EXHIBIT 99.2
FRONTSTREET HUGOTON LLC AND SUBSIDIARY
TABLE OF CONTENTS
| INDEPENDENT AUDITORS’ REPORT |
| Consolidated Balance Sheets as of December 31, 2006 and 2005 |
| Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004 |
| Consolidated Statements of Members’ Equity for the years ended December 31, 2006, 2005 and 2004 |
| Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004 |
| Notes to Consolidated Financial Statements |
Independent Auditors’ Report
The Members
FrontStreet Hugoton LLC:
We have audited the accompanying consolidated balance sheets of FrontStreet Hugoton LLC and subsidiaries as of December 31, 2006 and 2005 and the related consolidated statements of operations, members’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of FrontStreet Hugoton LLC and subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Dallas, Texas
March 17, 2008
| FRONTSTREET HUGOTON LLC AND SUBSIDIARY | ||||||||
| CONSOLIDATED BALANCE SHEETS | ||||||||
| AS OF DECEMBER 31, 2006 AND 2005 | ||||||||
| (In thousands) | ||||||||
| 2006 | 2005 | |||||||
| ASSETS | ||||||||
| CURRENT ASSETS: | ||||||||
| Cash and cash equivalents | $ | 1,906 | $ | 2,916 | ||||
| Accounts receivable | 7,426 | 3,953 | ||||||
| Other current assets | 134 | 138 | ||||||
| Total current assets | 9,466 | 7,007 | ||||||
| PIPELINE AND GATHERING FACILITIES: | ||||||||
| Pipeline and gathering facilities placed in service | 100,283 | 96,803 | ||||||
| Construction in progress | 7,905 | 1,313 | ||||||
| Total pipeline and gathering facilities | 108,188 | 98,116 | ||||||
| Less accumulated depreciation | (30,775 | ) | (24,122 | ) | ||||
| Total | 77,413 | 73,994 | ||||||
| TOTAL ASSETS | $ | 86,879 | $ | 81,001 | ||||
| LIABILITIES AND MEMBERS’ EQUITY | ||||||||
| CURRENT LIABILITIES: | ||||||||
| Accounts payable | $ | 9,078 | $ | 4,315 | ||||
| Accrued liabilities | 601 | 757 | ||||||
| Total current liabilities | 9,679 | 5,072 | ||||||
| MEMBERS’ EQUITY | 77,200 | 75,929 | ||||||
| TOTAL LIABILITIES AND MEMBERS' EQUITY | $ | 86,879 | $ | 81,001 | ||||
| See notes to consolidated financial statements. | ||||||||
| FRONTSTREET HUGOTON LLC AND SUBSIDIARY | ||||||||||||
| CONSOLIDATED STATEMENTS OF OPERATIONS | ||||||||||||
| FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 | ||||||||||||
| (In thousands) | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| OPERATING REVENUES—Pipeline and gathering revenues | $ | 40,463 | $ | 39,020 | $ | 36,955 | ||||||
| OPERATING EXPENSES: | ||||||||||||
| Operating and maintenance | 25,691 | 23,533 | 19,589 | |||||||||
| Depreciation | 6,671 | 7,027 | 7,094 | |||||||||
| Related party management fees | 281 | 320 | 323 | |||||||||
| Professional services: | ||||||||||||
| Audit fees | 55 | 42 | 46 | |||||||||
| Other services | 23 | 22 | 21 | |||||||||
| Total operating expenses | 32,721 | 30,944 | 27,073 | |||||||||
| OPERATING INCOME | 7,742 | 8,076 | 9,882 | |||||||||
| OTHER INCOME | 229 | 43 | 54 | |||||||||
| NET INCOME | $ | 7,971 | $ | 8,119 | $ | 9,936 | ||||||
| See notes to consolidated financial statements. | ||||||||||||
| FRONTSTEET HUGOTON LLC AND SUBSIDIARY | ||||||||||||
| CONSOLIDATED STATEMENTS OF MEMBERS’ EQUITY | ||||||||||||
| FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 | ||||||||||||
| (In thousands) | ||||||||||||
| FrontStreet | ASC | Total | ||||||||||
| EnergyOne, | Hugoton, | Members’ | ||||||||||
| LLC | LLC | Equity | ||||||||||
| BALANCE—December 31, 2003 | $ | 4,153 | $ | 78,907 | $ | 83,060 | ||||||
| Member contributions | 173 | 3,284 | 3,457 | |||||||||
| Net income | 497 | 9,439 | 9,936 | |||||||||
| Member distributions | (739 | ) | (14,036 | ) | (14,775 | ) | ||||||
| BALANCE—December 31, 2004 | 4,084 | 77,594 | 81,678 | |||||||||
| Member contributions | 185 | 3,521 | 3,706 | |||||||||
| Net income | 406 | 7,713 | 8,119 | |||||||||
| Member distributions | (878 | ) | (16,696 | ) | (17,574 | ) | ||||||
| BALANCE—December 31, 2005 | 3,797 | 72,132 | 75,929 | |||||||||
| Member contributions | 156 | 2,970 | 3,126 | |||||||||
| Net income | 399 | 7,572 | 7,971 | |||||||||
| Member distributions | (491 | ) | (9,335 | ) | (9,826 | ) | ||||||
| BALANCE—December 31, 2006 | $ | 3,861 | $ | 73,339 | $ | 77,200 | ||||||
| See notes to consolidated financial statements. | ||||||||||||
| FRONTSTREET HUGOTON LLC AND SUBSIDIARY | ||||||||||||
| CONSOLIDATED STATEMENTS OF CASH FLOWS | ||||||||||||
| FOR THE YEARS ENDED DECEMBER 31, 2006, 2005 AND 2004 | ||||||||||||
| (In thousands) | ||||||||||||
| 2006 | 2005 | 2004 | ||||||||||
| CASH FLOWS FROM OPERATING ACTIVITIES: | ||||||||||||
| Net income | $ | 7,971 | $ | 8,119 | $ | 9,936 | ||||||
| Adjustments to reconcile net income to net cash provided by | ||||||||||||
| operating activities: | ||||||||||||
| Depreciation | 6,671 | 7,027 | 7,094 | |||||||||
| Other | 21 | 21 | 59 | |||||||||
| Changes in operating assets and liabilities: | ||||||||||||
| Accounts receivable | (3,473 | ) | 2,427 | (3,295 | ) | |||||||
| Other current assets | 4 | 10 | ||||||||||
| Accounts payable | (2,315 | ) | 1,439 | 423 | ||||||||
| Accrued liabilities | (53 | ) | 57 | (47 | ) | |||||||
| Net cash provided by operating activities | 8,826 | 19,100 | 14,170 | |||||||||
| CASH FLOWS FROM INVESTING ACTIVITIES—Capital expenditures | (3,136 | ) | (3,713 | ) | (3,415 | ) | ||||||
| CASH FLOWS FROM FINANCING ACTIVITIES: | ||||||||||||
| Capital contributions | 3,126 | 3,706 | 3,457 | |||||||||
| Distributions to members | (9,826 | ) | (17,574 | ) | (14,775 | ) | ||||||
| Net cash used in financing activities | (6,700 | ) | (13,868 | ) | (11,318 | ) | ||||||
| NET (DECREASE) INCREASE IN CASH AND | ||||||||||||
| CASH EQUIVALENTS | (1,010 | ) | 1,519 | (563 | ) | |||||||
| CASH AND CASH EQUIVALENTS—at beginning of period | 2,916 | 1,397 | 1,960 | |||||||||
| CASH AND CASH EQUIVALENTS—at end of period | $ | 1,906 | $ | 2,916 | $ | 1,397 | ||||||
| SUPPLEMENTAL CASH FLOW INFORMATION—Noncash capital | ||||||||||||
| expenditures in accounts payable and accrued liabilities | $ | 7,295 | $ | 320 | $ | 200 | ||||||
| See notes to consolidated financial statements. | ||||||||||||
FRONTSTREET HUGOTON LLC AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. ORGANIZATION AND BASIS OF PRESENTATION
FrontStreet Hugoton LLC was formed in the State of Delaware and commenced operations on July 26, 2002, for the purpose of owning the equity interests of WGP-KHC, LLC (FrontStreet Hugoton LLC’s wholly owned subsidiary), whose purpose is owning the gas gathering pipeline in the southwest Kansas area. As of December 31, 2006 and 2005, the participating interests of FrontStreet Hugoton LLC and subsidiary (the “Company”) members were 95 percent by ASC Hugoton, LLC (“ASC”) and 5 percent by FrontStreet EnergyOne, LLC (“FSEO”).
Under terms of FrontStreet Hugoton LLC’s limited liability company operating agreement, additional capital contributions, gains and losses of the Company and cash distributions are allocated to the members based upon each member’s respective ownership interest.
The Company acquired 100 percent of the voting and ownership interests of WGP-KHC, LLC on July 26, 2002, for $79.9 million. The purpose of this transaction was to acquire ownership of a natural gas gathering system in Kansas (the “Gathering System”) and to hold the asset until the exhaustion of the underlying producing basin, which is the Hugoton gas field. The Company recorded no goodwill in conjunction with the acquisition.
| 2. | SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES |
Basis of Consolidation—The consolidated financial statements include the accounts of the Company. All material intercompany transactions and balances have been eliminated in consolidation.
Estimates—The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets, 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 reporting period. Actual results could differ from these estimates.
Cash and Cash Equivalents—All liquid investments with an original maturity of three months or less are considered cash equivalents.
Pipeline and Gathering Facilities—Amounts incurred in connection with the purchase of pipeline and gathering facilities are stated at cost and depreciated using the units-of-production method based upon the actual production transported through the system and the related estimated natural gas reserves of the Hugoton gas field. Construction in progress represents the ongoing development of the gathering system. Upon completion of construction, related costs are transferred to pipeline and gathering facilities placed in service and depreciated.
The Company assesses its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is assessed by comparing the carrying amount of an asset to future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured by the amount by which the carrying amounts of such assets exceed the fair value of the assets.
Income Taxes—The Company is not subject to income tax, but rather the taxable income or loss of the Company is reported on the respective income tax returns of its members.
Pipeline and Gathering Revenues—Pipeline and gathering revenues are recognized as gas volumes are transported through the pipeline and gathering facilities.
| 3. | BUSINESS AND CREDIT CONCENTRATIONS |
One customer accounted for approximately $39.8 million, $37.5 million and $35.7 million of the Company’s revenues for the years ended December 31, 2006, 2005 and 2004, respectively. The receivable balance related to this customer totaled $7.3 million and $3.8 million as of December 31, 2006 and 2005, respectively. This customer accounted for approximately $23.7 million of the Company’s operating expenses in 2006 and $10.1 million of the Company’s capital expenditures in 2006. This customer accounted for approximately $21.6 million of the Company’s operating expenses in 2005 and $3.8 million of the Company’s capital expenditures in 2005. This customer accounted for approximately $17.8 million of the Company’s operating expenses in 2004 and $2.7 million of the Company’s capital expenditures in 2004. The payable balance related to this customer totaled $8.4 million and $4.1 million as of December 31, 2006 and 2005, respectively.
| 4. | RELATED PARTY TRANSACTIONS |
The Company was charged approximately $281,000, $320,000 and $323,000 in management fees for the years ended December 31, 2006, 2005 and 2004, by FrontStreet Partners, LLC. Additionally, for the respective periods, the Company was charged approximately $270,000, $251,000 and $225,000 for management and administrative services, accounting and financial services, and operating services, which are included in operating and maintenance expenses in the consolidated statements of operations.
| 5. | COMMITMENTS AND CONTINGENCIES |
There are various claims and contingencies involving the Company, none of which, in the opinion of Management, will have a materially adverse effect on the Company.
| 6. | GATHERING AGREEMENT WITH BP |
In connection with the acquisition of WGP-KHC, LLC, the Company acquired rights and responsibilities under the Gathering Agreement with BP America Production Company (“BP”). Under the Gathering Agreement, BP dedicates for gathering by the Gathering System all of the commercially producible gas in a defined list of producing fields. The Gathering Agreement provides for the Company to charge a per unit gathering fee (the “Gathering Fee”) calculated on estimated cost of service over the total estimated units to be transported in a calendar year. The Gathering Fee is predetermined for a calendar year by November 7 of the preceding calendar year and then subject to redetermination on June 7. As part of the redetermination process on June 7, the Gathering Fee is trued-up, inclusive of interest, based on actual costs incurred including abandonment costs and actual units transported. For the years ended December 31, 2006, 2005 and 2004, the Company recorded $35.4 million, $38.8 million and $31.8 million, respectively, of revenue under the Gathering Agreement.
The term of the Gathering Agreement is for as long as gas is capable of being produced in commercial quantities, subject to certain exceptions in the event of an ownership change of the gas field, or the removal of BP as operator of the Gathering System.
| 7. | CONSTRUCTION AND OPERATING AGREEMENT |
In connection with the acquisition of WGP-KHC, LLC, the Company obtained the rights and responsibilities under a Construction and Operating Agreement (the “C&O Agreement”) with BP. Under the terms of the C&O Agreement, BP is responsible for operating, maintaining and repairing the Gathering System. Subject to prior approval, the Company is responsible for paying for capital additions and expenses incurred by BP as the operator of the Gathering System. For the years ended December 31, 2006, 2005 and 2004, the Company expensed $23.5 million, $21.4 million and $17.5 million respectively for operating and maintenance expenses under the C&O Agreement.
The C&O Agreement requires BP to comply with all applicable environmental standards. While the Company would be responsible for any environmental contamination as a result of the operation of the Gathering System, remedies are provided to the Company under the C&O Agreement allowing the Company to recover costs incurred to reclaim a contaminated site. Additionally, the C&O Agreement states the Company is specifically responsible for the removal, remediation and abatement of Polychlorinated Biphenyls (“Remediation Work”). However, under the terms of the C&O Agreement, the Company can include up to $2.2 million of expenditures for Remediation Work related to conditions in existence prior to October 1994. BP, exercising its right to review any additional expenditure for Remediation Work above and beyond the $2.2 million, has agreed to pay for remediation work in excess of $2.2 million as of December 31, 2006. Cumulatively, as of December 31, 2006, 2005 and 2004, $2.8 million, $2.1 million and $1.8 million had been spent to date on Remediation Work. The Company also obtained an indemnification against any environmental losses for preexisting conditions prior to the acquisition date from the previous owner. Approximately $750,000 has been escrowed in the event BP does not agree to include in the cost of service expenditures for Remediation Work. As of December 31, 2006, the Company has not recorded any obligation for Remediation Work.
The C&O Agreement shall remain in effect until such time as the Gathering Agreement terminates or BP is removed as operator in accordance with terms of the C&O Agreement.
| 8. | ANNUAL SETTLEMENT PAYMENT AGREEMENT |
The Company and BP are party to an Annual Settlement Payment Agreement (“ASPA”). The purpose of the ASPA is to provide the Company with a fixed return on its investment in the Gathering System. The ASPA also provides the mechanism for recovery of the costs of current period Remediation Work. The amount due under the ASPA is calculated monthly, inclusive of interest. Payments under the ASPA for a calendar year are due on the following March 15. As of December 31, 2006 and 2005, the Company was due $4.4 million from BP and owed $0.9 million to BP, respectively.
In addition to the settlement described above, the ASPA provides for a supplemental tailgate processing fee to be earned by the Company (the “Tailgate Fee”) through October 3, 2004. The Tailgate Fee is calculated based on certain BP gas transported through the Gathering System. For the year ended December 31, 2004, the Company recorded $1.2 million in Tailgate Fees.
The term of the ASPA is the same as the Gathering Agreement (see Note 6 above).
| 9. | SUBSEQUENT EVENT |
On January 7, 2008, ASC and FSEO sold all of their members’ equity to an affiliate of ASC for approximately $147 million.