XTXI Crosstex Energy, Inc. (MM)

 

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

 

Form 10-Q

 

 

Commission file number: 000-50536

 

CROSSTEX ENERGY, INC.

(Exact name of registrant as specified in its charter)

 

 

(214) 953-9500

(Registrant’s telephone number, including area code)

 

Indicate by check mark whether 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 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).   o  Yes      o  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. (Check one):

 

 

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

 

As of April 30, 2009, the Registrant had 46,452,911 shares of common stock outstanding.

 

 

TABLE OF CONTENTS

 

CROSSTEX ENERGY, INC.

 

Condensed Consolidated Balance Sheets

 

 

See accompanying notes to condensed consolidated financial statements.

CROSSTEX ENERGY, INC.

 

Consolidated Statements of Operations

 

 

See accompanying notes to condensed consolidated financial statements.

CROSSTEX ENERGY, INC.

 

Consolidated Statements of Changes in Stockholders’ Equity

Three Months Ended March 31, 2009

 

 

See accompanying notes to condensed consolidated financial statements.

CROSSTEX ENERGY, INC.

 

Consolidated Statements of Comprehensive Income

 

 

See accompanying notes to condensed consolidated financial statements.

CROSSTEX ENERGY, INC.

 

Consolidated Statements of Cash Flows

 

 

See accompanying notes to condensed consolidated financial statements.

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements

 

 

Unless the context requires otherwise, references to “we”,“us”,“our”, “CEI” or the “Company” mean Crosstex Energy, Inc. and its consolidated subsidiaries.

 

CEI, a Delaware corporation formed on April 28, 2000, is engaged, through its subsidiaries, in the gathering, transmission, treating, processing and marketing of natural gas and natural gas liquids (NGLs). The Company connects the wells of natural gas producers in the geographic areas of its gathering systems in order to gather for a fee or purchase the gas production, treats natural gas to remove impurities to ensure that it meets pipeline quality specifications, processes natural gas for the removal of NGLs, transports natural gas and NGLs and ultimately provides natural gas and NGLs to a variety of markets. In addition, the Company purchases natural gas and NGLs from producers not connected to its gathering systems for resale and markets natural gas and NGLs on behalf of producers for a fee.

 

The accompanying condensed consolidated financial statements include the assets, liabilities and results of operations of the Company, its majority owned subsidiaries and Crosstex Energy, L.P. (herein referred to as the Partnership or CELP), a publicly traded Delaware limited partnership. The Partnership is included because CEI controls the general partner of the Partnership.

 

The accompanying condensed consolidated financial statements are prepared in accordance with the instructions to Form 10-Q, are unaudited and do not include all the information and disclosures required by generally accepted accounting principles for complete financial statements. All adjustments that, in the opinion of management, are necessary for a fair presentation of the results of operations for the interim periods have been made and are of a recurring nature unless otherwise disclosed herein. The results of operations for such interim periods are not necessarily indicative of results of operations for a full year. All significant intercompany balances and transactions have been eliminated in consolidation. Certain reclassifications have been made to the consolidated financial statements for the prior years to conform to the current presentation. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2008.

 

(a)  Management’s Use of Estimates

 

The preparation of financial statements in accordance with accounting principles generally accepted in the United States of America requires management of the Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. Actual results could differ from these estimates.

 

(b)  Recent Accounting Pronouncements

 

In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (SFAS 141R) and SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160). SFAS 141R requires most identifiable assets, liabilities, noncontrolling interests and goodwill acquired in a business combination to be recorded at “full fair value.” The Statement applies to all business combinations, including combinations among mutual entities and combinations by contract alone. Under SFAS 141R, all business combinations will be accounted for by applying the acquisition method. SFAS 141R is effective for periods beginning on or after December 15, 2008. SFAS 160 requires noncontrolling interests (previously referred to as minority interests) to be treated as a separate component of equity, not as a liability or other item outside of permanent equity. SFAS 160 was adopted January 1, 2009 and comparative period information has been recast to classify noncontrolling interests in equity, and attribute net income and other comprehensive income to noncontrolling interests.

 

In March of 2008, the FASB issued Statement of Financial Accounting Standards No. 161, “Disclosures about Derivative Instruments and Hedging Activities, an amendment of FASB Statement No. 133” (SFAS 161). SFAS 161

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

requires entities to provide greater transparency about how and why the entity uses derivative instruments, how the instruments and related hedged items are accounted for under SFAS 133, and how the instruments and related hedged items affect the financial position, results of operations and cash flows of the entity. SFAS 161 is effective for fiscal years beginning after November 15, 2008. SFAS 161 was adopted effective January 1, 2009. Required disclosures were added to Note 7.

 

In June 2008, the Financial Accounting Standards Board (FASB) issued Staff Position FSP EITF 03-6-1 (the FSP) which requires unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents to be treated as participating securities as defined in EITF Issue No. 03-6, “Participating Securities and the Two-Class Method under FASB Statement No. 128,” and, therefore, included in the earnings allocation in computing earnings per share under the two-class method described in FASB Statement No. 128, Earnings per Share . The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company adopted the FSP effective January 1, 2009 and adjusted all prior reporting periods to conform to the requirements.

 

In May 2008, the FASB issued SFAS No. 162, The Hierarchy of Generally Accepted Accounting Principles (“SFAS No. 162”). SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States of America. SFAS No. 162 is effective for fiscal years beginning after November 15, 2008. The Company adopted of SFAS No. 162 effective January 1, 2009 and there was no material impact on our consolidated financial statements.

 

 

As part of the Partnership’s strategy to increase liquidity in response to the tightening financial markets, the Partnership has sold and is also marketing for sale certain non-strategic assets.

 

During the quarter ended March 31, 2009 the Partnership sold the Arkoma system to an unrelated third party for approximately $11.0 million. The asset had been impaired by $2.6 million in December 2008 to its fair value in anticipation of a first quarter disposition. The related loss on the sale recorded during the three months ended March 31, 2009 was less than $0.1 million.

 

In addition to the sale of the Arkoma system, the Partnership is marketing for sale certain other Midstream and related Treating assets as of March 31, 2009. In accordance with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” the consolidated balance sheet at March 31, 2009 reflects these assets as held for sale. The assets and liabilities consisted of the following (in thousands):

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The revenues, operating expenses, depreciation and amortization expense and an allocated interest expense related to the operations of the assets held for sale have been segregated from continuing operations and reported as discontinued operations for all periods. No income taxes are attributed to income from discontinued operations and no general and administrative costs have been allocated to income from discontinued operations. Following are revenues and income from discontinued operations (in thousands):

 

 

 

As of March 31, 2009 and December 31, 2008, long-term debt consisted of the following (in thousands):

 

 

Credit Facility.   As of March 31, 2009, the Partnership had a bank credit facility with a borrowing capacity of $1.183 billion that matures in June 2011. As of March 31, 2009, $946.3 million was outstanding under the bank credit facility, including $89.3 million of letters of credit, leaving approximately $237.0 million available for future borrowing. The bank credit facility is guaranteed by certain of the Partnership’s subsidiaries.

 

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

 

On February 27, 2009, the Partnership entered into the Sixth Amendment to the Fourth Amended and Restated Credit Agreement and Consent (the “Sixth Amendment”) to its credit facility with its bank lending group. Under the Sixth Amendment, borrowings will bear interest at the Partnership’s option at the administrative agent’s reference rate plus an applicable margin or London Interbank Offering Rate (LIBOR) plus an applicable margin. The applicable margins for the Partnership’s interest rate and letter of credit fees vary quarterly based on the Partnership’s leverage ratio as defined by the credit facility (the “Leverage Ratio” being generally computed as

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

total funded debt to consolidated earnings before interest, taxes, depreciation, amortization and certain other non-cash charges) are as follows:

 

 

 

 

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

 

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

 

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

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

 

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

 

 

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

 

The Sixth Amendment also limits the Partnership’s annual capital expenditures (excluding maintenance capital expenditures) to $120.0 million in 2009 and $75.0 million in 2010 and each year thereafter (with unused amounts in any year being carried forward to the next year). The Partnership does not intend to make any acquisitions during 2009.

 

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

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

using Excess Proceeds. Net proceeds from asset dispositions are required for prepayment at 100% regardless of the leverage ratio. The following table sets forth the amended prepayment terms:

 

 

 

 

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

 

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

 

 

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

 

 

If an event of default relating to bankruptcy or other insolvency events occurs, all indebtedness under the Partnership’s bank credit facility will immediately become due and payable. If any other event of default exists

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

under the bank credit facility, the lenders may accelerate the maturity of the obligations under the bank credit facility and exercise other rights and remedies.

 

The Partnership is subject to interest rate risk on the Partnership’s credit facility and has entered into interest rate swaps to reduce this risk. See Note 8 to the financial statements for a discussion of interest rate swaps.

 

Senior Secured Notes.   On February 27, 2009, the Partnership amended its senior note agreements to (i) increase the maximum permitted leverage ratio and to lower the minimum interest coverage ratio it must maintain consistent with the ratios under the Sixth Amendment to the bank credit facility, (ii) revise the mandatory prepayment terms consistent with the terms under the Sixth Amendment to the bank credit facility (iii) increase the interest rate it pays on the senior secured notes and (iv) provide for the payment of a leverage fee consistent with the terms of bank credit facility. The weighted average interest rate on the outstanding balance on the senior secured notes is 10.5% at March 31, 2009.

 

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

 

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

 

The Partnership recognized a $4.7 million loss on extinguishment of debt during the three months ended March 31, 2009 due to the February 2009 amendment to the senior secured note agreement. The modifications to this agreement pursuant to this amendment were substantive as defined in EITF Issue No. 96-19, “ Debtor’s Accounting for a Modification or Exchange of Debt Instruments ” and were accounted for as the extinguishment of the old debt and the creation of new debt. As a result, the unamortized costs associated with the senior secured notes prior to the amendment as well as the fees paid to the senior secured noteholders for the February 2009 amendment were expensed in the first quarter of 2009.

 

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

 

The senior secured notes issued in 2003 are redeemable, at the Partnership’s option and subject to certain notice requirements, at a purchase price equal to 100.0% of the principal amount together with accrued interest, plus a make-whole amount determined in accordance with the senior secured note agreement. The senior secured notes issued 2004, 2005 and 2006 provide for a call premium of 103.5% of par beginning three years after issuance at rates declining from 103.5% to 100.0%.

 

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

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

or interest occurs, any holder of outstanding notes affected by such event of default may declare all the notes held by such holder to be immediately due and payable.

 

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

 

The Partnership was in compliance with all debt covenants as of March 31, 2009 and expects to be in compliance with debt covenants for the next twelve months.

 

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

 

 

The Partnership entered into 9 and 10-year capital leases for certain equipment. Assets under capital leases as of March 31, 2009 are summarized as follows (in thousands):

 

 

The following are the minimum lease payments to be made in each of the following years indicated for the capital leases in effect as of March 31, 2009 (in thousands):

 

 

 

(a)  Senior Subordinated Series D Units

 

On March 23, 2007, the Partnership issued an aggregate of 3,875,340 senior subordinated series D units representing limited partner interests of the Partnership in a private offering. These senior subordinated series D

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

units converted into common units representing limited partner interests of the Partnership on March 23, 2009. Since the Partnership did not make distributions of available cash from operating surplus, as defined in the partnership agreement, of at least $0.62 per unit on each outstanding common unit for the quarter ending December 31, 2008, each senior subordinated series D unit converted into 1.05 common units for a total issuance of 4,069,107 common units.

 

(b)  Cash Distributions from the Partnership

 

Unless restricted by the terms of its credit facility, the Partnership must make distributions of 100% of available cash, as defined in the partnership agreement, within 45 days following the end of each quarter. Distributions will generally be made 98% to the common and subordinated unitholders and 2% to the general partner, subject to the payment of incentive distributions to the extent that certain target levels of cash distributions are achieved. Under the quarterly incentive distribution provisions, generally the Partnership’s general partner is entitled to 13% of amounts the Partnership distribute in excess of $0.25 per unit, 23% of the amounts it distributes in excess of $0.3125 per unit and 48% of amounts it distributes in excess of $0.375 per unit. No incentive distributions were earned by the Company as general partner for the three months ended March 31, 2009. Incentive distributions totaling $11.8 million were earned by the Company as general partner for the three months ended March 31, 2008.

 

See Note 3 for a description of the Partnership’s credit facilities which restrict the Partnership’s ability to make future distributions.

 

(c)  Allocation of Partnership Income

 

Net income for the general partner consists of incentive distributions as described in Note (b) above, a deduction for stock-based compensation attributable to CEI’s stock options and restricted shares and 2% of the original Partnership’s net income adjusted for the CEI stock-based compensation specifically allocated to the general partner. The remaining net income after incentive distributions and CEI-related stock-based compensation is allocated pro rata between the 2% general partner interest and the common units. The following table reflects the Company’s general partner share of the Partnership’s net income (loss) (in thousands):

 

 

The Company also owns limited partner common units in the Partnership. The Company’s share of the Partnership’s net income (loss) attributable to its limited partner common units was a net loss of $5.2 million and $2.7 million for the three months ended March 31, 2009 and 2008, respectively.

 

 

Basic earnings per share was computed by dividing net income by the weighted average number of common shares outstanding for the three months ended March 31, 2009 and 2008. The computation of diluted earnings per share further assumes the dilutive effect of common share options and restricted shares. All common unit equivalents were antidilutive in the three months ended March 31, 2009 because the limited partners were allocated net loss in that period.

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

FSP EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions are Participating Securities , was issued in May 2008 with an effective date for fiscal years beginning after December 15, 2008 and interim periods within those years. This FSP requires unvested share-based payments that entitle employees to receive non-forfeitable dividends to also be considered participating securities, as defined in EITF 03-6. The Company was impacted by this EITF and has included a calculation of earnings per share for unvested restricted shares in calculations for the current quarter ended March 31, 2009 and the comparative period ended March 31, 2008.

 

The following table reflects the computation of basic earnings share for the periods presented (in thousands except per unit amounts):

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The following are the common share amounts used to compute the basic and diluted earnings per common share for the three months ended March 31, 2009 and 2008 (in thousands):

 

 

All common share equivalents were antidilutive in the three months ended March 31, 2009 because the Company had a net loss.

 

 

(a)  Long-Term Incentive Plans

 

The Company accounts for share-based compensation in accordance with the provisions of Statement of Financial Accounting Standards No. 123R, “Share-Based Compensation” (SFAS No. 123R), which requires compensation related to all stock-based awards, including stock options, be recognized in the consolidated financial statements.

 

The Company and the Partnership each have similar unit or share-based payment plans for employees, which are described below. Amounts recognized in the consolidated financial statements with respect to these plans are as follows (in thousands):

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

(b)  Partnership Restricted Units

 

The restricted units are valued at their fair value at the date of grant which is equal to the market value of common units on such date. A summary of the restricted unit activity for the three months ended March 31, 2009 is provided below:

 

 

 

 

A summary of the restricted units aggregate intrinsic value (market value at vesting date) and fair value (market value at date of grant) of units vested during the three ended March 31, 2009 and 2008 are provided below (in thousands):

 

 

As of March 31, 2009, there was $6.4 million of unrecognized compensation cost related to non-vested restricted units. That cost is expected to be recognized over a weighted-average period of 2.4 years.

 

The Partnership issued performance-based restricted units in 2007 and 2008 to executive officers. The minimum level of performance-based awards is included in restricted units outstanding and is included in the current share-based compensation cost calculations at March 31, 2009. The achievement of greater than the minimum performance targets in the current business environment is less than probable. All performance-based awards are subject to reevaluation and adjustment until the restricted units vest.

 

(c)  Partnership Unit Options

 

No options were granted or exercised during the three months ended March 31, 2009.

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

A summary of the unit option activity for the three months ended March 31, 2009 is provided below:

 

 

As of March 31, 2009, there was $1.3 million of unrecognized compensation cost related to non-vested unit options. That cost is expected to be recognized over a weighted-average period of 1.3 years.

 

(d)  Crosstex Energy, Inc’s Stock and Option Plan

 

The Company’s restricted shares are included at their fair value at the date of grant which is equal to the market value of the common stock on such date. A summary of the restricted share activity for the three months ended March 31, 2009 is provided below:

 

 

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

A summary of the restricted shares’ aggregate intrinsic value (market value at vesting date) and fair value (market value at date of grant) of shares vested during the three months ended March 31, 2009 and 2008 are provided below (in thousands):

 

 

As of March 31, 2009 there was $5.9 million of unrecognized compensation costs related to non-vested CEI restricted shares for officers and employees. The cost is expected to be recognized over a weighted average period of 2.2 years.

 

The Company issued performance-based restricted shares in 2007 and 2008 to executive officers. The minimum level of performance-based awards is included in restricted shares outstanding and is included in the current share-based compensation cost calculations at March 31, 2009. The achievement of greater than the minimum performance targets in the current business environment is less than probable. All performance-based awards are subject to reevaluation and adjustment until the restricted shares vest.

 

CEI Stock Options

 

No CEI stock options were granted, exercised or forfeited during the three months ended March 31, 2009 and 2008. The following is a summary of the CEI stock options outstanding as of March 31, 2009:

 

 

A summary of the stock options intrinsic value exercised (market value in excess of exercise price at date of exercise) and fair value (value per Black-Scholes option pricing model at date of grant) of units vested during the three months ended March 31, 2009 and 2008 is provided below (in thousands):

 

 

As of March 31, 2009, there was less than $0.1 million of unrecognized compensation costs related to non-vested CEI stock options. The cost is expected to be recognized over a weighted average period of 0.5 years.

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

The Partnership manages exposure to interest rate risk and commodity price risk through the use of derivative instruments and hedging activities. The FASB issued Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities , in March 2008 requiring additional disclosures on derivative instruments that would provide insight into the reason for the use of derivative instruments, give transparency to the location of derivatives within the financial statements and the financial impact of the derivative activity and provide disclosure about credit risk related disclosures to provide additional information about liquidity. These disclosure requirements are in addition to those already required under FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities . The Partnership has historically presented detailed information about derivative activities, but has updated the current disclosure to provide the requirements of FASB Statement No. 161.

 

Interest Rate Swaps

 

The Partnership is subject to interest rate risk on its credit facility and has entered into interest rate swaps to reduce this risk.

 

The Partnership entered into eight interest rate swaps prior to 2008. Each swap fixed the three month LIBOR rate, prior to credit margin, at the indicated rates for the specified amounts of related debt outstanding over the term of each swap agreement. In January 2008, the Partnership amended existing swaps with the counterparties in order to reduce the fixed rates and extend the terms of the existing swaps by one year and entered into one new swap. The table below reflects the swaps as amended:

 

 

 

 

The Partnership had previously elected to designate all interest rate swaps (except the November 2006 swap) as cash flow hedges for FAS 133 accounting treatment. Accordingly, unrealized gains and losses relating to the designated interest rate swaps were recorded in accumulated other comprehensive income. Immediately prior to the January 2008 amendments, these swaps were de-designated as cash flow hedges. The unrealized loss in accumulated other comprehensive income of $17.0 million at the de-designation date is being reclassified to earnings over the remaining original terms of the swaps using the effective loss of interest method. The related loss reclassified to earnings and included in other income (expense) in the consolidated statements of operations as part of interest expense, net, during the three months ended March 31, 2009 and 2008 is $1.7 million and $1.3 million, respectively.

 

The Partnership elected not to designate any of the amended swaps or the new swap entered into in January 2008 as cash flow hedges for FAS 133 treatment. Accordingly, unrealized gains and losses are recorded through the

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

consolidated statement of operations in other income (expense) as part of interest expense, net, over the period hedged.

 

In September 2008, the Partnership entered into four additional interest rate swaps. The effect of the new interest rate swaps was to convert the floating rate portion of the original swaps on $450.0 million (all swaps except the January 22, 2008 swap that expired January 31, 2009) from three month LIBOR to one month LIBOR. The Partnership received a cash settlement in September 2008 of $1.4 million which represented the present value of the basis point differential between one month LIBOR and three month LIBOR.

 

The table below aligns the new swap which receives one month LIBOR and pays three month LIBOR with the original interest rate swaps.

 

 

The impact of the interest rate swaps on net income is included in other income (expense) in the consolidated statements of operations as part of interest expense, net, as follows (in thousands):

 

 

The fair value of derivative assets and liabilities relating to interest rate swaps are as follows (in thousands):

 

 

Commodity Swaps

 

The Partnership manages its exposure to fluctuations in commodity prices by hedging the impact of market fluctuations. Swaps are used to manage and hedge prices and location risk related to these market exposures. Swaps are also used to manage margins on offsetting fixed-price purchase or sale commitments for physical quantities of natural gas and NGLs.

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

The Partnership commonly enters into various derivative financial transactions which it does not designate as hedges. These transactions include “swing swaps,” “third party on-system financial swaps,” “marketing financial swaps,” “storage swaps,” “basis swaps” and “processing margin swaps.” Swing swaps are generally short-term in nature (one month), and are usually entered into to protect against changes in the volume of daily versus first-of-month index priced gas supplies or markets. Third party on-system financial swaps are hedges that the Partnership enters into on behalf of its customers who are connected to its systems, wherein the Partnership fixes a supply or market price for a period of time for its customers, and simultaneously enters into the derivative transaction. Marketing financial swaps are similar to on-system financial swaps, but are entered into for customers not connected to the Partnership’s systems. Storage swap transactions protect against changes in the value of gas that the Partnership has stored to serve various operational requirements. Basis swaps are used to hedge basis location price risk due to buying gas into one of our systems on one index and selling gas off that same system on a different index. Processing margin financial swaps are used to hedge fractionation spread risk at our processing plants relating to the option to process versus bypassing our equity gas.

 

The components of gain on derivatives in the consolidated statements of operations relating to commodity swaps are (in thousands):

 

 

The fair value of derivative assets and liabilities relating to commodity swaps excluding net fair value of derivatives included in assets held for sale of $0.9 million are as follows (in thousands):

 

 

 

 

Set forth below is the summarized notional volumes and fair values of all instruments held for price risk management purposes and related physical offsets at March 31, 2009 (all gas volumes are expressed in MMBtu’s and liquids are expressed in gallons). The remaining term of the contracts extend no later than June 2010 for derivatives, except for certain basis swaps that extend to March 2012. Changes in the fair value of the Partnership’s mark to market derivatives are recorded in earnings in the period the transaction is entered into. The effective portion of changes in the fair value of cash flow hedges is recorded in accumulated other comprehensive income until the related anticipated future cash flow is recognized in earnings. The ineffective portion is recorded in earnings immediately.

 

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

 

 

 

On all transactions where the Partnership is exposed to counterparty risk, the Partnership analyzes the counterparty’s financial condition prior to entering into an agreement, establishes limits and monitors the appropriateness of these limits on an ongoing basis. The Partnership primarily deals with two types of counterparties, financial institutions and other energy companies, when entering into financial derivatives on commodities. If the counterparties failed to completely perform according to the terms of the contracts the maximum loss the Partnership would sustain is $8.7 million with financial institutions and $4.9 million with other energy companies, which represents the current gross fair value on March 31, 2009.

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

Impact of Cash Flow Hedges

 

The impact of realized gains or losses from derivatives designated as cash flow hedge contracts in the consolidated statements of operations is summarized below (in thousands):

 

 

Natural Gas

 

As of March 31, 2009, an unrealized derivative fair value gain of $1.1 million related to cash flow hedges of gas price risk was recorded in accumulated other comprehensive income (loss) and is expected to be reclassified into earnings through December 2009. The actual reclassification to earnings will be based on mark to market prices at the contract settlement date, along with the realization of the gain or loss on the related physical volume, which amount is not reflected above.

 

The settlement of cash flow hedge contracts related to April 2009 gas production increased gas revenue by approximately $0.1 million.

 

Liquids

 

As of March 31, 2009, an unrealized derivative fair value gain of $6.4 million related to cash flow hedges of liquids price risk was recorded in accumulated other comprehensive income (loss), all of which is expected to be reclassified into earnings through December 2009. The actual reclassification to earnings will be based on mark to market prices at the contract settlement date, along with the realization of the gain or loss on the related physical volume, which amount is not reflected above.

 

Derivatives Other Than Cash Flow Hedges

 

Assets and liabilities related to third party derivative contracts, swing swaps, basis swaps, storage swaps and processing margin swaps are included in the fair value of derivative assets and liabilities and the profit and loss on the mark to market value of these contracts are recorded net as (gain) loss on derivatives in the consolidated statement of operations. The Partnership estimates the fair value of all of its energy trading contracts using actively quoted prices. The estimated fair value of energy trading contracts by maturity date was as follows (in thousands):

 

 

 

SFAS No. 157, “Fair Value Measurements” (SFAS 157) sets forth a framework for measuring fair value and required disclosure about fair value measurements of assets and liabilities. Fair value under SFAS 157 is defined as the price at which an asset could be exchanged in a current transaction between knowledgeable, willing parties. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor, not the amount that would be paid to settle the liability with the creditor. Where available, fair value is based on observable

 

CROSSTEX ENERGY, INC.

 

Notes to Condensed Consolidated Financial Statements — (Continued)

 

market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, use of unobservable prices or inputs are used to estimate the current fair value, often using an internal valuation model. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the item being valued.

 

SFAS 157 established a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include: Level 1, defined as observable inputs such as quoted prices in active markets; Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring an entity to develop its own assumptions.

 

The Partnership’s derivative contracts primarily consist of commodity swaps and interest rate swap contracts which are not traded on a public exchange. The fair values of commodity swap contracts are determined based on inputs that are readily available in public markets or can be derived from information available in publicly quoted markets. The Partnership determines the value of interest rate swap contracts by utilizing inputs and quotes from the counterparties to these contracts. The reasonableness of these inputs and quotes is verified by comparing similar inputs and quotes from other counterparties as of each date for which financial statements are prepared. The Partnership’s contracts are all level two contracts under SFAS 157.

 

Net assets (liabilities) measured at fair value on a recurring basis are summarized below (in thousands):