UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC  20549

FORM 10-Q

x                              QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2006

or

o                                 TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT Of 1934

 

For the transition period from                       to                         

Commission file number 1-9356

BUCKEYE PARTNERS, L.P.

(Exact name of registrant as specified in its charter)

 

Registrant’s telephone number, including area code: 484-232-4000

Not Applicable
(Former name, former address and former fiscal year, if changed since last report).

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

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

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

 

 

BUCKEYE PARTNERS, L.P.

INDEX

				Page No.
Part I.		Financial Information
Item 1.		Financial Statements
		Condensed Consolidated Statements of Income (unaudited) for the three and nine months ended September 30, 2006 and 2005		1
		Condensed Consolidated Balance Sheets (unaudited) September 30, 2006 and December 31, 2005		2
		Condensed Consolidated Statements of Cash Flows (unaudited) for the nine months ended September 30, 2006 and 2005		3
		Notes to Condensed Consolidated Financial Statements		4-19
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations		20-37
Item 3.		Quantitative and Qualitative Disclosures About Market Risk		37-38
Item 4.		Controls and Procedures		38
Part II.		Other Information
Item 1.		Legal Proceedings		38-39
Item 6.		Exhibits		39

 

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Part I. Financial Information

Item 1.                          Condensed Consolidated Financial Statements

Buckeye Partners, L.P.
Condensed Consolidated Statements of Income
(In thousands, except per Unit amounts)
(Unaudited)

 

Three Months Ended September 30,								Nine Months Ended September 30,
2006			2005					2006			2005
$	116,519		$	102,366		Revenue		$	333,759		$	300,171
						Costs and expenses:
54,345			47,733			Operating expenses		157,149			141,941
11,419			9,338			Depreciation and amortization		32,758			27,014
4,709			4,585			General and administrative expenses		14,261			13,471
70,473			61,656			Total costs and expenses		204,168			182,426
46,046			40,710			Operating income		129,591			117,745
						Other income (expenses):
2,040			1,626			Investment and equity income		5,236			4,354
(13,319)			(11,256		)	Interest and debt expense		(38,679		)	(32,213		)
(6,381)			(5,323		)	General Partner incentive compensation		(18,277		)	(14,658		)
(1,089)			(1,023		)	Minority interests and other		(3,430		)	(2,906		)
(18,749)			(15,976		)	Total other income (expenses)		(55,150		)	(45,423		)
$	27,297		$	24,734		Net income		$	74,441		$	72,322
$	168		$	171		Net income allocated to General Partner		$	461		$	492
$	27,129		$	24,563		Net income allocated to Limited Partners		$	73,980		$	71,830
39,676			38,158			Weighted average units outstanding: Basic		39,315			36,749
39,700			38,202			Assuming dilution		39,340			36,794
$	0.69		$	0.65		Earnings per Parnership Unit- basic: Net income allocated to General and Limited Partners per Partnership Unit		$	1.89		$	1.97
$	0.69		$	0.65		Earnings per Parnership Unit — assuming dilution: Net income allocated to General and Limited Partners per Partnership Unit		$	1.89		$	1.97

 

See Notes to condensed consolidated financial statements.

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Buckeye Partners, L.P.
Condensed Consolidated Balance Sheets
(In thousands)
(Unaudited)

		September 30,			December 31,
		2006			2005
Assets
Current assets:
Cash and cash equivalents		$	29,228		$	24,862
Trade receivables		40,690			38,864
Construction and pipeline relocation receivables		11,796			10,571
Inventories		13,985			12,997
Prepaid and other current assets		21,554			11,074
Total current assets		117,253			98,368
Property, plant and equipment, net		1,711,062			1,576,652
Goodwill		11,355			11,355
Other non-current assets		119,044			130,492
Total assets		$	1,958,714		$	1,816,867
Liabilities and partners’ capital
Current liabilities:
Accounts payable		$	16,389		$	16,925
Accrued and other current liabilities		53,123			45,228
Total current liabilities		69,512			62,153
Long-term debt		981,115			899,077
Minority interests		20,511			19,516
Other non-current liabilities		77,769			77,544
Total liabilities		1,148,907			1,058,290
Commitments and contingent liabilities		—			—
Partners’ capital:
General Partner		2,441			2,529
Limited partners		807,757			756,531
Receivable from exercise of options		(391		)	(483		)
Total partners’ capital		809,807			758,577
Total liabilities and partners’ capital		$	1,958,714		$	1,816,867

 

See Notes to condensed consolidated financial statements.

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Buckeye Partners, L.P.
Condensed Consolidated Statements of Cash Flows
 (In thousands)
(Unaudited)

		Nine Months Ended September 30,
		2006			2005
Cash flows from operating activities:
Net income		$	74,441		$	72,322
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		32,758			27,014
Minority interests		3,430			2,906
Equity earnings		(4,598		)	(3,678		)
Distributions from equity investments		4,460			2,428
Amortization of debt discount		38			28
Amortization of option grants		294			—
Change in assets and liabilities, net of amounts related to acquisitions:
Trade receivables		(1,826		)	(403		)
Construction and pipeline relocation receivables		(1,225		)	1,729
Inventories		(317		)	25
Prepaid and other current assets		(11,363		)	6,245
Accounts payable		(536		)	(6,017		)
Accrued and other current liabilities		7,861			(953		)
Other non-current assets		82			(521		)
Other non-current liabilities		225			1,184
Total adjustments from operating activities		29,283			29,987
Net cash provided by operating activities		103,724			102,309
Cash flows from investing activities:
Capital expenditures		(62,218		)	(51,906		)
Acquisitions		(93,330		)	(178,854		)
Net proceeds from disposal of property, plant and equipment		130			61
Net cash used in investing activities		(155,418		)	(230,699		)
Cash flows from financing activities:
Net proceeds from issuance of Partnership units		64,092			156,101
Debt issuance costs		—			(1,282		)
Proceeds from exercise of unit options		559			1,289
Distributions to minority interests		(2,435		)	(1,611		)
Proceeds from issuance of long-term debt		147,000			324,767
Payment of long-term debt		(65,000		)	(273,000		)
Distributions to Unitholders		(88,156		)	(76,640		)
Net cash provided by financing activities		56,060			129,624
Net increase in cash and cash equivalents		4,366			1,234
Cash and cash equivalents at beginning of period		24,862			19,017
Cash and cash equivalents at end of period		$	29,228		$	20,251
Supplemental cash flow information:
Cash paid for interest(net of amount capitalized)		$	40,964		$	33,283
Capitalized interest		$	1,271		$	1,860
Cash paid for income taxes		$	7		$	1,083
Non cash change in assets and liabilities:
Fair value hedge accounting		$	(176	)	$	(176	)
Environmental obligations related to acquisition of Northeastern Pipelines and Terminals		$	—		$	(2,332	)

 

See Notes to condensed consolidated financial statements.

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BUCKEYE PARTNERS, L.P.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. BASIS OF PRESENTATION

In the opinion of management, the accompanying condensed consolidated financial statements of Buckeye Partners, L.P. (the “Partnership”), which are unaudited except that the Balance Sheet as of December 31, 2005 is derived from audited financial statements, include all adjustments necessary to present fairly the Partnership’s financial position as of September 30, 2006, along with the results of the Partnership’s operations for the three and nine months ended September 30, 2006 and 2005 and its cash flows for the nine months ended September 30, 2006 and 2005.  The results of operations for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be expected for the full year ending December 31, 2006.

Pursuant to the rules and regulations of the Securities and Exchange Commission, the condensed consolidated financial statements do not include all of the information and notes normally included with financial statements prepared in accordance with accounting principles generally accepted in the United States of America.  These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2005.

The Partnership is a master limited partnership organized in 1986 under the laws of the state of Delaware.  The Partnership conducts all of its operations through subsidiary entities.  These operating subsidiaries are Buckeye Pipe Line Company, L.P. (“Buckeye”), Laurel Pipe Line Company, L.P. (“Laurel”), Everglades Pipe Line Company, L.P. (“Everglades”), Buckeye Pipe Line Holdings, L.P. (“BPH”), Wood River Pipe Lines LLC  (“Wood River”), Buckeye Pipe Line Transportation LLC (“BPL Transportation”) and Buckeye NGL Pipe Lines LLC (“Buckeye NGL”).  Buckeye NGL commenced operations on January 31, 2006 with the acquisition of a natural gas liquids pipeline located in Colorado and Kansas (see Note 3).  Each of these entities is referred to hereinafter as an “Operating Subsidiary” or collectively as the “Operating Subsidiaries.” The Partnership owns an approximate 99% limited partner interest in each Operating Subsidiary except Wood River, BPL Transportation and Buckeye NGL, in each of which it owns a 100% interest.

Buckeye GP LLC (the “General Partner”) is the general partner of the Partnership.  As of September 30, 2006, the General Partner owned an approximate 0.6% general partner interest in the Partnership.  The General Partner also owns and indirectly controls MainLine L.P. (the “Operating Subsidiary GP”), which is the general partner of and owns a 1% interest in, each of Buckeye, Laurel and Everglades and an approximate 0.6% interest in BPH.

The General Partner is a wholly-owned subsidiary of Buckeye GP Holdings L.P. (“BGH”), a Delaware limited partnership that is owned by an affiliate of  Carlyle/Riverstone Global Energy and Power Fund II, L.P. (“Carlyle/Riverstone”), certain members of the Partnership’s senior management and the public and is separately traded on the New York Stock Exchange (NYSE: BGH).  See Note 14 to these condensed consolidated financial statements for an explanation of the restructuring of the General Partner and the Operating

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Subsidiary GP that occurred in connection with the initial public offering of BGH common units on August 9, 2006.

The General Partner has historically received incentive compensation payments under an Incentive Compensation Agreement, which are based on cash distributions to the limited partners of the Partnership.  As described in Note 14, as part of the reorganization of the General Partner and the Operating Subsidiary GP on August 9, 2006, the Incentive Compensation Agreement and the Partnership Agreement were amended to recharacterize the payments received by the General Partner under the Incentive Compensation Agreement and the Partnership Agreement are distribution payments with respect to the general partner interest rather than compensation payments.  The General Partner also receives distributions based on the percentage ownership of the Partnership and the Operating Subsidiaries that its general partner interests represent. Finally, the General Partner receives distributions on 80,000 limited partnership units that it owns.

The method used to compute cash payments to the General Partner and the Partnership’s limited partners is unchanged by the foregoing amendments.  Accordingly, the timing and amounts of cash received by each of the general and limited partners are likewise unchanged.  However, commencing in the fourth quarter of 2006, the foregoing amendments will affect both the way the incentive compensation is reported and the allocation of the Partnership’s income between the general and limited partners for financial reporting purposes.  See Note 14 for a discussion of these changes.

At September 30, 2006, Buckeye Pipe Line Services Company (“Services Company”) employed all of the employees who work for the Operating Subsidiaries.  Under a services agreement entered into in December 2004 (the “Services Agreement”), the Operating Subsidiaries and their subsidiaries directly reimburse Services Company for the cost of the services provided by the employees.  Under the Services Agreement and an Executive Employment Agreement, certain executive compensation costs and related benefits for the General Partner’s four highest salaried officers are not reimbursed by the Partnership or the Operating Subsidiaries, but are reimbursed to Services Company by BGH. Prior to August 9, 2006, these executive compensation costs and related benefits were reimbursed to Services Company by MainLine Sub LLC (See Note 14). At September 30, 2006, Services Company owned an approximate 5.9% limited partner interest in the Partnership.

2. CONTINGENCIES

Claims and Proceedings

The Partnership and the Operating Subsidiaries in the ordinary course of business are involved in various claims and legal proceedings, some of which are covered by insurance.  The General Partner is generally unable to predict the timing or outcome of these claims and proceedings. Based upon its evaluation of existing claims and proceedings and the probability of losses relating to such contingencies, the Partnership has accrued certain amounts relating to such claims and proceedings.

The Partnership has received penalty assessments from the Internal Revenue Service (“IRS”) in the aggregate amount of $4.3 million based on a failure to file excise tax information returns relating to its terminal operations from January 2005 through February 2006.  The Partnership filed the information returns with the IRS on May 10, 2006.  The Partnership believes it had reasonable cause for the failure to file the information returns on a timely basis, and intends to seek the elimination of the asserted penalties.  The asserted penalties are for the failure to file information returns rather than any failure to pay taxes due, as no taxes were owed by the Partnership in

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connection with such information. The timing or outcome of this claim, and the total costs to be incurred by the Partnership in connection therewith, cannot be reasonably estimated at this time.

Environmental Expenditures

In accordance with its accounting policy on environmental expenditures, the Partnership recorded operating expenses, net of insurance recoveries, of $1.5 million and $0.7 million for the three months ended September 30, 2006 and 2005, respectively, and $5.4 million and $6.3 million for the nine months ended September 30, 2006 and 2005, respectively, which were related to environmental expenditures unrelated to claims and proceedings.  Expenditures, both capital and operating, relating to environmental matters are expected to continue due to the Partnership’s commitment to maintaining high environmental standards and to increasingly strict environmental laws and government enforcement policies.

3.  ACQUISITIONS

On January 1, 2006, the Partnership acquired a refined petroleum products terminal located in Niles, Michigan from affiliates of Shell Oil Products, U.S. (“Shell”) for $13.0 million.  On January 31, 2006, the Partnership completed the acquisition of a natural gas liquids pipeline, which extends generally from Wattenberg, Colorado to Bushton, Kansas, from BP Pipelines (North America) Inc. for approximately $87.0 million, which includes a deposit of $7.7 million paid in December 2005.  Buckeye NGL acquired the natural gas liquids pipeline and Buckeye Terminals, LLC, a subsidiary of BPH, acquired the refined petroleum products terminal.  The Partnership also completed certain miscellaneous asset acquisitions during the first nine months of 2006 which approximated $1.0 million.

In connection with each of these acquisitions, the Partnership determined that the transaction represented the acquisition of various assets, and not the acquisition of a business, as that term is defined in Statement of Financial Accounting Standards No. 141 — “Business Combinations”.  Accordingly, Buckeye has allocated, on a preliminary basis, the cost of each acquisition to the various tangible assets acquired, principally property, plant and equipment.  Buckeye is in the process of determining the final allocation.

In December 2005, the Partnership acquired a refined petroleum products terminal and related assets (including certain railroad offloading facilities) located in Taylor, Michigan for $20.0 million.  The Partnership allocated, on a preliminary basis, the cost of the assets to the tangible terminal assets acquired, and is in the process of determining the final allocation.

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4. LONG-TERM DEBT AND CREDIT FACILITY

Long-term debt consists of the following:

 

The fair value of the Partnership’s debt was estimated to be $950 million as of September 30, 2006 and $908 million at December 31, 2005.  The values at September 30, 2006 and December 31, 2005 were based on approximate market value on the respective dates.

The Partnership has a $400 million 5-year revolving credit facility (the “Credit Facility”) with a syndicate of banks led by SunTrust Bank.  The Credit Facility contains a one-time expansion feature to $550 million subject to certain conditions.  Borrowings under the Credit Facility are guaranteed by certain of the Partnership’s subsidiaries.  The Credit Facility matures on August 6, 2009.  The weighted average interest rate on amounts outstanding under the Credit Facility at September 30, 2006 was 5.9%.

Borrowings under the Credit Facility bear interest under one of two rate options, selected by the Partnership, equal to either (i) the greater of (a) the federal funds rate plus one half of one percent and (b) SunTrust Bank’s prime rate or (ii) the London Interbank Offered Rate (“LIBOR”) plus an applicable margin. The applicable margin is determined based upon ratings assigned by Standard & Poor’s and Moody’s Investor Services for the Partnership’s senior unsecured non-credit enhanced long-term debt. The applicable margin will increase during any period in which the Partnership’s Funded Debt Ratio (described below) exceeds 5.25 to 1.0.  At September 30, 2006 and December 31, 2005, the Partnership had $132.0 million and $50.0 million outstanding under the Credit Facility, respectively, and had committed $1.7 million and $1.3 million in support of letters of credit, respectively.

The Credit Facility contains covenants and provisions that:

·                  Restrict the Partnership and certain of its subsidiaries’ ability to incur additional indebtedness based on certain ratios described below;

·                  Prohibit the Partnership and certain of its subsidiaries from creating or incurring certain liens on their property;

·                  Prohibit the Partnership and certain of its subsidiaries from disposing of property material to their operations;

·                  Limit consolidations, mergers and asset transfers by the Partnership and certain of its subsidiaries.

The Credit Facility requires that the Partnership and certain of its subsidiaries maintain a maximum “Funded Debt Ratio” and a minimum “Fixed Charge Coverage Ratio,” both of which are calculated using  “Adjusted EBITDA.” Prior to the restructuring of the General

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Partner and Operating Subsidiary GP on August 9, 2006, the Credit Facility defined Adjusted EBITDA as earnings before interest, taxes, depreciation, depletion, amortization and incentive compensation payments to the General Partner, for the four preceding fiscal quarters. Incentive compensation payments were historically included in this definition because the Partnership accounted for them as an expense. Because the Partnership will no longer account for incentive compensation as an expense, it amended its Credit Facility effective as of the restructuring to define Adjusted EBITDA as earnings before interest, taxes, depreciation, depletion and amortization, for the four preceding fiscal quarters. Accordingly, calculations of the Partnership’s Funded Debt Ratio and Fixed Charge Coverage Ratio that include incentive compensation payments that are accounted for as an expense (i.e., those that became payable prior to August 9, 2006) were made using the prior definition of Adjusted EBITDA, and calculations of such ratios beginning in the fourth quarter of 2006 will be made using the current definition. Please read Note 14 to these condensed consolidated financial statements for a description of the General Partner and Operating Subsidiary GP restructuring.

The Partnership’s Funded Debt Ratio equals the ratio of the long-term debt of the Partnership and certain of its subsidiaries (including the current portion, if any) to Adjusted EBITDA. As of the end of any fiscal quarter, the Funded Debt Ratio may not exceed 4.75 to 1.00, subject to a provision for increases to 5.25 to 1.00 in connection with future acquisitions.  At September 30, 2006 the Partnership’s Funded Debt Ratio was 4.50 to 1.00.

The Partnership’s Fixed Charge Coverage Ratio is defined as the ratio of Adjusted EBITDA for the four preceding fiscal quarters to the sum of payments for interest and principal on debt plus certain capital expenditures required for the ongoing maintenance and operation of the Partnership’s assets.  The Partnership is required to maintain a Fixed Charge Coverage Ratio of greater than 1.25 to 1.00 as of the end of any fiscal quarter.  As of September 30, 2006, the Partnership’s Fixed Charge Coverage Ratio was 2.65 to 1.00.

At September 30, 2006 the Partnership was in compliance with all of the covenants under the Credit Facility.

In December 2004, the Partnership terminated an interest rate swap agreement associated with the 4.625% Notes due June 15, 2013 and received proceeds of $2.0 million.  In accordance with FASB Statement No. 133 — “Accounting for Derivative Instruments and Hedging Activities”, the Partnership has deferred the $2.0 million gain as an adjustment to the fair value of the hedged portion of the Partnership’s debt and is amortizing the gain as a reduction of interest expense over the remaining term of the hedged debt.  Interest expense was reduced by $59 thousand during each of the three months ended September 30, 2006 and 2005 and $176 thousand during each of the nine months ended September 30, 2006 and 2005, related to the amortization of the gain on the interest rate swap.

5.  PREPAID AND OTHER CURRENT ASSETS

Prepaid and other current assets consist of the following:

 

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6.  ACCRUED AND OTHER CURRENT LIABILITIES

Accrued and other current liabilities consist of the following:

 

7. PARTNERS’ CAPITAL AND EARNINGS PER PARTNERSHIP UNIT

Partners’ capital consists of the following:

								Receivable
		General			Limited			from Exercise
		Partner			Partners			of Options			Total
		(In thousands)
Partners’ Capital—1/1/06		$	2,529		$	756,531		$	(483	)	$	758,577
Net income		461			73,980			—			74,441
Distributions		(549		)	(87,607		)	—			(88,156		)
Net proceeds from issuance of Partnership units		—			64,092			—			64,092
Amortization of unit options		—			294			—			294
Decrease in receivable from exercise of unit options		—			—			92			92
Exercise of unit options		—			467			—			467
Partners’ Capital — 9/30/06		$	2,441		$	807,757		$	(391	)	$	809,807

 

During the nine months ended September 30, 2006, Partnership net income equaled comprehensive income.

The following is a reconciliation of basic and diluted net income per Partnership Unit for the three month and nine month periods ended September 30:

		Three Months Ended September 30,
		2006								2005
		Income (Numerator)			Units (Denominator)		Per Unit Amount			Income (Numerator)			Units (Denominator)		Per Unit Amount
		(In thousands, except per unit amounts)
Net income		$	27,297							$	24,734
Basic earnings per Partnership Unit		27,297			39,676		$	0.69		24,734			38,158		$	0.65
Effect of dilutive securities—options		—			24		—			—			44		—
Diluted earnings per Partnership Unit		$	27,297		39,700		$	0.69		$	24,734		38,202		$	0.65

 

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		Nine Months Ended September 30,
		2006								2005
		Income (Numerator)			Units (Denominator)		Per Unit Amount			Income (Numerator)			Units (Denominator)		Per Unit Amount
		(In thousands, except per unit amounts)
Net income		$	74,441							$	72,322
Basic earnings per Partnership Unit		74,441			39,315		$	1.89		72,322			36,749		$	1.97
Effect of dilutive securities — options		—			25		—			—			45		—
Diluted earnings per Partnership Unit		$	74,441		39,340		$	1.89		$	72,322		36,794		$	1.97

 

8. CASH DISTRIBUTIONS

The Partnership generally makes quarterly cash distributions of substan­tially all of its available cash, generally defined as consolidated cash receipts less consolidated cash expenditures and such retentions for working capital, anticipated cash expenditures and contingencies as the General Part­ner deems appropriate.

On October 26, 2006, the Partnership declared a cash distribution of $0.775 per unit payable on November 30, 2006 to Unitholders of record on November 6, 2006. The total cash distribution to Unitholders will amount to approximately $36,841,000.  As a result of the cash distribution, the Partnership will also pay to the General Partner an incentive compensation payment of approximately $6,588,000.

9. RELATED PARTY TRANSACTIONS

Accrued and other current liabilities include $98,000 and $3,821,000 due to the General Partner and affiliates for direct and indirect costs related to the business activities of the Partnership and Operating Subsidiaries at September 30, 2006 and December 31, 2005.  Accrued and other current liabilities included a payable to Services Company of $2,744,000 and $450,000 at September 30, 2006 and December 31, 2005, respectively.

Other Related Party Transactions

The General Partner is partially owned by Carlyle/Riverstone.  Three members of the eight-member board of directors of the General Partner are nominees of Carlyle/Riverstone.  On January 25, 2005, affiliates of Carlyle/Riverstone acquired general and limited partner interests in SemGroup, L.P. (“SemGroup”).  Carlyle/Riverstone’s total combined interest in SemGroup is approximately 30%.  One of the members of the seven-member board of directors of SemGroup’s general partner is a nominee of Carlyle/Riverstone, with three votes on that board.

The Partnership provides terminal and pipeline transportation services to an affiliate of SemGroup.  The Partnership received approximately $460,000 in revenue from the affiliate of SemGroup in the third quarter of 2006.

During the second quarter of 2006, an affiliate of Carlyle/Riverstone announced that it, along with a group of other investors, made an offer to acquire Kinder Morgan, Inc.  Among other assets, Kinder Morgan, Inc. owns the general partner interest of Kinder Morgan Energy Partners, L.P. (“Kinder Morgan”), a publicly traded partnership engaged in the transportation and distribution of petroleum products and natural gas that is a Partnership

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customer and competes with the Partnership to a limited extent in the Midwestern United States.  If this acquisition is completed, all transactions between the Partnership and Kinder Morgan, Inc. and its affiliates will become related party transactions.

Carlyle/Riverstone also has an ownership interest in the general partner of Magellan Midstream Partners, L.P. (“Magellan”).  The Partnership does not have a significant relationship with Magellan and does not have extensive operations in the geographic areas primarily served by Magellan.

The Partnership does compete directly with Kinder Morgan and Magellan for acquisition opportunities throughout the United States and potentially will compete with these entities for new business or extensions of the existing services provided by our Operating Subsidiaries.

The board of directors of the General Partner has adopted a policy to address board of director conflicts of interests.  In compliance with this policy, Carlyle/Riverstone has adopted procedures internally to ensure that the Partnership’s confidential information is protected from disclosure to competing companies in which Carlyle/Riverstone owns an interest.  As part of these procedures, none of the nominees of Carlyle/Riverstone who serve on the board of directors of the General Partner will also serve on the board of directors of the general partners of Magellan or SemGroup or on the boards of directors of competing companies in which Carlyle/Riverstone owns an interest.

10. UNIT OPTION AND DISTRIBUTION EQUIVALENT PLAN

The Partnership sponsors a Unit Option and Distribution Equivalent Plan (the “Option Plan”), pursuant to which it grants options to purchase limited partner units (“LP units”) at 100% of the market price of the LP units on the date of grant. The options vest three years from the date of grant and expire ten years from date of grant. As unit options are exercised, the Partnership issues new LP units. The Partnership has not historically repurchased, and does not expect to repurchase, any of its LP units in 2006.

Effective January 1, 2006, the Partnership adopted the fair value measurement and recognition provisions of Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment” (“SFAS No. 123R”), using the modified prospective basis transition method. Under this method, unit-based compensation expense recognized in the first nine months of fiscal year 2006 includes: (a) compensation expense for all grants made prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, and (b) compensation expense for all grants made on or after January 1, 2006, based on the grant date fair value estimated using the Black-Scholes option pricing model.  The Partnership will recognize compensation expense for awards granted on or after January 1, 2006 on a straight-line basis over the requisite service period.

For the retirement eligibility provisions of the Option Plan, the Partnership follows the non-substantive vesting method and recognizes compensation expense immediately for options granted to retirement-eligible employees, or over the period from the grant date to the date retirement eligibility is achieved. Unit-based compensation expense recognized in the Condensed Consolidated Statements of Income for the first nine months of 2006 is based upon options ultimately expected to vest. In accordance with SFAS No. 123R, forfeitures have been estimated at the time of grant and will be revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Forfeitures were estimated based upon historical experience.

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As a result of adopting SFAS No. 123R on January 1, 2006, the Partnership’s net income for the three month and nine month periods ended September 30, 2006 was $0.1 million and $0.3 million, respectively, lower than it would have been if the Partnership had continued to account for unit-based compensation under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB No. 25”).  Basic and diluted earnings per unit would not have changed for the three months ended September 30, 2006. The reported basic and diluted earnings per unit for the three months ended September 30, 2006 were $0.69 each. Basic and diluted earnings per unit would have been $0.01 greater for the nine months ended September 30, 2006. The reported basic and diluted earnings per unit for the nine months ended September 30, 2006 were $1.89 each.  The following table summarizes the total unit-based compensation expense included in the Partnership’s Condensed Consolidated Statements of Income:

		Three Months Ended			Nine Months Ended
		September 30, 2006			September 30, 2006
		(in thousands)
Unit-based operating expenses		$	42		$	226
Unit-based general and administrative expenses		13			68
Total unit-based compensation		$	55		$	294

 

Prior to January 1, 2006, the Partnership accounted for the Option Plan under the recognition and measurement provisions of APB No. 25, and related Interpretations, as permitted by Financial Accounting Standards Board Statement No. 123, “Accounting for Stock-Based Compensation” (“SFAS No. 123”), as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure” (“SFAS No. 148”).  No unit-based employee compensation cost was recognized in the Condensed Consolidated Statements of Income for the three-month and nine-month periods ended September 30, 2005, as all unit options granted under the Option Plan had an exercise price equal to the market value of the underlying units on the date of grant.

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The following table illustrates the effect on net income for the three and nine months ended September 30, 2005 as if the Partnership had applied the fair value recognition provisions of SFAS No. 123 to options granted under the Option Plan.  For purposes of this pro forma disclosure, the value of the options is estimated using the Black-Scholes option pricing model and amortized to expense over the units’ vesting periods:

				Three Months Ended September 30, 2005			Nine Months Ended September 30, 2005
				(in thousands, except per unit amounts)
Net income as reported				$	24,734		$	72,322
Stock-based employeecompensation cost includedin net income				—			—
Stock-based employeecompensation cost thatwould have been includedin net income under thefair value method				(61		)	(180		)
Pro forma net income as if the fair value method had been applied to all awards				$	24,673		$	72,142
Basic earnings per unit		As reported		$	0.65		$	1.97
		Pro forma		$	0.65		$	1.96
Diluted earnings per unit		As reported		$	0.65		$	1.97
		Pro forma		$	0.65		$	1.96

 

The fair value of unit options granted to employees was estimated using the Black-Scholes option pricing model with the following weighted-average assumptions for the three and nine months ended September 30, 2006 and 2005, respectively: 

 

The expected volatility is based on historic volatility of the Partnership’s market-traded LP units. Effective January 1, 2006, the Partnership has elected to use the simplified method for the expected life which is the option vesting period of three years plus the option term of ten years divided by two. The risk-free interest rate is calculated using the U.S. Treasury yield curves in effect at the time of grant, for the periods within the expected life of the options.

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The following table summarizes employee unit option activity for the nine month period ended September 30, 2006:

		Number of Options		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value
Outstanding, January 1, 2006		246,900		$	39.44
Granted		82,900		44.72
Exercised		(13,400	)	34.86
Forfeited, cancelled or expired		—		—
Outstanding, September 30, 2006		316,400		$	41.02		7.3		$	816,700
Exercisable, September 30, 2006		114,700		$	34.34		5.2		$	965,400

 

The aggregate intrinsic value in the preceding table represents the total intrinsic value that would have been received by the option holders had all option holders exercised their options on September 30, 2006. Intrinsic value is determined by calculating the difference between the Partnerships’s closing LP unit price on the last trading day of the third quarter of 2006 and the exercise price, multiplied by the number of units. The total intrinsic value of options exercised during the nine month period ended September 30, 2006 was $122,000. The total number of in-the-money options exercisable as of September 30, 2006 was 114,700. As of September 30, 2006, total unrecognized compensation cost related to unvested options was $324,600.  The cost is expected to be recognized over a weighted average period of 1.0 years.  At September 30, 2006, 575,000 LP units were available for grant in connection with the Option Plan.

11. PENSIONS AND OTHER POSTRETIREMENT BENEFITS

Services Company sponsors a retirement income guaranty plan (the “Defined Benefit Plan”), which is a defined benefit plan and generally guarantees employees hired before January 1, 1986 a retirement benefit at least equal to the benefit they would have received under a previously terminated defined benefit plan.  Services Company’s policy is to fund the Defined Benefit Plan with amounts necessary to at least meet the minimum funding requirements under ERISA.

Services Company also provides postretirement health care and life insurance benefits to certain of its retirees (“Postretirement Benefit”).  To be eligible for these benefits, an employee must have been hired prior to January 1, 1991 with respect to health care benefits and January 1, 2002 with respect to life insurance benefits, and the employee must satisfy certain age and service requirements.  Services Company does not pre-fund this postretirement benefit obligation.

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In the three months ended September 30, 2006 and 2005, the components of the net periodic benefit cost recognized by the Partnership for the Defined Benefit Plan and postretirement health care and life insurance plan were as follows:

 

In the nine months ended September 30, 2006 and 2005, the components of the net periodic benefit cost recognized by the Partnership for the Defined Benefit Plan and postretirement health care and life insurance plan were as follows:

 

The Partnership previously disclosed in its financial statements for the year ended December 31, 2005 that a minimum funding contribution was not required to be made during 2006.  However, the Partnership made a voluntary contribution of approximately $575,000 in September of 2006.

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12.  SEGMENT INFORMATION

Prior to 2005, the Partnership determined that it had one reportable operating segment, the transportation segment, based on its management and financial reporting structure.  Beginning in the fourth quarter of 2004 and continuing throughout 2005, the Partnership substantially expanded its business, including a significant increase in its terminalling operations.   In the fourth quarter of 2005, the Partnership determined that its operations are appropriately presented in three reportable operating segments: Pipeline Operations, Terminalling and Storage and Other Operations.

Pipeline Operations:

The Pipeline Operations segment receives petroleum products including gasoline, jet and diesel fuel and other distillates from refineries, connecting pipelines, bulk and marine terminals and transports these products to other locations for a tariff charge.  This segment owns and operates approximately 5,350 miles of pipelines in the following states: California, Colorado, Connecticut, Florida, Illinois, Indiana, Kansas, Massachusetts, Michigan, Missouri, New Jersey, Nevada, New York, Ohio, Pennsylvania and Tennessee.  This segment also includes the operations of Buckeye NGL.

Terminalling and Storage:

The Terminalling and Storage segment provides bulk storage and terminal throughput services.  This segment owns and operates 45 terminals that have the capacity to store an aggregate of approximately 17.6 million barrels of refined petroleum products.  The terminals are located in Illinois, Indiana, Massachusetts, Michigan, Missouri, New York, Ohio and Pennsylvania.

Other Operations:

The Other Operations segment consists primarily of the Partnership’s contract operation and maintenance of third-party pipelines, which are owned primarily by major petrochemical companies and are located in Texas.  This segment also performs pipeline construction management services, typically for cost plus a fixed fee, for these same customers.  The Other Operations segment also includes the Partnership’s ownership and operation of interests in two petrochemical pipelines.

Financial information about each segment is presented below. Each segment uses the same accounting policies as those used in the preparation of the Partnership’s condensed consolidated financial statements. All inter-segment revenues, operating income and assets have been eliminated.  All periods are presented on a consistent basis.

 

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		Nine Months Ended September 30,
		2006			2005
		(in thousands)
Capital expenditures:
Pipeline Operations		$	48,425		$	48,104
Terminalling and Storage		11,038			3,449
Other Operations		2,755			353
Total		$	62,218		$	51,906

 

Acquisitions:
Pipeline Operations		$	79,826		$	153,633
Terminalling and Storage		13,504			25,221
Other Operations		—			—
Total		$	93,330		$	178,854

 

		September 30,			December 31,
		2006			2005
		(In thousands)
*Assets:
Pipeline Operations		$	1,580,669		$	1,466,512
Terminalling and Storage		310,130			288,972
Other Operations		67,915			61,383
Total		$	1,958,714		$	1,816,867

*                    All equity investments are included in the assets of Pipeline Operations.

13.  RECENT ACCOUNTING PRONOUNCEMENTS

In July 2006, the Financial Accounting Standards Board (“FASB”) adopted FASB Interpretation No. 48 “Accounting for Uncertainty in Income Taxes” (“FIN 48”). FIN 48 sets forth a recognition threshold and measurement attribute for financial statement recognition of positions taken or expected to be taken in income tax returns. Only tax positions meeting a “more-likely-than-not” threshold of being sustained should be recognized under FIN 48. FIN 48 also provides guidance on derecognizing, classification of interest and penalties and accounting and disclosures for annual and interim financial statements. FIN 48 is effective for fiscal years beginning after December 15,

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2006. The cumulative effect of the changes arising from the initial application of FIN 48 is required to be reported as an adjustment to the opening balance of retained earnings in the period of adoption. The Partnership does not expect the adoption of FIN 48 to have a material impact on its financial statements.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS No. 157”).  This statement clarifies the definition of fair value, establishes a framework for measuring fair value, and expands the disclosures on fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007.  The Partnership is still determining the impact, if any, of the adoption of SFAS No. 157 on its financial statements.

In September 2006, the FASB adopted Statement of Financial Accounting Standards No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements No. 87, 106, and 132(R)” (“SFAS No. 158”).  SFAS No. 158 requires companies to recognize a net liability or asset and an offsetting adjustment to accumulated other comprehensive income in connection with reporting on the funded status of defined benefit pension and other postretirement benefit plans. SFAS No. 158 requires prospective application, and the recognition and disclosure requirements are effective for the Partnership’s fiscal year ending December 31, 2006. Additionally, SFAS No. 158 requires companies to measure plan assets and obligations at their year-end balance sheet date.  This requirement is effective for fiscal years ending after December 15, 2008.  It is estimated that upon adoption of SFAS No. 158, the Partnership will record an initial increase in liabilities, and an offsetting reduction to accumulated other comprehensive income and equity, in the range of $15.0 to $17.0 million in the fourth quarter of 2006 to record the funded status of its defined benefit pension and post retirement healthcare and life insurance benefit plans (see Note 11).

In September 2006, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements” (“SAB No. 108”). SAB No. 108 provides guidance on how prior year misstatements should be taken into consideration when quantifying misstatements in current year financial statements for purposes of determining whether the current year’s financial statements are materially misstated. SAB No. 108 becomes effective for fiscal years ending after November 15, 2006. The Partnership does not expect the adoption of SAB No. 108 to have an impact on its financial statements.

14.  OTHER EVENTS

BGH IPO and General Partner Restructuring

On August 9, 2006, BGH consummated its initial public offering (“IPO”) of its common units. Following the IPO, approximately 54% of the limited partnership units are owned by Carlyle/Riverstone, approximately 9% of the limited partnership units are owned by certain members of senior management and the public owns approximately 37% of the limited partnership units of BGH. In connection with the closing of the offering, BGH and the General Partner restructured the ownership of the General Partner.  This restructuring will not have any impact on the amounts or timing of cash distributions paid to the general or limited partners of the Partnership.

MainLine Sub LLC (“MainLine Sub”), which was then a wholly-owned subsidiary of BGH and the owner of the General Partner, assigned all of its rights under the Fourth Amended and Restated Incentive Compensation Agreement, dated as of December 15, 2004, between MainLine Sub and the Partnership to the General Partner.  Thereafter, the Partnership and the General Partner amended and

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restated that agreement by entering into the Fifth Amended and Restated Incentive Compensation Agreement, dated as of August 9, 2006 (the “Incentive Compensation Agreement”).  On August 9, 2006, the Partnership and the General Partner also entered into the Amended and Restated Agreement of Limited Partnership of Buckeye Partners, L.P. (the “Partnership Agreement”).  The amendments to the Incentive Compensation Agreement and the Partnership Agreement reflect the assignment of the Incentive Compensation Agreement to the General Partner and the recharacterization that payments to the General Partner under the Incentive Compensation Agreement and the Partnership Agreement are distribution payments with respect to the general partner interest rather than compensation payments.  On August 18, 2006, MainLine Sub was merged with and into BGH.

Because the quarterly unit distribution was declared prior to August 9, 2006 and, therefore, the related incentive compensation attributable to the General Partner became payable prior to such date, incentive compensation paid in the third quarter of 2006 was recorded as an expense by the Partnership in the accompanying condensed consolidated financial statements, consistent with the Partnership’s prior practice.  Commencing with the fourth quarter of 2006, the Partnership will cease recording incentive compensation payable to the General Partner as an expense and instead will record such payments as distributions from equity.

The amendments to the Incentive Compensation Agreement and the Partnership Agreement were effective on August 9, 2006.  These amendments will result in certain prospective changes in the financial statements of the Partnership beginning in the fourth quarter of 2006.  Commencing in the fourth quarter of 2006, the incentive compensation will no longer be recorded as an expense, but instead as an equity distribution to the General Partner, and the Partnership will change the attribution of income between the General Partner and the limited partners.   Generally, the Partnership will attribute income to the General Partner and the Limited Partners as if the net income of the Partnership were entirely distributed to its Unitholders.  The Partnership will determine the amount of income allocable to the General Partner, which represents the sum of the incentive compensation that would have been payable to the General Partner if the total distribution equaled net income, plus the General Partner’s proportional share of the remaining income of the Partnership. The recording of incentive payments as equity distributions rather than an expense will likely result in a relative increase in reported net income for the Partnership, however.

As discussed above, none of these changes will affect the amounts or timing of cash distributions to the general or limited partners.  The Partnership’s criteria for determining the amount of cash distributions and its policies regarding the timing of declaring and paying such cash distributions remain unchanged.

Immediately prior to the closing of the BGH IPO, in connection with the restructuring of the ownership of the General Partner, the General Partner transferred its 1% general partner interest in each of Buckeye, Laurel and Everglades and its approximate 0.6% interest in BPH to the Operating Subsidiary GP, which is owned by the General Partner.  In connection with the transfer, the Agreement of Limited Partnership of each Operating Partnership, as well as the Management Agreement between each Operating Partnership and its general partner, now the Operating Subsidiary GP in each case, were amended and restated to reflect the Operating Subsidiary GP as the new general partner.

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