant had units outstanding as follows: Energy Transfer Equity, L.P. 279,955,608 Common Units FORM 10-Q ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES TABLE OF CONTENTS i Forward-Looking Statements Certain matters discussed in this report, excluding historical information, as well as some statements by Energy Transfer Equity, L.P. (“Energy Transfer Equity,” the “Partnership” or “ETE”) in periodic press releases and some oral statements of Energy Transfer Equity officials during presentations about the Partnership, include forward-looking statements. These forward-looking statements are identified as any statement that does not relate strictly to historical or current facts. Statements using words such as “anticipate,” “project,” “expect,” “plan,” “goal,” “forecast,” “estimate,” “intend,” “continue,” “believe,” “may,” “will” or similar expressions help identify forward-looking statements. Although the Partnership and its General Partner believe such forward-looking statements are based on reasonable assumptions and current expectations and projections about future events, no assurance can be given that such assumptions, expectations or projections will prove to be correct. Forward-looking statements are subject to a variety of risks, uncertainties and assumptions. If one or more of these risks or uncertainties materialize, or if underlying assumptions prove incorrect, the Partnership’s actual results may vary materially from those anticipated, estimated or expressed, forecasted, projected or expected in forward-looking statements since many of the factors that determine these results are subject to uncertainties and risks that are difficult to predict and beyond management’s control. For additional discussion of risks, uncertainties and assumptions, see “Part II — Other Information – Item 1A. Risk Factors” for the quarter ended March 31, 2012 and included in this Quarterly Report on Form 10-Q, as well as “Part I — Item 1A. Risk Factors” in the Partnership’s Report on Form 10-K for the year ended December 31, 2011 filed with the Securities and Exchange Commission on February 22, 2012. Definitions The following is a list of certain acronyms and terms generally used in the energy industry and throughout this document:
ii
iii
Adjusted EBITDA is a term used throughout this document, which we define as earnings before interest, taxes, depreciation, amortization and other non-cash items, such as non-cash compensation expense, gains and losses on disposals of assets, the allowance for equity funds used during construction, unrealized gains and losses on commodity risk management activities, non-cash impairment charges, loss on extinguishment of debt, gain on deconsolidation of ETP's Propane Business and other non-operating income or expense items. Unrealized gains and losses on commodity risk management activities includes unrealized gains and losses on commodity derivatives and inventory fair value adjustments (excluding lower of cost or market adjustments). Adjusted EBITDA reflects amounts for less than wholly owned subsidiaries and unconsolidated affiliates based on proportionate ownership. iv PART I — FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 1 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Dollars in thousands) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 2 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (Dollars in thousands, except per unit data) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 3 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (Dollars in thousands) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 4 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENT OF EQUITY FOR THE SIX MONTHS ENDED JUNE 30, 2012 (Dollars in thousands) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 5 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Dollars in thousands) (unaudited)
The accompanying notes are an integral part of these consolidated financial statements. 6 ENERGY TRANSFER EQUITY, L.P. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Tabular dollar amounts, except per unit data, are in thousands) (unaudited)
Business Operations Unless the context requires otherwise, references to “we,” “us,” “our,” the “Partnership” and “ETE” mean Energy Transfer Equity, L.P. and its consolidated subsidiaries, which include ETP, ETP GP, ETP LLC, Regency, Regency GP, Regency LLC, and Southern Union. References to the “Parent Company” mean Energy Transfer Equity, L.P. on a stand-alone basis. At June 30, 2012, our equity interests in ETP and Regency consisted of:
On March 26, 2012, we acquired all of the outstanding shares of Southern Union for approximately $3.01 billion in cash and approximately 57.0 million ETE Common Units. See Note 3 for more information regarding the Southern Union Merger. The unaudited consolidated financial statements of ETE presented herein for the three and six month periods ended June 30, 2012 and 2011 include the results of operations of: •the Parent Company;
Our unaudited consolidated financial statements include the results of operations of Southern Union from March 26, 2012, the date we acquired Southern Union, through June 30, 2012. Business Operations The Parent Company’s principal sources of cash flow have historically derived from its direct and indirect investments in the limited partner and general partner interests in ETP and Regency. Effective with the acquisition of Southern Union, the Parent Company also generates cash flows through its wholly-owned subsidiary, Southern Union. The Parent Company’s primary cash requirements are for general and administrative expenses, debt service requirements and distributions to its partners and holders of the Preferred Units. Parent Company-only assets are not available to satisfy the debts and other obligations of ETE’s subsidiaries. In order to understand the financial condition of the Parent Company on a stand-alone basis, see Note 21 for stand-alone financial information apart from that of the consolidated partnership information included herein. The following is a brief description of our operating entities:
7
See Note 20 for discussion regarding our reportable segments. Preparation of Interim Financial Statements The accompanying consolidated balance sheet as of December 31, 2011, which has been derived from audited financial statements, and the unaudited interim consolidated financial statements and notes thereto of the Partnership as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011, have been prepared in accordance with GAAP for interim consolidated financial information and pursuant to the rules and regulations of the SEC. Accordingly, they do not include all the information and footnotes required by GAAP for complete consolidated financial statements. However, management believes that the disclosures made are adequate to make the information not misleading. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year due to the seasonal nature of the Partnership’s operations, maintenance activities of the Partnership’s subsidiaries and the impact of forward natural gas prices and differentials on certain derivative financial instruments that are accounted for using mark-to-market accounting. Management has evaluated subsequent events through the date the financial statements were issued. In the opinion of management, all adjustments (all of which are normal and recurring) have been made that are necessary to fairly state the consolidated financial position of the Partnership as of June 30, 2012, and the Partnership’s results of operations and cash flows for the three and six months ended June 30, 2012 and 2011. The unaudited interim consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto presented in the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2011, as filed with the SEC on February 22, 2012. Certain prior period amounts have been reclassified to conform to the 2012 presentation. These reclassifications had no impact on net income or total equity.
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the accrual for and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. The natural gas industry conducts its business by processing actual transactions at the end of the month following the month of delivery. Consequently, the most current month’s financial results for natural gas and NGL related operations are estimated using volume estimates and market prices. Any differences between estimated results and actual results are recognized in the following month’s financial statements. Management believes that the estimated operating results represent the actual results in all material respects. Some of the other significant estimates made by management include, but are not limited to, the timing of certain forecasted transactions that are hedged, the fair value of derivative instruments, useful lives for depreciation and amortization, purchase accounting allocations and subsequent realizability of intangible assets, fair value measurements used in the goodwill impairment test, market value of inventory, assets and liabilities resulting from the regulated ratemaking process, contingency reserves and environmental reserves. Actual values and results could differ from those estimates. 8 Significant Accounting Policies As a result of the Southern Union Merger on March 26, 2012, the following significant accounting policies have been added to our significant accounting policies described in our Form 10-K for the year ended December 31, 2011. Pensions and Other Postretirement Benefit Plans Employers are required to recognize in their balance sheets the overfunded or underfunded status of defined benefit pension and other postretirement plans, measured as the difference between the fair value of the plan assets and the benefit obligation (the projected benefit obligation for pension plans and the accumulated postretirement benefit obligation for other postretirement plans). Each overfunded plan is recognized as an asset and each underfunded plan is recognized as a liability. Employers must recognize the change in the funded status of the plan in the year in which the change occurs through Accumulated other comprehensive income in equity. See Note 14 for further information regarding pensions and other postretirement benefit plans. Revenue Recognition for Southern Union's Natural Gas Distribution Operations In Southern Union's natural gas distribution operations, natural gas utility customers are billed on a monthly-cycle basis. The related cost of natural gas and revenue taxes are matched with cycle-billed revenues through utilization of purchased natural gas adjustment provisions in tariffs approved by the regulatory agencies having jurisdiction. Revenues from natural gas delivered but not yet billed are accrued, along with the related natural gas purchase costs and revenue-related taxes.
Southern Union Merger On March 26, 2012, Sigma Acquisition Corporation, a Delaware corporation and a wholly-owned subsidiary of ETE, completed its acquisition of Southern Union. Southern Union is the surviving entity in the merger and operates as a wholly-owned subsidiary of ETE. The assets acquired as a result of this merger significantly expand our existing geographic footprint of natural gas pipeline and natural gas transportation capacity and into natural gas utilities distribution, and are complementary to the assets owned and operated by our other entities. Under the terms of the merger agreement, Southern Union stockholders were able to elect to exchange each outstanding share of Southern Union common stock for $44.25 in cash or 1.00 ETE Common Unit, with no more than 60% of the aggregate merger consideration payable in cash and no more than 50% of the merger consideration payable in ETE Common Units. Based on the final results of the merger consideration, elections were as follows:
Effective with the closing of the transaction, Southern Union's common stock is no longer publicly traded. Citrus Merger In connection with the Southern Union Merger on March 26, 2012, ETP completed its acquisition of CrossCountry, a subsidiary of Southern Union which owns an indirect 50% interest in Citrus, the owner of FGT. The total merger consideration was approximately $2.0 billion, consisting of approximately $1.9 billion in cash and approximately 2.25 million ETP Common Units. See Note 4 for more information regarding ETP's equity method investment in Citrus. In connection with the Citrus Merger, we relinquished our rights to an aggregate $220 million of IDRs from ETP that we would otherwise be entitled to receive over 16 consecutive quarters following the closing of the merger. Pursuant to the merger agreement, we also granted ETP a right of first offer with respect to any disposition by us or SUGS, a subsidiary of Southern Union that owns and operates a natural gas gathering and processing system serving the Permian Basin in West Texas and New Mexico. 9 Summary of Assets Acquired and Liabilities Assumed We accounted for the Southern Union Merger using the acquisition method of accounting, which requires, among other things, that assets acquired and liabilities assumed be recognized on the balance sheet at their fair values as of the acquisition date. Our consolidated balance sheet presented as of June 30, 2012 reflects the preliminary purchase price allocations based on available information. Certain amounts included in the preliminary purchase price allocation as of June 30, 2012 have been changed from amounts reflected as of March 31, 2012 based on management's review of the valuation. Management is continuing to review the valuation and expects to be substantially complete with the purchase price allocation in the third quarter of 2012. The following table summarizes the preliminary assets acquired and liabilities assumed recognized as of the merger date:
Goodwill was allocated by reportable business segment as $1.17 billion to the Southern Union Transportation and Storage segment; $598.3 million to the Southern Union Gathering and Processing segment; $251.8 million to the Southern Union Distribution segment; and $10.8 million to Corporate and other. Other liabilities assumed include approximately $46.0 million of AROs, which are primarily related to owned natural gas storage wells and offshore lines and platforms. At the end of the useful life of these underlying assets, Southern Union is legally or contractually required to abandon in place or remove the asset. An ARO is required to be recorded when a legal obligation to retire an asset exists and such obligation can be reasonably estimated. Although a number of other onshore assets in Southern Union's system are subject to agreements that give rise to an ARO upon the discontinued use of the assets, AROs were not recorded because these assets have an indeterminate removal or abandonment date given the expected continued use of the assets with proper maintenance or replacement. As of June 30, 2012 AROs assumed as a result of the Southern Union Merger were approximately $46.5 million. Pro Forma Results of Operations The following unaudited pro forma consolidated results of operations for the three and six months ended June 30, 2012 and 2011 are presented as if the Southern Union Merger had been completed on January 1, 2011. Actual results for the three months ended June 30, 2012 include Southern Union for the entire period; however, pro forma amounts shown below reflect adjustments for certain acquisition-related costs recognized during the period.
10 The pro forma consolidated results of operations include adjustments to: •include the results of Southern Union for all periods presented;
•include incremental interest expense related to financing the transactions; •adjust for one-time expenses; and •adjust for relative changes in ownership resulting from the transactions. The pro forma information is not necessarily indicative of the results of operations that would have occurred had the Southern Union Merger been completed at the beginning of the periods presented or the future results of the combined operations. Southern Union's revenue included in our consolidated statement of operations was approximately $472.5 million and $512.2 million for the three months ended June 30, 2012 and since the acquisition date to June 30, 2012, respectively. Southern Union's net income and net loss included in our consolidated statement of operations were approximately $11.7 million and $26.8 million for the three months ended June 30, 2012 and since the acquisition date to June 30, 2012, respectively. Expenses Related to the Southern Union Merger As a result of the acquisition, we recognized $8.3 million of merger-related costs during the three months ended June 30, 2012 and $38.2 million during the six months ended June 30, 2012. Pending Sunoco Merger On April 30, 2012, ETP announced that it had entered into a definitive merger agreement whereby ETP will acquire Sunoco in exchange for ETP Common Units and cash. Under the terms of the merger agreement, Sunoco shareholders would receive, for each Sunoco common share, either $50.00 in cash, 1.0490 ETP Common Units or a combination of $25.00 in cash and 0.5245 of an ETP Common Unit. The cash and unit elections, however, will be subject to proration to ensure that the total amount of cash paid and the total number of ETP Common Units issued in the merger to Sunoco shareholders as a whole are equal to the total amount of cash and number of ETP Common Units that would have been paid and issued if all Sunoco shareholders received the standard mix of consideration. Upon closing, Sunoco shareholders are expected to own approximately 20% of ETP's outstanding limited partner units. This transaction is expected to close in the third or fourth quarter of 2012, subject to approval of Sunoco's shareholders and customary regulatory approvals. Sunoco owns the general partner interest of Sunoco Logistics, consisting of a 2% general partner interest, 100% of the IDRs, and 32.4% of the outstanding common units of Sunoco Logistics. Sunoco also generates cash flow from a portfolio of retail outlets for the sale of gasoline and middle distillates in the east coast, midwest and southeast areas of the United States. Sunoco Logistics is a publicly traded limited partnership that owns and operates a logistics business consisting of a geographically diverse portfolio of complementary pipeline, terminalling and crude oil acquisition and marketing assets. Pending Holdco Transaction On June 15, 2012, ETE and ETP entered into a transaction agreement pursuant to which, immediately following and subject to the closing of the Sunoco merger, (i) ETE will contribute its interest in Southern Union into an ETP-controlled entity in exchange for a 60% equity interest in the new entity, to be called Holdco and (ii) ETP will contribute its interest in Sunoco to Holdco and will retain a 40% equity interest in Holdco (the "Holdco Transaction"). Prior to the contribution of Sunoco to Holdco, Sunoco will contribute its interests in Sunoco Logistics to ETP in exchange for 50,706,000 ETP Class F Units representing limited partner interest in ETP ("ETP Class F Units") plus an additional number of ETP Class F Units determined based upon the amount of cash contributed to ETP by Sunoco at the closing of the merger, as calculated in accordance with the merger agreement. The ETP Class F Units will be entitled to 35% of the quarterly cash distributions generated by ETP and its subsidiaries other than Holdco, subject to a maximum cash distribution of $3.75 per ETP Class F Unit per year. Pursuant to a stockholders agreement between ETE and ETP, ETP will control Holdco. Consequently, ETP expects to consolidate Holdco (including Sunoco and Southern Union) in its consolidated financial statements subsequent to consummation of the Holdco Transaction. Under the terms of the Holdco Transaction agreement, we will relinquish an aggregate of $210 million of IDRs over 12 consecutive quarters following the closing of the Holdco Transaction. 11
Citrus Corp. ETP acquired a 50% interest in Citrus, which owns 100% of FGT on March 26, 2012. A subsidiary of Kinder Morgan, Inc. owns the remaining 50% interest in Citrus. In exchange for the interest in Citrus, Southern Union received $1.9 billion in cash and $105 million of ETP Common Units. ETP initially recorded its investment in Citrus at $2.0 billion, which exceeded its proportionate share of Citrus' equity by $1.03 billion, all of which is treated as equity method goodwill due to the application of regulatory accounting. AmeriGas Partners, L.P. On January 12, 2012, ETP contributed its Propane Business to AmeriGas in exchange for approximately $1.46 billion in cash and approximately 29.6 million AmeriGas Common Units valued at $1.12 billion at the time of the contribution. In addition, AmeriGas assumed approximately $71 million of existing debt of the Propane Business. ETP recognized a gain on deconsolidation of $1.06 billion and recorded equity in losses of $36.4 million and equity in earnings of $3.1 million related to AmeriGas for the three and six months ended June 30, 2012, respectively. ETP's investment in AmeriGas initially reflected $630.0 million in excess of the proportionate share of AmeriGas' limited partners' capital. Of this excess fair value, $288.6 million is being amortized over a weighted average period of 14 years and $341.4 million is being treated as equity method goodwill and non-amortizable intangible assets. We have not reflected the Propane operations as discontinued operations as ETP will have a continuing involvement in this business as a result of the investment in AmeriGas. In June 2012, we sold the remainder of our retail propane operations, consisting of our cylinder exchange business, to a third party. In connection with the contribution agreement with AmeriGas, certain excess sales proceeds from the sale of the cylinder exchange business were remitted to AmeriGas, and we received net proceeds of approximately $43.0 million. Midcontinent Express Pipeline LLC Regency owns a 50% interest in MEP, which owns approximately 500 miles of natural gas pipelines that extend from Southeast Oklahoma, across Northeast Texas, Northern Louisiana and Central Mississippi to an interconnect with the Transcontinental natural gas pipeline system in Butler, Alabama. RIGS Haynesville Partnership Co. Regency owns a 49.99% interest in HPC, which, through its ownership of the RIGS, delivers natural gas from Northwest Louisiana to downstream pipelines and markets through a 450-mile intrastate pipeline system. Fayetteville Express Pipeline LLC ETP owns a 50% interest in the FEP, which owns an approximately 185-mile natural gas pipeline that originates in Conway County, Arkansas, continues eastward through White County, Arkansas and terminates at an interconnect with Trunkline Gas Company in Panola County, Mississippi. Summarized Financial Information The following tables present aggregated selected income statement data for our unconsolidated affiliates, including AmeriGas, Citrus, FEP, HPC and MEP (on a 100% basis for all periods presented).
In addition to the equity method investments described above, ETP, Regency and Southern Union each have other insignificant equity method investments. 12
Cash and cash equivalents include all cash on hand, demand deposits, and investments with original maturities of three months or less. We consider cash equivalents to include short-term, highly liquid investments that are readily convertible to known amounts of cash and that are subject to an insignificant risk of changes in value. We place our cash deposits and temporary cash investments with high credit quality financial institutions. At times, our cash and cash equivalents may be uninsured or in deposit accounts that exceed the Federal Deposit Insurance Corporation insurance limit. Non-cash investing and financing activities are as follows:
Inventories consisted of the following:
ETP utilizes commodity derivatives to manage price volatility associated with its natural gas inventory and designates certain of these derivatives as fair value hedges for accounting purposes. Changes in fair value of the designated hedged inventory have been recorded in inventory on our consolidated balance sheets and in cost of products sold in our consolidated statements of operations.
A net increase in goodwill of $1.42 billion was recorded during the six months ended June 30, 2012, which includes goodwill of $2.03 billion recorded as a result of the Southern Union Merger partially offset by a decrease of $605.6 million as a result of ETP's contribution of its Propane Business to AmeriGas. The goodwill recorded as a result of the Southern Union Merger was primarily due to expected commercial and operational synergies and is subject to change based on final purchase price allocations. None of the goodwill recorded as a result of this transaction is deductible for tax purposes. See Note 3 for further discussion of Southern Union Merger. 13
The carrying amounts of cash and cash equivalents, accounts receivable and accounts payable approximate their fair value. Price risk management assets and liabilities are recorded at fair value. We have marketable securities, commodity derivatives, interest rate derivatives, the Preferred Units and embedded derivatives in the Regency Preferred Units that are accounted for as assets and liabilities at fair value in our consolidated balance sheets. We determine the fair value of our assets and liabilities subject to fair value measurement by using the highest possible “level” of inputs. Level 1 inputs are observable quotes in an active market for identical assets and liabilities. We consider the valuation of marketable securities and commodity derivatives transacted through a clearing broker with a published price from the appropriate exchange as a Level 1 valuation. Level 2 inputs are inputs observable for similar assets and liabilities. We consider OTC commodity derivatives entered into directly with third parties as a Level 2 valuation since the values of these derivatives are quoted on an exchange for similar transactions. Additionally, we consider our options transacted through our clearing broker as having Level 2 inputs due to the level of activity of these contracts on the exchange in which they trade. We consider the valuation of our interest rate derivatives as Level 2 as the primary input, the LIBOR curve, is based on quotes from an active exchange of Eurodollar futures for the same period as the future interest swap settlements, and we discount the future cash flows accordingly, including the effects of credit risk. Level 3 inputs are unobservable. Derivatives related to the Regency Preferred Units are valued using a binomial lattice model. The market inputs utilized in the model include credit spread, probabilities of the occurrence of certain events, common unit price, dividend yield, and expected value, and are considered Level 3. The fair value of the Preferred Units was based predominantly on an income approach model and is also considered Level 3. Based on the estimated borrowing rates currently available to us and our subsidiaries for long-term loans with similar terms and average maturities, the aggregate fair value and carrying amount of our consolidated debt obligations as of June 30, 2012 was $19.33 billion and $18.07 billion, respectively. As of December 31, 2011, the aggregate fair value and carrying amount of our consolidated debt obligations was $12.21 billion and $11.37 billion, respectively. The fair value of our consolidated debt obligations is a Level 2 valuation based on the observable inputs used for similar liabilities. 14 The following tables summarize the fair value of our financial assets and liabilities measured and recorded at fair value on a recurring basis as of June 30, 2012 and December 31, 2011 based on inputs used to derive their fair values:
15
The following table presents the material unobservable inputs used to estimate the fair value of the Preferred Units and the embedded derivatives in Regency's Preferred Units:
16 Changes in the remaining term of the Preferred Units, U.S. Treasury yields and valuations in related instruments would cause a change in the yield to value the Preferred Units. Changes in Regency's cost of equity and U. S. Treasury yields would cause a change in the credit spread used to value the embedded derivatives in the Regency Preferred Units. Changes in Regency's historical unit price volatility would cause a change in the volatility used to value the embedded derivatives. The following table presents a reconciliation of the beginning and ending balances for our Level 3 financial instruments measured at fair value on a recurring basis using significant unobservable inputs for the six months ended June 30, 2012. There were no transfers between the fair value hierarchy levels during the six months ended June 30, 2012 or 2011.
A reconciliation of net income and weighted average units used in computing basic and diluted net income per unit is as follows:
The calculation above for the three and six months ended June 30, 2012 for diluted net income per limited partner unit excludes the impact of any ETE Common Units that would be issued upon conversion of the Preferred Units, because inclusion would have been antidilutive. The Preferred Units have a liquidation preference of $300 million and are subject to mandatory conversion as discussed in Note 11. 17
Our debt obligations consisted of the following:
The following table reflects future maturities of long-term debt for each of the next five years and thereafter. These amounts exclude $157.4 million in net unamortized premiums and fair value adjustments related to interest rate swaps:
ETE Senior Secured Term Loan We used the net proceeds from our Senior Secured Term Loan, along with proceeds received from ETP in the Citrus Merger, to fund the cash portion of the Southern Union Merger and pay related fees and expenses, including existing borrowings under our revolving credit facility and for general partnership purposes. 18 Borrowings bear interest at either the Eurodollar rate plus an applicable margin or the alternative base rate plus an applicable margin. The alternative base rate used to calculate interest on base rate loans will be calculated using the greater of a prime rate, a federal funds effective rate plus 0.50%, and an adjusted one-month LIBOR rate plus 1.00%. The applicable margins are 3.0% for Eurodollar loans and from 2.0% for base rate loans. The effective interest rate on the amount outstanding as of June 30, 2012 was 3.75%. Southern Union Junior Subordinated Notes Southern Union has interest rate swap agreements that effectively fix the interest rate applicable to the floating rate on $525.0 million of the $600.0 million Junior Subordinated Notes due 2066. The interest rate on the remaining notes is a variable rate based upon the three-month LIBOR rate plus 3.0175%. The balance of the variable rate portion of the Junior Subordinated Notes was $75.0 million at an effective interest rate of 3.48% at June 30, 2012. Panhandle Term Loans In February 2012, Southern Union refinanced LNG Holdings' $455.0 million term loan due March 2012 with an unsecured three-year term loan facility due February 2015, with LNG Holdings as borrower and PEPL and Trunkline LNG as guarantors and a floating interest rate tied to LIBOR plus a margin based on the rating of PEPL's senior unsecured debt. The effective interest rate of PEPL's term loan was 1.87% at June 30, 2012. Bridge Term Loan Facility Upon obtaining permanent financing for the Southern Union Merger in March 2012, we terminated the 364-day Bridge Term Loan Facility. For the six months ended June 30, 2012, bridge loan related fees reflects the recognition of $62.2 million of commitment fees upon termination of the facility. ETP Senior Notes In January 2012 ETP completed a public offering of $1.00 billion aggregate principal amount of 5.20% Senior Notes due February 1, 2022 and $1.00 billion aggregate principal amount of 6.50% Senior Notes due February 1, 2042 and used the net proceeds of $1.98 billion from the offering to fund the cash portion of the purchase price of the Citrus Merger and for general partnership purposes. ETP may redeem some or all of the notes at any time and from time to time pursuant to the terms of the indenture subject to the payment of a “make-whole” premium. Interest will be paid semi-annually. In January 2012 ETP announced a tender offer for approximately $750.0 million aggregate principal amount of specified series of the ETP Senior Notes. The tender offer consisted of two separate offers: an Any and All Offer and a Maximum Tender Offer. The senior notes described below were repurchased under the offers for a total cost of $885.9 million and a loss on extinguishment of debt of $115.0 million was recorded during the six months ended June 30, 2012. In the Any and All Offer ETP offered to purchase any and all of its 5.65% Senior Notes due August 1, 2012, at a fixed price. Pursuant to the Any and All Offer, ETP purchased $292 million aggregate principal amount of its 5.65% Senior Notes due August 1, 2012. In the Maximum Tender Offer ETP offered to purchase certain series of outstanding ETP Senior Notes at a fixed spread over the index rate. Pursuant to the Maximum Tender Offer, on February 7, 2012, ETP purchased $200 million aggregate principal amount of its 9.7% Senior Notes due March 15, 2019, $200 million aggregate principal amount of its 9.0% Senior Notes due April 15, 2019 and $58.1 million aggregate principal amount of its 8.5% Senior Notes due April 15, 2014. Regency Senior Notes In May 2012, Regency exercised its option to redeem 35%, or $87.5 million, of its outstanding senior notes due 2016 at a price of 109.375%. Revolving Credit Facilities Parent Company Credit Facility As of June 30, 2012, we had $10.0 million outstanding borrowings under the Parent Company Credit Facility and the amount available for future borrowings was $190.0 million. The weighted average interest rate on the total amount outstanding as of June 30, 2012 was 3.74%. 19 ETP Credit Facility As of June 30, 2012, ETP had a balance of $493.4 million outstanding under the ETP Credit Facility, and the amount available for future borrowings was $1.98 billion after taking into account letters of credit of $30.3 million. The weighted average interest rate on the total amount outstanding as of June 30, 2012 was 1.74%. Regency Credit Facility As of June 30, 2012, there was a balance outstanding under the Regency Credit Facility of $515.0 million in revolving credit loans and approximately $9.0 million in letters of credit. The total amount available under the Regency Credit Facility, as of June 30, 2012, which is reduced by any letters of credit, was approximately $376.0 million. The weighted average interest rate on the total amount outstanding as of June 30, 2012 was 2.88%. Southern Union Credit Facilities The Southern Union Credit Facility provides for a $700 million revolving credit facility which matures on May 20, 2016. Borrowings on the Southern Union Credit Facility are available for working capital, other general company purposes and letter of credit requirements. The interest rate and commitment fee under the Southern Union Credit Facility are calculated using a pricing grid, which is based on the credit ratings for Southern Union's senior unsecured notes. The annualized interest rate for the Southern Union Credit Facility was 1.87% as of June 30, 2012. Covenants Related to Our Credit Agreements Covenants Related to Southern Union Southern Union is not party to any lending agreement that would accelerate the maturity date of any obligation due to a failure to maintain any specific credit rating, nor would a reduction in any credit rating, by itself, cause an event of default under any of Southern Union’s lending agreements. Covenants exist in certain of the Southern Union’s debt agreements that require Southern Union to maintain a certain level of net worth, to meet certain debt to total capitalization ratios and to meet certain ratios of earnings before depreciation, interest and taxes to cash interest expense. A failure by Southern Union to satisfy any such covenant would give rise to an event of default under the associated debt, which could become immediately due and payable if Southern Union did not cure such default within any permitted cure period or if Southern Union did not obtain amendments, consents or waivers from its lenders with respect to such covenants. Southern Union’s restrictive covenants include restrictions on debt levels, restrictions on liens securing debt and guarantees, restrictions on mergers and on the sales of assets, capitalization requirements, dividend restrictions, cross default and cross-acceleration and prepayment of debt provisions. A breach of any of these covenants could result in acceleration of Southern Union’s debt and other financial obligations and that of its subsidiaries. Under the current credit agreements, the significant debt covenants and cross defaults are as follows:
In addition to the above restrictions and default provisions, Southern Union and/or its subsidiaries are subject to a number of additional restrictions and covenants. These restrictions and covenants include limitations on additional debt at some of its subsidiaries; limitations on the use of proceeds from borrowing at some of its subsidiaries; limitations, in some cases, on transactions with its affiliates; limitations on the incurrence of liens; potential limitations on the abilities of some of its subsidiaries to declare and pay dividends and potential limitations on some of its subsidiaries to participate in Southern Union’s cash management program; and limitations on Southern Union’s ability to prepay debt. 20 Compliance with Our Covenants We were in compliance with all requirements, tests, limitations, and covenants related to our respective credit agreements as of June 30, 2012.
ETE Preferred Units The Parent Company has outstanding 3,000,000 Series A Convertible Preferred Units to an affiliate of GE Energy Financial Services, Inc. having an aggregate liquidation preference of $300.0 million. These units are reflected as a non-current liability in our consolidated balance sheets. The Preferred Units are measured at fair value on a recurring basis. Changes in the estimated fair value of the ETE Preferred Units are recorded in other income (expense) on the consolidated statements of operations. Regency Preferred Units Regency had 4,371,586 Regency Preferred Units outstanding at June 30, 2012, which were convertible into 4,645,229 Regency Common Units. If outstanding on September 2, 2029, the Regency Preferred Units are mandatorily redeemable for $80.0 million plus all accrued but unpaid distributions thereon. Holders of the Regency Preferred Units receive fixed quarterly cash distributions of $0.445 per unit. Holders can elect to convert Regency Preferred Units to Regency Common Units at any time in accordance with Regency’s Partnership Agreement.
ETE Common Units Issued The change in ETE Common Units during the six months ended June 30, 2012 was as follows:
Sales of Common Units by Subsidiaries The Parent Company accounts for the difference between the carrying amount of its investments in ETP and Regency and the underlying book value arising from the issuance or redemption of units by ETP or Regency (excluding transactions with the Parent Company) as capital transactions. As a result of ETP’s and Regency’s issuances of common units during the six months ended June 30, 2012, we recognized decreases in partners’ capital of $13.9 million. Sales of Common Units by ETP On July 3, 2012, ETP issued 15,525,000 ETP Common Units representing limited partner interests at $44.57 per ETP Common Unit in a public offering. Proceeds, net of commissions, of approximately $671.1 million from the offering were used to repay amounts outstanding under the ETP Credit Facility, to fund capital expenditures related to pipeline construction projects and for general partnership purposes. During the six months ended June 30, 2012, ETP received proceeds from units issued pursuant to an Equity Distribution Agreement with Credit Suisse Securities (USA) LLC of $76.7 million, net of commissions, which were used for general partnership purposes. No ETP Common Units remain available to be issued under the ETP Equity Distribution Agreement as of June 30, 2012. For the six months ended June 30, 2012, distributions of approximately $16.8 million were reinvested under its DRIP resulting in the issuance of 379,258 ETP Common Units. As of June 30, 2012, a total of 5,017,063 ETP Common Units remain available to be issued under this registration statement. 21 ETP issued approximately 2.25 million ETP Common Units to Southern Union as a portion of consideration in the Citrus Merger. See Note 3 for additional discussion. Sale of Common Units by Regency In March 2012, Regency issued 12,650,000 Regency Common Units through a public offering. The net proceeds of approximately $296.8 million were used to repay borrowings outstanding under the Regency Credit Facility and were used to redeem 35% in aggregate principal amount of its outstanding Senior Notes due 2016 and pay related premium expenses and interest. On June 19, 2012, Regency entered into an Equity Distribution Agreement with Citi under which Regency may offer and sell Regency Common Units, having an aggregate offering price of up to $200 million from time to time through Citi, as sales agent for Regency. Sales of these units, if any, made under the Regency Equity Distribution Agreement will be made by means of ordinary brokers’ transactions on the New York Stock Exchange at market prices, in block transactions, or as otherwise agreed upon by Regency and Citi. Under the terms of this agreement, Regency may also sell Regency Common Units to Citi as principal for its own account at a price agreed upon at the time of sale. Any sale of Regency Common Units to Citi as principal would be pursuant to the terms of a separate agreement between the Partnership and Citi. Regency intends to use the net proceeds from the sale of these units for general partnership purposes. As of June 30, 2012, Regency has not issued any Regency Common Units pursuant to this agreement. Parent Company Quarterly Distributions of Available Cash Following are distributions declared and/or paid by us subsequent to December 31, 2011:
ETP Quarterly Distributions of Available Cash Following are distributions declared and/or paid by ETP subsequent to December 31, 2011:
Regency Quarterly Distributions of Available Cash Following are distributions declared and/or paid by Regency subsequent to December 31, 2011:
22 Accumulated Other Comprehensive Income The following table presents the components of AOCI, net of tax:
We, ETP, and Regency have equity incentive plans for employees, officers and directors, which provide for various types of awards, including options to purchase common units, restricted units, phantom units, DERs, common unit appreciation rights, and other unit-based awards. ETE Long-Term Incentive Plan During the six months ended June 30, 2012, no awards were granted to ETE employees. As of June 30, 2012 a total of 76,172 unit awards remain unvested, including the new awards granted to ETE directors during the period. We expect to recognize a total of $0.9 million in compensation expense over a weighted average period of 1.7 years related to unvested awards. ETP Unit-Based Compensation Plans During the six months ended June 30, 2012, ETP employees were granted a total of 62,917 unvested awards with five-year service vesting requirements, and directors were granted a total of 4,400 unvested awards with three-year service vesting requirements. The weighted average grant-date fair value of these awards was 46.99 per unit. As of June 30, 2012 a total of 2,369,652 unit awards remain unvested, including the new awards granted during the period. ETP expects to recognize a total of $61.8 million in compensation expense over a weighted average period of 1.7 years related to unvested awards. Regency Unit-Based Compensation Plans Common Unit Options There was no Regency Common Unit Option activity for the six months ended June 30, 2012. The aggregate intrinsic value and weighted average contractual term in years as of June 30, 2012 for the outstanding and exercisable common unit options was $0.3 million and 3.9 years, respectively. During the six months ended June 30, 2011, Regency received $0.7 million in proceeds from the exercise of unit options. Phantom Units During the six months ended June 30, 2012, Regency employees and directors were granted 7,250 Regency phantom units with three-year service vesting requirements. As of June 30, 2012, a total of 991,206 Regency Phantom Units remain unvested, with a weighted average grant date fair value of $24.59. Regency expects to recognize a total of $17.8 million in compensation expense over a weighted average period of 3.8 years related to Regency’s unvested phantom units.
Southern Union has pension plans that cover substantially all of its distribution operations' employees. Normal retirement age is 65, but certain plan provisions allow for earlier retirement. Pension benefits are calculated under formulas principally based on average earnings and length of service for salaried and non-union employees and average earnings and length of service or negotiated non-wage based formulas for union employees. 23 Southern Union has other postretirement plans that cover most of its employees. The health care plans generally provide for cost sharing between Southern Union and its retirees in the form of retiree contributions, deductibles, coinsurance, and a fixed cost cap on the amount Southern Union pays annually to provide future retiree health care coverage under certain of these plans. Pension and other postretirement benefit liabilities are accrued on an actuarial basis during the years an employee provides services. The following table contains information at the acquisition date (March 26, 2012) about the obligations and funded status of Southern Union’s pension and other postretirement plans on a combined basis:
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