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



 

FORM 10-Q



 

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

For the Quarterly Period Ended June 30, 2012

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: 001-32384



 

MACQUARIE INFRASTRUCTURE COMPANY LLC

(Exact Name of Registrant as Specified in Its Charter)

 
Delaware   43-2052503
(State or Other Jurisdiction of
Incorporation or Organization)
  (IRS Employer
Identification No.)

125 West 55th Street
New York, New York 10019

(Address of Principal Executive Offices) (Zip Code)

(212) 231-1000

(Registrant’s Telephone Number, Including Area Code)



 

(Former Name, Former Address and Former Fiscal Year if Changed Since Last Report): N/A



 

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 has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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):

     
Large Accelerated Filer x    Accelerated Filer o   Non-accelerated Filer o   Smaller Reporting Company o

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

There were 46,645,028 limited liability company interests without par value outstanding at July 31, 2012.

 

 


 
 

TABLE OF CONTENTS

MACQUARIE INFRASTRUCTURE COMPANY LLC
  
TABLE OF CONTENTS

 
  Page
PART I. FINANCIAL INFORMATION
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations     1  
Quantitative and Qualitative Disclosure About Market Risk     34  
Controls and Procedures     34  
Consolidated Condensed Balance Sheets as of June 30, 2012 (Unaudited) and December 31, 2011     35  
Consolidated Condensed Statements of Operations for the Quarters and Six Months Ended June 30, 2012 and 2011 (Unaudited)     36  
Consolidated Condensed Statements of Comprehensive Income for the Quarters and Six Months Ended June 30, 2012 and 2011 (Unaudited)     37  
Consolidated Condensed Statements of Cash Flows for the Six Months Ended June 30, 2012 and 2011 (Unaudited)     38  
Notes to Consolidated Condensed Financial Statements (Unaudited)     39  
PART II. OTHER INFORMATION
 

Item 1.

Legal Proceedings

    57  

Item 1A.

Risk Factors

    57  

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

    58  

Item 3.

Defaults Upon Senior Securities

    58  

Item 4.

Mine Safety Disclosures

    58  

Item 5.

Other Information

    58  

Item 6.

Exhibits

    58  

Macquarie Infrastructure Company LLC is not an authorized deposit-taking institution for the purposes of the Banking Act 1959 (Commonwealth of Australia) and its obligations do not represent deposits or other liabilities of Macquarie Bank Limited ABN 46 008 583 542 (MBL). MBL does not guarantee or otherwise provide assurance in respect of the obligations of Macquarie Infrastructure Company LLC.

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PART I
  
FINANCIAL INFORMATION

Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion of the financial condition and results of operations of Macquarie Infrastructure Company LLC should be read in conjunction with the consolidated condensed financial statements and the notes to those statements included elsewhere herein. This discussion contains forward-looking statements that involve risks and uncertainties and are made under the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Words such as “anticipates,” “expects,” “intends,” “plans,” “believes,” “seeks,” “estimates,” and similar expressions identify such forward-looking statements. Our actual results and timing of certain events could differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited to, those set forth under “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Unless required by law, we can undertake no obligation to update forward-looking statements. Readers should also carefully review the risk factors set forth in other reports and documents filed from time to time with the SEC.

Except as otherwise specified, “Macquarie Infrastructure Company,” “MIC,” “we,” “us,” and “our” refer to the Company and its subsidiaries together from June 25, 2007 and, prior to that date, to the Trust, the Company and its subsidiaries. Macquarie Infrastructure Management (USA) Inc., which we refer to as our Manager, is part of the Macquarie Group, comprised of Macquarie Group Limited and its subsidiaries and affiliates worldwide.

We own, operate and invest in a diversified group of infrastructure businesses that provide basic services, such as chilled water for building cooling and gas utility services to businesses and individuals primarily in the U.S. The businesses we own and operate are energy-related businesses consisting of: a 50% interest in International Matex Tank Terminals, or IMTT, The Gas Company and our controlling interest in District Energy; and an aviation-related business, Atlantic Aviation.

Our infrastructure businesses generally operate in sectors with limited competition and significant barriers to entry, including high initial development and construction costs, the existence of long-term contracts or the requirement to obtain government approvals and a lack of immediate cost-efficient alternatives to the services provided. Overall they tend to generate sustainable long-term cash flows.

Overview

In analyzing the financial condition and results of operations of our businesses, we focus primarily on cash generation generally, and our ability to distribute cash to shareholders in particular. The ability of our businesses to generate cash, broadly, is tied to their ability to effectively manage the volume of products/ services sold and the margin earned on those sales. Offsetting these are required payments on debt facilities, taxes and capital expenditures necessary to maintain the productivity of the fixed assets of the businesses, among others.

At IMTT, we focus on the amount of storage under contract and the rates at which that storage is leased to third parties and on making appropriate expenditures in maintaining fixed assets of the business. Management of IMTT believes that the average rate on all storage contracts will be modestly higher in 2012 compared with 2011. Storage utilization is expected to be consistent with 2011, with certain larger tanks to be removed from service for cleaning and inspection later in the year.

At The Gas Company, our focus is on the number of customers served by each of the utility and non-utility portions of the business, and in the case of the non-utility portion, the margins achieved on sales of gas as well. The Gas Company has an active marketing program that seeks to develop new customers throughout Hawaii. We periodically pursue rate cases that allow for adjustment of the rates in the utility portion of the business, although we do not intend to pursue any significant rate case in 2012. The pricing of non-utility gas will be adjusted to reflect changes in the cost of the product and the costs associated with delivering it to customers. In addition to the existing utility and non-utility operations, The Gas Company is developing strategies related to the importation and distribution of Liquefied Natural Gas, or LNG. Small scale importation of LNG is expected to be underway in late 2012 or early 2013.

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At District Energy, we focus on attracting and maintaining relationships with building owners and managers such that they choose to install or continue to use the business’ cooling services. Absent a resurgence in new construction in downtown Chicago, we expect District Energy to produce financial results consistent with prior years’, although full year results remain subject to slight variation based on the extent to which the temperatures and humidity in Chicago are above or below historic norms.

Our energy-related businesses were largely resistant to the recent economic downturn, primarily due to the contracted or utility-like nature of their revenues combined with the essential services they provide and the contractual or regulatory ability to pass through most cost increases to customers. We believe these businesses are generally able to generate consistent cash flows throughout the business cycle.

At Atlantic Aviation, our focus is on attracting and maintaining relationships with general aviation aircraft owners and pilots such that they are incentivized to use our FBOs. General aviation activity has improved since the first quarter of 2009. However, forecasting flight activity levels remains difficult. Nonetheless, we believe that flight activity levels will continue to increase in 2012, subject to continued economic recovery in the United States.

Improvement in general aviation activity levels has resulted in improvement in the operating performance of Atlantic Aviation. Atlantic Aviation is generating a substantial amount of cash; however a significant portion of that cash will be used to reduce Atlantic Aviation’s indebtedness. Those repayments are expected to enhance the terms on which we may be able to refinance this debt prior to its maturity in 2014.

Arbitration Proceeding Between MIC and Co-investor in IMTT

On April 18, 2011, MIC initiated formal arbitration proceedings with the Voting Trust of IMTT Holdings Inc. (“Voting Trust”) and IMTT Holdings Inc. under the auspices of the American Arbitration Association, as provided under the Shareholders’ Agreement, with respect to a dispute with the co-owner of IMTT regarding distributions. IMTT was named as a respondent because under the Shareholders’ Agreement it is responsible for any monetary damages resulting from a breach of the Shareholders’ Agreement by the Voting Trust. On March 29, 2012, the arbitration proceeding concluded with an award in MIC’s favor. The arbitration panel directed IMTT to pay a distribution in the amount of $221.2 million ($110.6 million to each of MIC and its co-investor) as the total distribution through December 31, 2011. The arbitration panel also denied all of the Voting Trust’s counterclaims and directed the parties to comply with certain corporate governance recommendations, including, among others, the retention of independent counsel to advise the Board of Directors of IMTT with respect to the rights, duties and obligations of its members under Delaware law. On May 25, 2012, the Delaware Court of Chancery entered a judgment confirming the arbitration award in all respects, following which, in June of 2012, MIC received $110.6 million from IMTT in payment of a distribution.

2012 Distribution Dispute Between MIC and Co-Investor in IMTT

Distributions calculated by us in accordance with the Shareholders’ Agreement between MIC and its co-investor in IMTT (“Voting Trust”) for the first and second quarters of 2012 were $45.3 million ($22.6 million per shareholder) and $55.3 million ($27.7 million per shareholder), respectively. The Voting Trust appointed members of IMTT’s Board voted against resolutions authorizing those distributions, saying that they would prefer IMTT retain greater cash reserves in the business. Cash, cash equivalents and available committed and unutilized credit facilities would have totaled $219.6 million and $241.4 million at March 31, 2012 and June 30, 2012, respectively, had the distributions been paid as required under the Shareholders’Agreement. MIC believes that these cash reserve amounts are more than sufficient for IMTT.

Subsequently, on July 20, 2012 and July 31, 2012, the IMTT Board unanimously approved the payment of distributions in the amounts of $17.8 million ($8.9 million per shareholder) and $18.7 million ($9.3 million per shareholder) for the first and second quarters of 2012, respectively. The first quarter distribution was paid on July 24, 2012 and the second quarter distribution is expected to be paid in August of 2012. Both shareholders reserved their rights to dispute the amounts payable.

We believe that the failure of the Voting Trust-appointed members of IMTT’s Board to approve the distributions as calculated by MIC is a breach of the Shareholders’ Agreement and violates the terms of the

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March 30, 2012 Arbitration Award that clarified the Shareholders’ Agreement and prescribed the manner for calculating the distribution payable. We further believe that this failure is a violation of the Arbitration Award and has damaged MIC.

The parties appear to be at an impasse with respect to determining the amount of cash, cash equivalents and/or available committed and unutilized credit facilities that are required to be maintained under the Shareholders’ Agreement as interpreted by the Arbitration Award. Accordingly, as prescribed by the Shareholders’Agreement, we may have to commence an arbitration proceeding to collect the total amounts due MIC for the first and second quarters of 2012 and to recover costs and damages. While no timeline has been established for the proceeding, we believe it can be concluded in early 2013.

Dividends

Since January 1, 2011, MIC has paid or declared the following dividends:

       
Declared   Period Covered   $ per LLC Interest   Record Date   Payable Date
July 30, 2012     Second quarter 2012     $ 0.625       August 13, 2012       August 16, 2012  
April 30, 2012     First quarter 2012     $ 0.20       May 14, 2012       May 17, 2012  
February 1, 2012     Fourth quarter 2011     $ 0.20       March 5, 2012       March 8, 2012  
October 31, 2011     Third quarter 2011     $ 0.20       November 14, 2011       November 17, 2011  
August 1, 2011     Second quarter 2011     $ 0.20       August 15, 2011       August 18, 2011  
May 2, 2011     First quarter 2011     $ 0.20       May 11, 2011       May 18, 2011  

Our Board has expressed its intent to distribute substantially all of the cash generated by our businesses to our shareholders in the form of a quarterly cash dividend. Not all of the cash flow generated by our businesses is currently available for distribution. The payment of a cash dividend of $0.625 per share is being paid out of cash generated by our operating entities, supplemented by cash on hand, including the $110.6 million of distributions received from IMTT discussed above. Following the successful refinancing of Atlantic Aviation’s debt facilities prior to their maturity in October of 2014, and contingent upon the resolution of matters limiting the distribution of cash from IMTT (described above), the continued stable performance of MIC’s businesses, and subject to prevailing economic conditions, our Board will consider increasing the amount of the quarterly cash dividend.

Tax Treatment of Dividends

We expect that dividends paid in 2012 are likely to be characterized in part as a dividend and in part as a return of capital for tax purposes. Shareholders would include in their taxable income that portion which is characterized as a dividend. We anticipate that any portion that is characterized as a dividend for U.S. federal income tax purposes will be eligible for treatment as qualified dividend income, subject to the shareholder having met the holding period requirements as defined by the Internal Revenue Code. Any portion that is characterized as a return of capital for tax purposes would generally not be includable in the shareholder’s taxable income, but would reduce the shareholder’s basis in the shares on which the dividend was paid. Dividends characterized as a return of capital in excess of a shareholder’s tax basis may result in a capital gain. Holders of MIC LLC interests are encouraged to seek their own tax advice with regards to their investment in MIC.

Income Taxes

We file a consolidated federal income tax return that includes the taxable income of The Gas Company and Atlantic Aviation. IMTT and District Energy file separate federal income tax returns. Distributions from IMTT and District Energy may be characterized as non-taxable returns of capital and reduce our tax basis in these businesses, or as a taxable dividend. We will include in our taxable income the dividend portion of any distributions, which are eligible for the 80% dividends received deduction. We also receive and include in taxable income interest income from District Energy on intercompany debt.

As a result of having federal net operating loss, or NOL, carryforwards, we do not expect to have a consolidated regular federal income tax liability or make regular federal tax payments at least through the 2013 tax year. However, we expect to pay an Alternative Minimum Tax of approximately $620,000 for 2012,

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which includes $150,000 related to District Energy. We expect that the Alternative Minimum Tax paid for 2012 will be available as a credit against regular federal income taxes in the future. The cash state and local taxes paid by our individual businesses are discussed in the sections entitled “Income Taxes” for each of these businesses.

Pursuant to the tax sharing agreements, the individual businesses included in our consolidated federal income tax return pay MIC an amount equal to the federal income taxes each would have paid on a standalone basis if they were not part of the MIC consolidated federal income tax return.

Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010

In December 2010, the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (the “Act”) was signed. The Act provides for 100% tax depreciation for certain fixed assets placed in service after September 8, 2010 and before January 1, 2012, and 50% tax depreciation for certain fixed assets placed in service during 2012 for federal income tax purposes. Generally, states do not allow this tax depreciation deduction in determining state taxable income. Importantly, Illinois and Louisiana, two states in which we have significant operations, do permit the use of federal tax depreciation deductions in calculating state taxable income. The Company took and will take into consideration the benefits of these accelerated depreciation provisions of the Act when evaluating capital expenditure plans for the remainder of 2012.

President Obama’s proposed budget for 2012 includes an extension of the 100% tax depreciation for certain fixed assets. There is some congressional support for this proposal, although there can be no certainty that any extension will be approved. Such approval, if made, may result in our accelerating a portion of our business’ maintenance capital expenditures into 2012 in order to capture the associated tax benefit.

Results of Operations

Consolidated

Key Factors Affecting Operating Results:

strong performance from our energy-related businesses reflecting:
an increase in average storage rates and capacity utilization at IMTT;
an increase in non-utility contribution margin at The Gas Company; and
an increase in consumption gross profit at District Energy.
improved contribution from Atlantic Aviation reflecting:
increased volume of general aviation fuel sold; and
lower interest expense; partially offset by
reduced de-icing revenue.

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Results of Operations: Consolidated – (continued)

Our consolidated results of operations are as follows:

               
  Quarter Ended June 30,   Change Favorable/(Unfavorable)   Six Months Ended June 30,   Change Favorable/(Unfavorable)
     2012   2011   $   %   2012   2011   $   %
     ($ In Thousands) (Unaudited)
Revenue
                                                                       
Revenue from product sales   $ 169,129     $ 161,582       7,547       4.7     $ 342,083     $ 314,646       27,437       8.7  
Revenue from product sales – utility     36,807       36,421       386       1.1       75,121       70,694       4,427       6.3  
Service revenue     51,430       47,923       3,507       7.3       103,839       99,170       4,669       4.7  
Financing and equipment lease income     1,150       1,261       (111 )      (8.8 )      2,329       2,548       (219 )      (8.6 ) 
Total revenue     258,516       247,187       11,329       4.6       523,372       487,058       36,314       7.5  
Costs and expenses
                                                                       
Cost of product sales     115,720       113,226       (2,494 )      (2.2 )      235,101       218,551       (16,550 )      (7.6 ) 
Cost of product sales – utility     31,324       30,772       (552 )      (1.8 )      63,496       57,637       (5,859 )      (10.2 ) 
Cost of services     13,784       12,690       (1,094 )      (8.6 )      26,445       24,844       (1,601 )      (6.4 ) 
Gross profit     97,688       90,499       7,189       7.9       198,330       186,026       12,304       6.6  
Selling, general and administrative     50,467       48,309       (2,158 )      (4.5 )      105,730       99,979       (5,751 )      (5.8 ) 
Fees to manager-related party     4,760       4,156       (604 )      (14.5 )      9,755       7,788       (1,967 )      (25.3 ) 
Depreciation     7,557       8,623       1,066       12.4       15,108       15,833       725       4.6  
Amortization of intangibles     8,546       16,044       7,498       46.7       17,092       24,763       7,671       31.0  
Loss on disposal of assets     327       1,225       898       73.3       327       1,225       898       73.3  
Total operating expenses     71,657       78,357       6,700       8.6       148,012       149,588       1,576       1.1  
Operating income     26,031       12,142       13,889       114.4       50,318       36,438       13,880       38.1  
Other income (expense)
                                                                       
Interest income     4       97       (93 )      (95.9 )      6       101       (95 )      (94.1 ) 
Interest expense(1)     (10,925 )      (19,866 )      8,941       45.0       (23,932 )      (34,335 )      10,403       30.3  
Equity in earnings and amortization charges of investees     6,805       3,270       3,535       108.1       16,306       11,632       4,674       40.2  
Other income (expense), net     48       (46 )      94       NM       (4 )      (395 )      391       99.0  
Net income (loss) before income taxes     21,963       (4,403 )      26,366       NM       42,694       13,441       29,253       NM  
(Provision) benefit for income taxes     (9,935 )      488       (10,423 )      NM       (16,456 )      (6,498 )      (9,958 )      (153.2 ) 
Net income (loss)   $ 12,028     $ (3,915 )      15,943       NM     $ 26,238     $ 6,943       19,295       NM  
Less: net income (loss) attributable to noncontrolling interests     890       (1,425 )      (2,315 )      (162.5 )      1,008       (1,732 )      (2,740 )      (158.2 ) 
Net income (loss) attributable to MIC LLC   $ 11,138     $ (2,490 )      13,628       NM     $ 25,230     $ 8,675       16,555       190.8  

NM — Not meaningful

(1) Interest expense includes non-cash gains on derivative instruments of $7.5 million and $13.1 million for the quarter and six months ended June 30, 2012, respectively. For the quarter and six months ended June 30, 2011, interest expense includes non-cash losses on derivative instruments of $545,000 and non-cash gains on derivative instruments of $5.0 million, respectively.

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Results of Operations: Consolidated – (continued)

Gross Profit

Consolidated gross profit increased reflecting improved results in the non-utility business at The Gas Company and both fuel and non-fuel gross profit at Atlantic Aviation and at District Energy.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased primarily due to legal costs at the holding company level, most significantly those incurred in the arbitration proceedings between MIC and its IMTT co-investor. Selling, general and administrative expenses were also higher at The Gas Company and District Energy.

Fees to Manager

Base management fees to our Manager increased in line with our increased market capitalization. Our Manager elected to reinvest its base management fees for the six months ended June 30, 2012 and the year ended December 31, 2011, respectively, in additional LLC interests as follows:

     
Period   Base Management Fee Amount
($ in thousands)
  LLC Interests Issued   Issue Date
2012 Activities:
                          
Second quarter 2012   $ 4,760       (1)       (1)  
First quarter 2012     4,995       147,682       May 31, 2012  
2011 Activities:
                          
Fourth quarter 2011   $ 4,222       135,987       March 20, 2012  
Third quarter 2011     3,465       130,344       November 30, 2011  
Second quarter 2011     4,156       179,623       August 31, 2011  
First quarter 2011     3,632       144,742       June 6, 2011  

(1) LLC interests for the second quarter of 2012 base management fee will be issued to our Manager during the third quarter of 2012.

Depreciation

The decrease in depreciation primarily reflects the non-cash asset impairment charge of $1.4 million recorded at Atlantic Aviation during the quarter ended June 30, 2011. This non-cash impairment charge resulted from adverse trading conditions specific to three small locations. There were no fixed asset related impairment charges during the six months ended June 30, 2012.

Amortization of Intangibles

The decrease in amortization of intangibles expense reflects the non-cash impairment charge of $7.3 million recorded at Atlantic Aviation during the quarter ended June 30, 2011. This impairment charge resulted from adverse trading conditions specific to three small locations. There were no intangible asset related impairment charges during the six months ended June 30, 2012.

Interest Expense and Gains on Derivative Instruments

Interest expense includes non-cash gains on derivative instruments of $7.5 million and $13.1 million for the quarter and six months ended June 30, 2012, respectively, and non-cash losses of $545,000 and non-cash gains on derivative instruments of $5.0 million for the quarter and six months ended June 30, 2011, respectively. Non-cash gains (losses) on derivatives recorded in interest expense are attributable to the change in fair value of interest rate swaps and includes the reclassification of amounts from accumulated other comprehensive loss into earnings. Excluding the portion related to non-cash gains (losses) on derivatives, interest expense decreased for the six months ended June 30, 2012 primarily due to the lower term loan principal balance at Atlantic Aviation.

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Results of Operations: Consolidated – (continued)

Equity in Earnings and Amortization Charges of Investee

The increase in equity in the earnings for the six months ended June 30, 2012 reflects our share of the net income of IMTT and our share of the non-cash derivative gains for the six months ended June 30, 2012 compared with non-cash losses for the six months ended June 30, 2011.

The increase in equity in the earnings for the quarter ended June 30, 2012 reflects our share of the net income of IMTT and our share of the decrease in non-cash losses for the quarter ended June 30, 2012 compared with the quarter ended June 30, 2011.

IMTT’s net income increased for the quarter and six months ended June 30, 2012 as a result of improvements in operating results.

Income Taxes

For 2012, we expect that any consolidated taxable income will be fully offset by our NOL carryforwards. At December 31, 2011, our federal NOL balance was $135.2 million. This balance excludes the NOL carryforwards of District Energy (see District Energy — Income Taxes below). For 2012, we expect to pay a federal Alternative Minimum Tax of approximately $620,000, which includes $150,000 related to District Energy.

As we own less than 80% of IMTT and District Energy, these businesses are not included in our consolidated federal tax return. These businesses file separate federal income tax returns. We expect that dividends from District Energy in 2012 will be treated as taxable dividends and qualify for the 80% Dividends Received Deduction. With respect to IMTT, we expect that no more than $190,000 of distributions received will be taxable as a dividend, with the balance being a return of capital.

As of June 30, 2012, our projected full year federal and state income taxes will be approximately 38.54% of net income before taxes. Accordingly, our provision for income taxes for the six months ended June 30, 2012 is approximately $16.5 million, of which $2.2 million is for state and local income taxes. The difference between our effective tax rate and the U.S. federal statutory rate of 35% is primarily attributable to state and local income taxes and adjustments for our less than 80% owned businesses.

Valuation allowance:

From the date of sale of the noncontrolling interest in District Energy and onwards, we evaluate the need for a valuation allowance against our deferred tax assets without taking into consideration the deferred tax liabilities of District Energy. As of December 31, 2011, our valuation allowance was approximately $10.5 million. In calculating our consolidated income tax provision for the six months ended June 30, 2012, we provided for an increase in the valuation allowance of $897,000. During 2011, we increased the valuation allowance by $1.3 million for certain state NOL carryforwards.

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Results of Operations: Consolidated – (continued)

Earnings Before Interest, Taxes, Depreciation and Amortization (EBITDA) excluding non-cash items and Free Cash Flow

We have disclosed EBITDA excluding non-cash items for our Company and each of our operating segments in Note 9, “Reportable Segments”, in our consolidated condensed financial statements, as a key performance metric relied on by management in evaluating our performance. EBITDA excluding non-cash items is defined as earnings before interest, taxes, depreciation and amortization and non-cash items, which includes impairments, derivative gains and losses and adjustments for other non-cash items reflected in the statements of operations. We believe EBITDA excluding non-cash items provides additional insight into the performance of our operating businesses relative to each other and similar businesses without regard to their capital structure, and their ability to service or reduce debt, fund capital expenditures and/or support distributions to the holding company.

We also disclose Free Cash Flow, as defined by us, as a means of assessing the amount of cash generated by our businesses and supplementing other information provided in accordance with GAAP. We define Free Cash Flow as cash from operating activities, less maintenance capital expenditures and changes in working capital.

We believe that reporting Free Cash Flow will provide our investors with additional insight into our future ability to deploy cash, as GAAP metrics such as net income and cash from operating activities do not reflect all of the items that our management considers in estimating the amount of cash generated by our operating entities. In this Quarterly Report on Form 10-Q, we have disclosed Free Cash Flow for our consolidated results and for each of our operating segments.

We note that Free Cash Flow does not fully reflect our ability to freely deploy generated cash, as it does not reflect required payments to be made on our indebtedness, pay dividends and other fixed obligations or the other cash items excluded when calculating Free Cash Flow. We also note that Free Cash Flow may be calculated in a different manner by other companies, which limits its usefulness as a comparative measure. Therefore, our Free Cash Flow should be used as a supplemental measure and not in lieu of our financial results reported under GAAP.

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Results of Operations: Consolidated – (continued)

A reconciliation of net income (loss) attributable to MIC LLC to EBITDA excluding non-cash items and EBITDA excluding non-cash items to Free Cash Flow, on a consolidated basis, is provided below:

               
  Quarter Ended June 30,   Change Favorable/(Unfavorable)   Six Months Ended June 30,   Change Favorable/(Unfavorable)
     2012   2011   $   %   2012   2011   $   %
     ($ In Thousands) (Unaudited)
Net income (loss) attributable to MIC LLC(1)   $ 11,138     $ (2,490 )                      $ 25,230     $ 8,675                    
Interest expense, net(2)     10,921       19,769                         23,926       34,234                    
Provision (benefit) for income taxes     9,935       (488 )                        16,456       6,498                    
Depreciation(3)     7,557       8,623                         15,108       15,833                    
Depreciation – cost of services(3)     1,677       1,658                         3,351       3,305                    
Amortization of intangibles(4)     8,546       16,044                         17,092       24,763                    
Loss on disposal of assets     47       1,153                         47       1,153                    
Equity in earnings and amortization charges of investees(5)     9,501       (3,270 )                              (11,632 )                   
Base management fees settled/to be settled in LLC interests     4,760       4,156                         9,755       7,788                    
Other non-cash expense (income), net     1,974       (759 )                     2,725       (313 )                
EBITDA excluding non-cash items   $ 66,056     $ 44,396       21,660       48.8     $ 113,690     $ 90,304       23,386       25.9  
EBITDA excluding non-cash items   $ 66,056     $ 44,396                       $ 113,690     $ 90,304                    
Interest expense, net(2)     (10,921 )      (19,769 )                        (23,926 )      (34,234 )                   
Interest rate swap breakage fees(2)     (252 )      (627 )                        (500 )      (1,732 )                   
Non-cash derivative (gains) losses recorded in interest expense(2)     (7,232 )      1,172                         (12,614 )      (3,233 )                   
Amortization of debt financing costs(2)     965       1,030                         1,943       2,060                    
Cash distributions received in excess of equity in earnings and amortization charges of investees(6)     54,625                               54,625                          
Equipment lease receivables, net     872       753                         1,710       1,493                    
Provision/benefit for income taxes, net of changes in deferred taxes     (1,573 )      (196 )                        (2,326 )      (1,128 )                   
Changes in working capital     (1,439 )      (7,014 )                  (7,771 )      (12,243 )             
Cash provided by operating activities     101,101       19,745                         124,831       41,287                    
Changes in working capital     1,439       7,014                         7,771       12,243                    
Maintenance capital expenditures     (4,734 )      (3,912 )                     (8,461 )      (7,074 )                
Free cash flow   $ 97,806     $ 22,847       74,959       NM     $ 124,141     $ 46,456       77,685       167.2  

(1) Net income (loss) attributable to MIC LLC excludes net income attributable to noncontrolling interests of $890,000 and $1.0 million for the quarter and six months ended June 30, 2012, respectively, and net loss attributable to noncontrolling interests of $1.4 million and $1.7 million for the quarter and six months ended June 30, 2011, respectively.
(2) Interest expense, net, includes non-cash gains (losses) on derivative instruments, non-cash amortization of deferred financing fees and interest rate swap breakage fees.
(3) Depreciation — cost of services includes depreciation expense for District Energy, which is reported in cost of services in our consolidated condensed statements of operations. Depreciation and Depreciation — cost of services does not include acquisition-related step-up depreciation expense of $2.0 million and $3.9 million for the quarter and six months ended June 30, 2012, respectively, and $1.9 million and $3.6 million for the quarter and six months ended June 30, 2011, respectively, in connection with our investment in IMTT, which is reported in equity in earnings and amortization charges of investees in our consolidated condensed statements of operations.

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Results of Operations: Consolidated – (continued)

  

(4) Amortization of intangibles does not include acquisition-related step-up amortization expense of $85,000 and $171,000 for the quarter and six months ended June 30, 2012, respectively, and $151,000 and $435,000 for the quarter and six months ended June 30, 2011, respectively, in connection with our investment in IMTT, which is reported in equity in earnings and amortization charges of investees in our consolidated condensed statements of operations.
(5) Equity in earnings and amortization charges of investees in the above table includes our 50% share of IMTT's earnings, offset by the distributions we received only up to our share of the earnings recorded in the calculation for EBITDA excluding non-cash items. For the quarter and six months ended June 30, 2012, we recognized equity in earnings and amortization charges of investee income of $6.8 million and $16.3 million, respectively, in the consolidated condensed statement of operations, which was fully offset by the cash distributions received in June of 2012. The $9.5 million for the quarter ended June 30, 2012 represents the excess cash distributions received from IMTT over $16.3 million that was applied on the equity in earnings and amortization charges of investee income recognized during the quarter. See “Arbitration Proceeding Between MIC and Co-investor in IMTT” for further discussions.
(6) Cash distributions received in excess of equity in earnings and amortization charges of investee in the above table is the excess cumulative distributions received to the cumulative earnings recorded in equity in earnings and amortization charges of investees, since our investment in IMTT, adjusted for the current periods equity in earnings and amortization charges of investees in the calculation from net income (loss) attributable to MIC LLC to EBITDA excluding non-cash items above. The cummulative allocation of the $110.6 million distributions received in June of 2012 was $70.9 million recorded in net cash provided by operating activities and $39.6 million recorded in net cash provided by investing activities, as a return on investment, on the consolidated condensed statements of cash flows. See“Arbitration Proceeding Between MIC and Co-investor in IMTT” for further discussions.

Energy-Related Businesses

IMTT

We account for our 50% interest in IMTT under the equity method. To enable meaningful analysis of IMTT’s performance across periods, IMTT’s overall performance is discussed below, rather than IMTT’s contribution to our consolidated results.

Key Factors Affecting Operating Results:

terminal revenue and terminal gross profit increased principally due to an increase in average tank rental rates and higher utilization; and
lower labor and repairs and maintenance costs; partially offset by
a decrease in environmental response service gross profit, principally due to a lower level of spill response activity.

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Energy-Related Business: IMTT – (continued)

               
  Quarter Ended June 30,       Six Months Ended June 30,  
     2012   2011   Change Favorable/(Unfavorable)   2012   2011   Change Favorable/(Unfavorable)
     $   $   $   %   $   $   $   %
     ($ In Thousands) (Unaudited)
Revenue
                                                                       
Terminal revenue     109,167       101,436       7,731       7.6       220,784       207,451       13,333       6.4  
Environmental response revenue     4,596       5,514       (918 )      (16.6 )      10,983       10,330       653       6.3  
Total revenue     113,763       106,950       6,813       6.4       231,767       217,781       13,986       6.4  
Costs and expenses
                                                                       
Terminal operating costs     45,905       48,121       2,216       4.6       92,377       94,170       1,793       1.9  
Environmental response operating costs     4,446       4,012       (434 )      (10.8 )      9,602       8,743       (859 )      (9.8 ) 
Total operating costs     50,351       52,133       1,782       3.4       101,979       102,913       934       0.9  
Terminal gross profit     63,262       53,315       9,947       18.7       128,407       113,281       15,126       13.4  
Environmental response gross profit     150       1,502       (1,352 )      (90.0 )      1,381       1,587       (206 )      (13.0 ) 
Gross profit     63,412       54,817       8,595       15.7       129,788       114,868       14,920       13.0  
General and administrative expenses     7,341       7,717       376       4.9       14,800       15,580       780       5.0  
Depreciation and amortization     17,117       16,360       (757 )      (4.6 )      34,024       32,035       (1,989 )      (6.2 ) 
Operating income     38,954       30,740       8,214       26.7       80,964       67,253       13,711       20.4  
Interest expense, net(1)     (11,790 )      (16,311 )      4,521       27.7       (18,381 )      (20,994 )      2,613       12.4  
Other income     807       341       466       136.7       1,263       1,120       143       12.8  
Provision for income taxes     (11,869 )      (5,903 )      (5,966 )      (101.1 )      (26,236 )      (19,447 )      (6,789 )      (34.9 ) 
Noncontrolling interest     (86 )      66       (152 )      NM       (185 )      91       (276 )      NM  
Net income     16,016       8,933       7,083       79.3       37,425       28,023       9,402       33.6  
Reconciliation of net income to EBITDA excluding non-cash items:
                                                                       
Net income     16,016       8,933                         37,425       28,023                    
Interest expense, net(1)     11,790       16,311                         18,381       20,994                    
Provision for income taxes     11,869       5,903                         26,236       19,447                    
Depreciation and amortization     17,117       16,360                         34,024       32,035                    
Other non-cash expense (income)     90       (46 )                     278       (54 )                
EBITDA excluding non-cash items
    56,882       47,461       9,421       19.8       116,344       100,445       15,899       15.8  
EBITDA excluding non-cash items
    56,882       47,461                         116,344       100,445                    
Interest expense, net(1)     (11,790 )      (16,311 )                        (18,381 )      (20,994 )                   
Non-cash derivative losses (gains) recorded in interest expense(1)
    2,316       7,640                         (363 )      3,308                    
Amortization of debt financing costs(1)     809       807                         1,614       1,618                    
Provision for income taxes, net of changes in deferred taxes     (3,769 )      304                         (8,603 )      (7,584 )                   
Changes in working capital     4,683       (14,479 )                  12,298       (12,847 )             
Cash provided by operating activities     49,131       25,422                         102,909       63,946                    
Changes in working capital     (4,683 )      14,479                         (12,298 )      12,847                    
Maintenance capital expenditures     (7,335 )      (13,005 )                     (15,453 )      (21,519 )                
Free cash flow     37,113       26,896       10,217       38.0       75,158       55,274       19,884       36.0  

NM — Not meaningful

(1) Interest expense, net, includes non-cash (losses) gains on derivative instruments and non-cash amortization of deferred financing fees.

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Energy-Related Business: IMTT – (continued)

Revenue and Gross Profit

The increase in terminal revenue primarily reflects growth in storage revenue. Storage revenue grew due to an increase in average rental rates of 5.8% and 5.7% for the quarter and six months ended June 30, 2012, respectively, as compared with the quarter and six months ended June 30, 2011. Of the 12.7 million barrels of storage to be renewed in 2012, approximately 31% was renewed during the six months ended June 30, 2012. As previously disclosed, a disproportionately large share of the 2012 renewals is due to occur in the latter part of the year. At this stage, visibility into future pricing remains unclear. MIC believes that full year average storage rates will increase for fiscal 2012 as compared with fiscal 2011 between 5.5% and 7.5%.

Capacity utilization was 94.3% and 95.1% for the quarter and six months ended June 30, 2012, respectively, compared with 94.3% and 94.0% for the quarter and six months ended June 30, 2011, respectively, as fewer tanks were taken out of service for cleaning and inspection in the first quarter of 2012 as compared with the second quarter of 2012. MIC believes the full year capacity utilization will be at 2011 levels.

Terminal operating costs were lower for the quarter and six months ended June 30, 2012 as compared with the quarter and six months ended June 30, 2011 primarily due to lower fuel costs, reflecting a lower cost of natural gas, labor costs and maintenance and repair costs. As anticipated, repair and maintenance costs and labor costs decreased as unfavorable health care claims and tank repairs in the first half of 2011 did not recur.

Gross profit from environmental response services decreased with a lower level of spill response activity during the quarter and six months ended June 30, 2012.

General and Administrative Expenses

General and administrative expenses decreased for the quarter and six months ended June 30, 2012 as compared with the quarter and six months ended June 30, 2011 primarily due to reclassification of loan commitment fees to interest expense.

Depreciation and Amortization

Depreciation and amortization expense increased for the quarter and six months ended June 30, 2012 as IMTT placed capital assets in service, resulting in higher asset balances.

Interest Expense, Net

Interest expense, net, includes non-cash losses of $2.3 million and non-cash gains of $363,000 on derivative instruments for the quarter and six months ended June 30, 2012, respectively. For the quarter and six months ended June 30, 2011, interest expense, net, includes non-cash losses on derivative instruments of $7.6 million and $3.3 million, respectively.

Cash interest paid was $8.4 million and $16.7 million for the quarter and six months ended June 30, 2012, respectively, and $8.2 million and $16.8 million for the quarter and six months ended June 30, 2011, respectively.

Income Taxes

The business files a consolidated federal income tax return and separate state income tax returns in five states.

For 2012, IMTT estimates it will pay approximately $12.0 million of federal income taxes and $5.2 million of state income taxes. IMTT’s actual federal tax liability could be higher or lower depending on value of capital assets placed in service during the year and the extent to which IMTT is able to realize the benefits of bonus depreciation of those assets.

In the first quarter of 2012, IMTT recorded a current income tax provision of $11.4 million. This provision included the tax benefits of accelerated depreciation on only those assets actually placed in service during the first quarter of 2012. Generally Accepted Accounting Principles require IMTT to estimate the tax benefits of accelerated depreciation on assets expected to be placed in service during the entire year and recognize those benefits on a pro-rata basis in each interim period. Therefore, MIC recalculated the current income tax provision provided by IMTT.

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Energy-Related Business: IMTT – (continued)

Based on MIC’s recalculation, the current income tax provision for the first quarter of 2012 should have been $4.8 million instead of the $11.4 million reported. The $6.6 million reduction in the current income tax provision for the first quarter of 2012 was offset by a $6.6 million increase in the deferred income tax provision resulting in no net change to the total tax provision for the first quarter of 2012. The recalculated current income tax provision for the quarter and six months ended June 30, 2012 of $3.8 million and $8.6 million, respectively, is reflected in the “Provision for income taxes, net of changes in deferred taxes” line in the above table.

For 2011, IMTT recorded $28.9 million of federal income tax expense and $5.9 million of state income tax expense. IMTT made federal tax payments related to 2011 of $8.4 million and state tax payments of $4.7 million. The federal income tax expense exceeded the cash taxes primarily due to the benefit of accelerated tax depreciation, which is discussed below.

A significant difference between IMTT’s book and federal taxable income relates to depreciation of terminalling fixed assets. For book purposes, these fixed assets are depreciated primarily over 15 to 30 years using the straight-line method of depreciation. For federal income tax purposes, these fixed assets are depreciated primarily over 5 to 15 years using accelerated methods. Most terminalling fixed assets placed in service in 2010, 2011 and 2012 did or should qualify for the federal 50% or 100% tax depreciation, except assets placed in service in Louisiana and financed with GO Zone Bonds. A significant portion of Louisiana terminalling fixed assets constructed since Hurricane Katrina were financed with Gulf Opportunity Zone Bonds (“GO Zone Bonds”). GO Zone Bond financed assets are depreciated, for tax purposes, primarily over 9 to 20 years using the straight-line depreciation method. Most of the states in which the business operates do not allow the use of the federal tax depreciation calculation methods.

The Gas Company

Key Factors Affecting Operating Results:

an increase in non-utility contribution margin driven by margin management and an increase in the volume of gas sold; and
an increase in utility contribution margin driven by an increase in the volume of gas sold; partially offset by
higher operating costs primarily due to an increase in welfare and benefit costs, overtime and vendor services.

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Energy-Related Business: The Gas Company – (continued)

               
  Quarter Ended June 30,       Six Months EndedJune 30,  
     2012   2011   Change Favorable/(Unfavorable)   2012   2011   Change Favorable/(Unfavorable)
     $   $   $   %   $   $   $   %
     ($ In Thousands) (Unaudited)
Contribution margin
                                                                       
Revenue – non-utility     29,748       26,935       2,813       10.4       61,377       54,286       7,091       13.1  
Cost of revenue – non-utility     13,554       14,315       761       5.3       29,127       30,372       1,245       4.1  
Contribution margin – non-utility     16,194       12,620       3,574       28.3       32,250       23,914       8,336       34.9  
Revenue – utility     36,807       36,421       386       1.1       75,121       70,694       4,427       6.3  
Cost of revenue – utility     27,149       27,206       57       0.2       55,366       51,211       (4,155 )      (8.1 ) 
Contribution margin – utility     9,658       9,215       443       4.8       19,755       19,483       272       1.4  
Total contribution margin     25,852       21,835       4,017       18.4       52,005       43,397       8,608       19.8  
Production     2,127       1,778       (349 )      (19.6 )      4,133       3,454       (679 )      (19.7 ) 
Transmission and distribution     5,649       5,021       (628 )      (12.5 )      11,097       9,419       (1,678 )      (17.8 ) 
Gross profit     18,076       15,036       3,040       20.2       36,775       30,524       6,251       20.5  
Selling, general and administrative expenses     4,558       4,041       (517 )      (12.8 )      9,815       8,258       (1,557 )      (18.9 ) 
Depreciation and amortization     1,902       1,802       (100 )      (5.5 )      3,843       3,575       (268 )      (7.5 ) 
Operating income     11,616       9,193       2,423       26.4       23,117       18,691       4,426       23.7  
Interest expense, net(1)     (1,516 )      (3,483 )      1,967       56.5       (3,407 )      (5,497 )      2,090       38.0  
Other expense     (63 )      (127 )      64       50.4       (132 )      (279 )      147       52.7  
Provision for income taxes     (3,913 )      (2,310 )      (1,603 )      (69.4 )      (7,712 )      (5,212 )      (2,500 )      (48.0 ) 
Net income(2)     6,124       3,273       2,851       87.1       11,866       7,703       4,163       54.0  
Reconciliation of net income to EBITDA excluding non-cash items:
                                                                       
Net income(2)     6,124       3,273                         11,866       7,703                    
Interest expense, net(1)     1,516       3,483                         3,407       5,497                    
Provision for income taxes     3,913       2,310                         7,712       5,212                    
Depreciation and amortization     1,902       1,802                         3,843       3,575                    
Other non-cash expenses     995       512                      1,802       1,182                 
EBITDA excluding non-cash items
    14,450       11,380       3,070       27.0       28,630       23,169       5,461       23.6  
EBITDA excluding non-cash items
    14,450       11,380                         28,630       23,169                    
Interest expense, net(1)     (1,516 )      (3,483 )                        (3,407 )      (5,497 )                   
Non-cash derivative (gains) losses recorded in interest expense(1)
    (832 )      1,173                         (1,297 )      897                    
Amortization of debt financing costs(1)     119       120                         239       239                    
Provision for income taxes, net of changes in deferred taxes     (2,205 )      (1,260 )                        (4,375 )      (3,545 )                   
Changes in working capital     (847 )      (2,034 )                  (3,705 )      (6,449 )             
Cash provided by operating activities     9,169       5,896                         16,085       8,814                    
Changes in working capital     847       2,034                         3,705       6,449                    
Maintenance capital expenditures     (1,421 )      (1,660 )                     (3,185 )      (3,920 )                
Free cash flow     8,595       6,270       2,325       37.1       16,605       11,343       5,262       46.4  

(1) Interest expense, net, includes non-cash gains (losses) on derivative instruments and non-cash amortization of deferred financing fees.
(2) Corporate allocation expense, intercompany fees and the tax effect have been excluded from the above table as they are eliminated on consolidation at the MIC Inc. level.

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Energy-Related Business: The Gas Company – (continued)

Management believes that the presentation and analysis of contribution margin, a non-GAAP performance measure, is meaningful to understanding the business’ performance under both a utility rate structure and a non-utility unregulated pricing structure. Regulation of the utility portion of The Gas Company’s operations provides for the pass through of increases or decreases in feedstock costs to customers. Changes in the cost of Liquefied Petroleum Gas, or LPG, distributed to non-utility customers can be recovered in pricing, subject to competitive conditions.

Contribution margin should not be considered an alternative to revenue, gross profit, operating income, or net income, determined in accordance with U.S. GAAP. A reconciliation of contribution margin to gross profit is presented in the above table. The business calculates contribution margin as revenue less direct costs of revenue other than production and transmission and distribution costs. Other companies may calculate contribution margin differently or may use different metrics and, therefore, the contribution margin presented for The Gas Company is not necessarily comparable with metrics of other companies.

Contribution Margin and Operating Income

Non-utility contribution margin improved as the result of margin management, input cost reduction and an increase in volume of gas sold. The volume of gas sold in the non-utility business increased 10.0% and 8.3% for the quarter and six months ended June 30, 2012, respectively, despite disruptions in supply from the local refineries.

Utility contribution margin was higher for the quarter and six months ended June 30, 2012 driven by a 2.1% and 2.7% increase in the volume of gas sold, respectively. The feedstock contract negotiated between The Gas Company and Tesoro during 2011 was formally approved by the HPUC on May 2, 2012.

As previously noted, in January of 2012, Tesoro announced plans to consider selling all of its operations in Hawaii, including its refinery on Oahu. The Tesoro refinery currently supplies The Gas Company with naphtha, which it converts into Synthetic Natural Gas, or SNG, for its Oahu utility business. As The Gas Company had been concerned about its ability to rely upon the Tesoro facility in the long-term to supply naphtha, it has been actively evaluating alternatives for some time in the event that the facility closes or limits supply. The alternatives include some combination of: extended usage of the backup utility propane air unit; importation of naphtha; sourcing of naphtha from the Chevron refinery; and the importation of LNG. The Gas Company is developing strategies related to the importation and distribution of LNG and placed orders for equipment to import LNG in small scale from the west coast of North America as an emergency backup feedstock. This small scale importation of LNG is expected to be underway in late 2012. The Gas Company believes that it will be able to supply Oahu utility customers with gas irrespective of whether the Tesoro refinery continues to operate.

Production, transmission and distribution and selling, general and administrative expenses are composed primarily of labor-related expenses and professional fees. On a combined basis, these costs were higher for the quarter and six months ended June 30, 2012 compared with the quarter and six months ended June 30, 2011 reflecting higher incentive compensation, increase in medical premiums and increased vendor services. In addition, costs were higher for the quarter ended June 30, 2012 due to increase in overtime.

Interest Expense, Net

Interest expense, net, includes non-cash gains on derivative instruments of $832,000 and $1.3 million for the quarter and six months ended June 30, 2012, respectively. For the quarter and six months ended June 30, 2011, interest expense, net, includes non-cash losses on derivative instruments of $1.2 million and $897,000, respectively. Excluding the non-cash gains (losses) on derivative instruments, interest expense was slightly higher primarily due to increased capital expenditure facility borrowings and a contractual increase in interest rate margin for The Gas Company’s primary debt facility beginning in June of 2011.

Cash interest paid was $2.3 million and $4.5 million for the quarter and six months ended June 30, 2012, respectively, compared with $2.1 million and $4.3 million for the quarter and six months ended June 30, 2011, respectively.

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Energy-Related Business: The Gas Company – (continued)

Income Taxes

Income from The Gas Company is included in our consolidated federal income tax return, and is subject to Hawaii state income taxes. The tax expense in the table above includes both state taxes and the portion of the consolidated federal tax liability attributable to the business. For the year ending December 31, 2012, the business expects to pay cash state income taxes of approximately $1.5 million, for which a provision of $808,000 was recorded for the six months ended June 30, 2012. The “Provision for income taxes, net of changes in deferred taxes” of $4.4 million for the six months ended June 30, 2012 in the above table, includes $3.6 million of federal income taxes payable to MIC for the six months ended June 30, 2012. Any current federal income tax liability is expected to be offset in consolidation by the application of NOLs.

The business’ federal taxable income differs from book income primarily as a result of differences in the depreciation of fixed assets. The state of Hawaii does not allow the federal bonus depreciation deduction of 100% for 2011 or 50% for 2012 in determining state taxable income.

District Energy

Customers of District Energy pay two charges to receive chilled water services: a fixed charge based on contracted capacity and a variable charge based on the consumption of chilled water. Capacity charges are typically adjusted annually at a fixed rate or are indexed to the Consumer Price Index (CPI). The terms of the business’ customer contracts provide for the pass through of increases or decreases in electricity costs, the largest component of the business’ direct expenses.

The financial results discussed below reflect 100% of District Energy’s performance during the periods presented below.

Key Factors Affecting Operating Results:

an increase in consumption revenue, net of electricity costs, driven by warmer average temperatures;
an increase in capacity revenue from new customers and annual inflation-linked increases in contract capacity rates; and
a decrease in other direct expenses due to the timing of system maintenance work.

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Energy-Related Business: District Energy – (continued)

               
  Quarter Ended June 30,       Six Months Ended June 30,  
     2012   2011   Change Favorable/(Unfavorable)   2012   2011   Change Favorable/(Unfavorable)
     $   $   $   %   $   $   $   %
     ($ In Thousands) (Unaudited)
Cooling capacity revenue     5,567       5,428       139       2.6       11,062       10,759       303       2.8  
Cooling consumption revenue     6,890       5,924       966       16.3       10,363       8,354       2,009       24.0  
Other revenue     682       903       (221 )      (24.5 )      1,321       1,593       (272 )      (17.1 ) 
Finance lease revenue     1,150       1,261       (111 )      (8.8 )      2,329       2,548       (219 )      (8.6 ) 
Total revenue     14,289       13,516       773       5.7       25,075       23,254       1,821       7.8  
Direct expenses – electricity     4,148       3,675       (473 )      (12.9 )      6,686       5,621       (1,065 )      (18.9 ) 
Direct expenses – other(1)     5,072       5,231       159       3.0       9,629       10,190       561       5.5  
Direct expenses – total     9,220       8,906       (314 )      (3.5 )      16,315       15,811       (504 )      (3.2 ) 
Gross profit     5,069       4,610       459       10.0       8,760       7,443       1,317       17.7  
Selling, general and administrative expenses     961       762       (199 )      (26.1 )      1,852       1,685       (167 )      (9.9 ) 
Amortization of intangibles     341       341                   682       678       (4 )      (0.6 ) 
Operating income     3,767       3,507       260       7.4       6,226       5,080       1,146       22.6  
Interest expense, net(2)     (2,127 )      (4,925 )      2,798       56.8       (4,456 )      (7,184 )      2,728       38.0  
Other income     75       55       20       36.4       132       111       21       18.9  
(Provision) benefit for income taxes     (621 )      650       (1,271 )      (195.5 )      (611 )      997       (1,608 )      (161.3 ) 
Noncontrolling interest     (208 )      (213 )      5       2.3       (419 )      (426 )      7       1.6  
Net income (loss)     886       (926 )      1,812       195.7       872       (1,422 )      2,294       161.3  
Reconciliation of net income (loss) to EBITDA excluding non-cash items:
                                                                       
Net income (loss)     886       (926 )                        872       (1,422 )                   
Interest expense, net(2)     2,127       4,925                         4,456       7,184                    
Provision (benefit) for income taxes     621       (650 )                        611       (997 )                   
Depreciation(1)     1,677       1,658                         3,351       3,305                    
Amortization of intangibles     341       341                         682       678                    
Other non-cash expenses     240       300                      269       338                 
EBITDA excluding non-cash items
    5,892       5,648       244       4.3       10,241       9,086       1,155       12.7  
EBITDA excluding non-cash items
    5,892       5,648                         10,241       9,086                    
Interest expense, net(2)     (2,127 )      (4,925 )                        (4,456 )      (7,184 )                   
Non-cash derivative (gains) losses recorded in interest expense(2)
    (566 )      2,304                         (869 )      1,943                    
Amortization of debt financing costs(2)     175       170                         345       340                    
Equipment lease receivable, net     872       753                         1,710       1,493                    
Provision/benefit for income taxes, net of changes in deferred taxes
    (320 )      230                         (273 )      185                    
Changes in working capital     (47 )      (1,142 )                  (1,872 )      181              
Cash provided by operating activities     3,879       3,038                         4,826       6,044                    
Changes in working capital     47       1,142                         1,872       (181 )                   
Maintenance capital expenditures     (77 )      (59 )                     (164 )      (125 )                
Free cash flow     3,849       4,121       (272 )      (6.6 )      6,534       5,738       796       13.9  

(1) Includes depreciation expense of $1.7 million and $3.4 million for the quarter and six months ended June 30, 2012, respectively, and $1.7 million and $3.3 million for the quarter and six months ended June 30, 2011, respectively.
(2) Interest expense, net, includes non-cash gains (losses) on derivative instruments and non-cash amortization of deferred financing fees.

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Energy-Related Business: District Energy – (continued)

Gross Profit

Gross profit increased primarily due to warmer average temperatures during the quarter and six months ended June 30, 2012 compared with quarter and six months ended June 30, 2011 resulting in higher consumption revenue, net of electricity costs. Additionally, cooling capacity revenue increased from new customers and annual inflation-related increases in contract capacity rates in accordance with customer contract terms. Other direct expenses decreased due to the timing of system maintenance work.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased for the quarter and six months ended June 30, 2012 compared with quarter and six months ended June 30, 2011 primarily due to higher legal fees.

Interest Expense, Net

Interest expense, net, includes non-cash gains on derivative instruments of $566,000 and $869,000 for the quarter and six months ended June 30, 2012, respectively. For the quarter and six months ended June 30, 2011, interest expense, net, includes non-cash losses on derivative instruments of $2.3 million and $1.9 million, respectively. Excluding the non-cash gains and losses on derivative instruments, interest expense was higher for the six months ended June 30, 2012.

Cash interest paid was $2.6 million and $5.0 million for the quarter and six months ended June 30, 2012, respectively, and $2.5 million and $5.0 million for the quarter and six months ended June 30, 2011, respectively.

Income Taxes

District Energy files a separate federal income tax return and a separate Illinois state income tax return. As of December 31, 2011, the business had approximately $16.4 million in federal NOL carryforwards available to offset positive taxable income and $23.1 million in Illinois state NOL carryforwards, for which utilization is deferred until 2015. For 2012, District Energy expects to pay a federal Alternative Minimum Tax of approximately $150,000 and state income taxes of approximately $787,000. For the six months ended June 30, 2012, a federal and state income tax expense of $273,000 was recorded and is reflected in the “Provision/benefit for income taxes, net of changes in deferred taxes” in the above table. The tax expense for the six months ended June 30, 2012 includes a benefit recorded in the three months ended March 31, 2012 that is expected to reverse and will be offset by tax expense in subsequent quarters during 2012. The business does not expect to pay federal income taxes in 2012 or 2013 due to the utilization of NOL carryforwards.

Aviation-Related Business

Atlantic Aviation

Key Factors Affecting Operating Results:

higher general aviation (“GA”) volume of fuel sold and higher weighted average GA fuel margins, partially offset by reduced de-icing revenue; and
lower cash interest expense driven by reduced debt levels.

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Aviation-Related Business: Atlantic Aviation – (continued)

               
  Quarter Ended June 30,       Six Months Ended June 30,  
     2012   2011   Change Favorable/(Unfavorable)   2012   2011   Change Favorable/(Unfavorable)
     $   $   $   %   $   $   $   %
     ($ In Thousands) (Unaudited)
Revenue
                                                                       
Fuel revenue     139,381       134,647       4,734       3.5       280,706       260,360       20,346       7.8  
Non-fuel revenue     38,291       35,668       2,623       7.4       81,093       78,464       2,629       3.4  
Total revenue     177,672       170,315       7,357       4.3       361,799       338,824       22,975       6.8  
Cost of revenue
                                                                       
Cost of revenue – fuel     98,567       95,678       (2,889 )      (3.0 )      198,875       181,732       (17,143 )      (9.4 ) 
Cost of revenue – non-fuel     4,563       3,785       (778 )      (20.6 )      10,130       9,033       (1,097 )      (12.1 ) 
Total cost of revenue     103,130       99,463       (3,667 )      (3.7 )      209,005       190,765       (18,240 )      (9.6 ) 
Fuel gross profit     40,814       38,969       1,845       4.7       81,831       78,628       3,203       4.1  
Non-fuel gross profit     33,728       31,883       1,845       5.8       70,963       69,431       1,532       2.2  
Gross profit     74,542       70,852       3,690       5.2       152,794       148,059       4,735       3.2  
Selling, general and administrative expenses     42,903       41,624       (1,279 )      (3.1 )      86,847       86,675       (172 )      (0.2 ) 
Depreciation and amortization     13,860       22,524       8,664       38.5       27,675       36,343       8,668       23.9  
Loss on disposal of assets     327       1,225       898       73.3       327       1,225       898       73.3  
Operating income     17,452       5,479       11,973       NM       37,945       23,816       14,129       59.3  
Interest expense, net(1)     (7,282 )      (11,361 )      4,079       35.9       (16,067 )      (21,554 )      5,487       25.5  
Other income (expense)     64       50       14       28.0       48       (177 )      225       127.1  
(Provision) benefit for income taxes
    (4,574 )      2,335       (6,909 )      NM       (9,284 )      (840 )      (8,444 )      NM  
Net income (loss)(2)     5,660       (3,497 )      9,157       NM       12,642       1,245       11,397       NM  
Reconciliation of net income (loss) to EBITDA excluding non-cash items:
                                                                       
Net income (loss)(2)     5,660       (3,497 )                        12,642       1,245                    
Interest expense, net(1)     7,282       11,361                         16,067       21,554                    
Provision (benefit) for income taxes
    4,574       (2,335 )                        9,284       840                    
Depreciation and amortization     13,860       22,524                         27,675       36,343                    
Loss on disposal of assets     47       1,153                         47       1,153                    
Other non-cash (income) expenses     (88 )      (43 )                     (229 )      103                 
EBITDA excluding non-cash items
    31,335       29,163       2,172       7.4       65,486       61,238       4,248       6.9  
EBITDA excluding non-cash items
    31,335       29,163                         65,486       61,238                    
Interest expense, net(1)     (7,282 )      (11,361 )                        (16,067 )      (21,554 )                   
Interest rate swap breakage fees(1)     (252 )      (627 )                        (500 )      (1,732 )                   
Non-cash derivative gains recorded in interest expense(1)
    (5,834 )      (2,305 )                        (10,448 )      (6,073 )                   
Amortization of debt financing costs(1)     671       740                         1,359       1,481                    
Provision/benefit for income taxes, net of changes in deferred taxes
    (768 )      (121 )                        (975 )      (616 )