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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-Q

 

(MARK ONE)

 

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

 

For the quarterly period ended September 30, 2015

or

 

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 001-36260

 

CYPRESS ENERGY PARTNERS, L.P.

(Exact name of Registrant as specified in its charter)

 

Delaware

61-1721523

(State of or other jurisdiction of

(I.R.S. Employer

incorporation or organization) Identification No.)

 

 

5727 South Lewis Avenue, Suite 300

Tulsa, Oklahoma 74105

(Address of principal executive offices)

(zip code)

 

Registrant’s telephone number, including area code: (918) 748-3900

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  No

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes  No

 

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

 

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller  reporting company    

 

 

 

 

(Do not check if a smaller reporting company)

 

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

 

The registrant's common units began trading on the New York Stock Exchange on January 15, 2014.

 

As of November 13, 2015, the registrant had 5,920,467 common units and 5,913,000 subordinated units outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:     None.

 


 
 

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CYPRESS ENERGY PARTNERS, L.P.

 

  Table of Contents

 

 

 

Page

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

Unaudited Condensed Consolidated Financial Statements

5

 

 

 

 

Unaudited Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014

5

 

 

 

 

Unaudited Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2015 and 2014

6

 

 

 

 

Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2015 and 2014

7

 

 

 

 

Unaudited Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2015 and 2014

8

 

 

 

 

Unaudited Condensed Consolidated Statement of Owners’ Equity for the Nine Months Ended September 30, 2015

9

 

 

 

 

Notes to the Unaudited Condensed Consolidated Financial Statements

10

 

 

 

ITEM 2.

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

32

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

47

 

 

 

ITEM 4.

Controls and Procedures

48

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

ITEM 1.

Legal Proceedings

49

 

 

 

ITEM 1A.

Risk Factors

49

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

49

 

 

 

ITEM 3.

Defaults upon Senior Securities

49

 

 

 

ITEM 4.

Mine Safety Disclosures

49

 

 

 

ITEM 5.

Other Information

49

 

 

 

ITEM 6.

Exhibits

49

 

 

 

SIGNATURES

51

 

 
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 NAMES OF ENTITIES

 

Unless the context otherwise requires, references in this Quarterly Report on Form 10-Q to “Cypress Energy Partners, L.P.,” “our partnership,” “we,” “our,” “us,” or like terms, refer to Cypress Energy Partners, L.P. and its subsidiaries.

 

References to:

 

 

● 

Brown” refers to Brown Integrity, LLC, a 51% owned subsidiary of CEP LLC acquired May 1, 2015;

 

 

● 

CEM LLC” refers to Cypress Energy Management, LLC, a wholly owned subsidiary of the General Partner;

 

 

● 

CEM TIR” refers to Cypress Energy Management - TIR, LLC, a wholly owned subsidiary of CEM LLC;

 

 

● 

CEM-BO” refers to Cypress Energy Management – Bakken Operations, LLC, a wholly owned subsidiary of CEM LLC;

 

 

● 

CEP LLC” refers to Cypress Energy Partners, LLC, which became our wholly owned subsidiary at the closing of our initial public offering (“IPO”);

 

 

● 

CEP-TIR” refers to Cypress Energy Partners – TIR, LLC, an indirect subsidiary of Holdings, and an owner of 673,400 common units representing 11.4% of our outstanding common units, 673,400 subordinated units representing 11.4% of our subordinated units and an owner of a 36.2% interest in the TIR Entities prior to the sale of its interests to the Partnership effective February 1, 2015;

 

 

● 

CES LLC” refers to Cypress Energy Services, LLC, a wholly owned subsidiary as of June 1, 2015 that performs management services for our salt water disposal (“SWD”) facilities, as well as third party facilities.  SBG Energy Services, LLC (“SBG Energy”) owned 49% of CES LLC prior to the Partnership’s June 1, 2015 acquisition of this ownership interest;

 

 

● 

CF Inspection” refers to CF Inspection Management, LLC, owned 49% by TIR-PUC and consolidated under generally accepted accounting principles by TIR-PUC. CF Inspection is 51% owned, managed and controlled by Cynthia A. Field, an affiliate of Holdings;

 

 

● 

General Partner” refers to Cypress Energy Partners GP, LLC, a subsidiary of Holdings II;

 

 

● 

Holdings” refers to Cypress Energy Holdings, LLC, the owner of Holdings II;

 

 

● 

Holdings II” refers to Cypress Energy Holdings II, LLC, the owner of 671,250 common units representing 11.3% of our outstanding common units and 4,939,299 subordinated units representing 83.5% of our subordinated units;

 

 

● 

IS” refers to our Integrity Services business segment;

 

 

● 

Partnership” refers to the registrant, Cypress Energy Partners, L.P.;

 

 

● 

“PIS” refers to our Pipeline Inspection Services business segment;

   

 

● 

TIR Entities” refer collectively to TIR LLC and its subsidiary, TIR Holdings and its subsidiaries and TIR-NDE, all of which were 50.1% owned by CEP LLC from our IPO until February 1, 2015, at which time CEP LLC acquired the remaining interests from affiliates of Holdings and now owns 100%;

 

 

● 

TIR Holdings” refers to Tulsa Inspection Resources Holdings, LLC;

 

 

● 

TIR LLC” refers to Tulsa Inspection Resources, LLC;

 

 

● 

TIR-Canada” refers to Tulsa Inspection Resources – Canada ULC, a Canadian subsidiary of TIR Holdings;

 

 

● 

TIR-Foley” refers to Foley Inspection Services ULC, a Canadian subsidiary of TIR Holdings;

 

 

● 

TIR-NDE” refers to Tulsa Inspection Resources – Nondestructive Examination, LLC;

 

 

● 

TIR-PUC” refers to Tulsa Inspection Resources – PUC, LLC, a subsidiary of TIR LLC that has elected to be treated as a corporation for federal income tax purposes; and

 

 

● 

“W&ES” refers to our Water and Environmental Services business segment.

 

 
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CAUTIONARY REMARKS REGARDING FORWARD LOOKING STATEMENTS

   

The information discussed in this Quarterly Report on Form 10-Q includes “forward-looking statements.”  These forward-looking statements are identified by their use of terms and phrases such as “may,” “expect,” “estimate,” “project,” “plan,” “believe,” “intend,” “achievable,” “anticipate,” “continue,” “potential,” “should,” “could,” and similar terms and phrases.  Although we believe that the expectations reflected in these forward-looking statements are reasonable, they do involve certain assumptions, risks and uncertainties and we can give no assurance that such expectations or assumptions will be achieved.  Important factors that could cause actual results to differ materially from those in the forward-looking statements are described under “Item 1A – Risk Factors” and “Item 7 – Management's Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K for the year ended December 31, 2014, as amended by our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 8, 2015, and in this report.  All forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements in this paragraph and elsewhere in this Quarterly Report on Form 10-Q and speak only as of the date of this Quarterly Report on Form 10-Q.  Other than as required under the securities laws, we do not assume a duty to update these forward-looking statements, whether as a result of new information, subsequent events or circumstances, changes in expectations or otherwise.

 

 
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PART I.   FINANCIAL INFORMATION

 

ITEM 1.

Unaudited Condensed Consolidated Financial Statements

 

CYPRESS ENERGY PARTNERS, L.P.

Unaudited Condensed Consolidated Balance Sheets 

As of September 30, 2015 and December 31, 2014 

(in thousands, except unit data) 

 

   

September 30,

   

December 31,

 
   

2015

   

2014

 

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 25,677     $ 20,757  

Trade accounts receivable, net

    56,470       54,075  

Accounts receivable - affiliates

    65       -  

Deferred tax assets

    36       68  

Prepaid expenses and other

    3,043       2,440  

Total current assets

    85,291       77,340  

Property and equipment:

               

Property and equipment, at cost

    24,515       27,878  

Less: Accumulated depreciation

    4,671       3,538  

Total property and equipment, net

    19,844       24,340  

Intangible assets, net

    33,279       30,245  

Goodwill

    65,323       55,545  

Debt issuance costs, net

    1,910       2,318  

Other assets

    66       54  

Total assets

  $ 205,713     $ 189,842  
                 

LIABILITIES AND OWNERS' EQUITY

               

Current liabilities:

               

Accounts payable

  $ 3,172     $ 2,461  

Accounts payable - affiliates

    -       586  

Accrued payroll and other

    16,797       7,750  

Income taxes payable

    379       546  

Total current liabilities

    20,348       11,343  

Long-term debt

    140,900       77,600  

Deferred tax liabilities

    386       438  

Asset retirement obligations

    78       33  

Total liabilities

    161,712       89,414  
                 

Commitments and contingencies - Note 11

               
                 

Owners' equity:

               

Partners’ capital:

               

Common units (5,920,467 and 5,913,000 units outstanding at September 30, 2015 and December 31, 2014, respectively)

    1,734       6,285  

Subordinated units (5,913,000 units outstanding at September 30, 2015 and December 31, 2014)

    60,961       66,096  

General partner

    (25,876 )     1,999  

Accumulated other comprehensive loss

    (2,451 )     (525 )

Total partners' capital

    34,368       73,855  

Non-controlling interests

    9,633       26,573  

Total owners' equity

    44,001       100,428  

Total liabilities and owners' equity

  $ 205,713     $ 189,842  

 

See accompanying notes.

  

 
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CYPRESS ENERGY PARTNERS, L.P.

Unaudited Condensed Consolidated Statements of Operations 

For the Three and Nine Months Ended September 30, 2015 and 2014 

(in thousands, except unit and per unit data) 

 

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 

Revenues

  $ 96,408     $ 111,016     $ 281,427     $ 302,261  

Costs of services

    84,307       97,735       248,014       265,257  

Gross margin

    12,101       13,281       33,413       37,004  

Operating costs and expense:

                               

General and administrative

    6,024       5,437       17,353       15,358  

Depreciation, amortization and accretion

    1,481       1,582       4,113       4,719  

Impairments

    5,567       -       5,567       -  

Operating income (loss)

    (971 )     6,262       6,380       16,927  
                                 

Other (expense) income:

                               

Interest expense, net

    (1,623 )     (795 )     (4,070 )     (2,352 )

Offering costs

    -       -       -       (446 )

Other, net

    1,043       43       1,106       68  

Net income (loss) before income tax expense

    (1,551 )     5,510       3,416       14,197  

Income tax expense

    89       413       371       654  

Net income (loss)

    (1,640 )     5,097       3,045       13,543  
                                 

Net income attributable to non-controlling interests

    169       1,542       259       3,564  

Net income (loss) attributable to partners

    (1,809 )     3,555       2,786       9,979  
                                 

Net income (loss) attributable to general partner

    -       -       (183 )     646  

Net income (loss) attributable to limited partners

  $ (1,809 )   $ 3,555     $ 2,969     $ 9,333  
                                 

Net income (loss) attributable to limited partners allocated to:

                               

Common unitholders

  $ (905 )   $ 1,778     $ 1,485     $ 4,667  

Subordinated unitholders

    (904 )     1,777       1,484       4,666  
    $ (1,809 )   $ 3,555     $ 2,969     $ 9,333  
                                 

Net income (loss) per common limited partner unit

                               

Basic

  $ (0.15 )   $ 0.30     $ 0.25     $ 0.79  

Diluted

  $ (0.15 )   $ 0.30     $ 0.25     $ 0.78  
                                 

Net income (loss) per subordinated limited partner unit - basic and diluted

  $ (0.15 )   $ 0.30     $ 0.25     $ 0.79  
                                 

Weighted average common units outstanding:

                               

Basic

    5,920,467       5,913,000       5,917,981       5,913,000  

Diluted

    5,920,467       5,978,804       5,917,981       5,986,328  
                                 

Weighted average subordinated units outstanding - basic and diluted

    5,913,000       5,913,000       5,913,000       5,913,000  

 

See accompanying notes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)

For the Three and Nine Months Ended September 30, 2015 and 2014 

(in thousands) 

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
                                 

Net income (loss)

  $ (1,640 )   $ 5,097     $ 3,045     $ 13,543  

Other comprehensive loss - foreign currency translation

    (654 )     (497 )     (1,402 )     (541 )
                                 

Comprehensive income (loss)

  $ (2,294 )   $ 4,600     $ 1,643     $ 13,002  
                                 

Comprehensive income (loss) attributable to non-controlling interests

    169       1,294       (198 )     3,446  
                                 

Comprehensive income (loss) attributable to partners

  $ (2,463 )   $ 3,306     $ 1,841     $ 9,556  

 

See accompanying notes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Unaudited Condensed Consolidated Statements of Cash Flows

For the Nine Months Ended September 30, 2015 and 2014

(in thousands) 

 

   

Nine Months Ended September 30,

 
   

2015

   

2014

 

Operating activities:

               

Net income

  $ 3,045     $ 13,543  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Depreciation, amortization and accretion

    4,493       4,847  

Impairments

    5,567       -  

(Gain) loss on asset disposals

    (1,001 )     3  

Interest expense from debt issuance cost amortization

    408       565  

Amortization of equity-based compensation

    828       594  

Equity earnings in investee company

    (81 )     (16 )

Distributions from investee company

    50       -  

Deferred tax (benefit) expense, net

    (58 )     23  

Non-cash allocated expenses

    183       -  

Changes in assets and liabilities:

               

Trade accounts receivable

    769       (1,539 )

Prepaid expenses and other

    (478 )     (1,185 )

Accounts payable and accrued payroll and other

    8,635       8,854  

Income taxes payable

    (167 )     (15,517 )

Net cash provided by operating activities

    22,193       10,172  
                 

Investing activities:

               

Proceeds from asset disposals

    1,002       -  

Cash paid for acquisition of 49.9% interest in the TIR Entities (Note 4)

    (52,588 )     -  

Cash paid for acquisition of 51% interest in Brown Integrity, LLC, net of cash acquired (Note 4)

    (10,436 )     -  

Purchase of property and equipment

    (1,651 )     (471 )

Net cash used in investing activities

    (63,673 )     (471 )
                 

Financing activities:

               

Proceeds from initial public offering

    -       80,213  

Distribution of initial public offering proceeds to Cypress Energy Holdings, LLC

    -       (80,213 )

Payment of deferred offering costs

    -       (314 )

Advances on long-term debt

    68,800       5,000  

Repayment of long-term debt

    (5,500 )     (5,000 )

Payments on behalf of affiliates

    -       (279 )

Net advances from members

    -       314  

Distributions to limited partners

    (14,423 )     (8,258 )

Distributions to non-controlling members of the TIR Entities

    (1,567 )     (2,797 )

Net cash provided by (used in) financing activities

    47,310       (11,334 )
                 

Effect of exchange rates on cash

    (910 )     (363 )
                 

Net increase in cash and cash equivalents

    4,920       (1,996 )

Cash and cash equivalents, beginning of period

    20,757       26,690  

Cash and cash equivalents, end of period

  $ 25,677     $ 24,694  
                 
Non-cash items:                
Accounts payable excluded from capital expenditures   $ -     $ 10  

See accompanying notes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Unaudited Condensed Consolidated Statement of Owners' Equity 

For the Nine Months Ended September 30, 2015 

(in thousands) 

 

   

General Partner

   

Common Units

   

Subordinated Units

   

Accumulated Other Comprehensive Loss

   

Non-controlling Interests

   

Total Owners' Equity

 
                                                 

Owners' equity at December 31, 2014

  $ 1,999     $ 6,285     $ 66,096     $ (525 )   $ 26,573     $ 100,428  

Net income (loss) for the nine months ended September 30, 2015

    (183 )     1,485       1,484       -       259       3,045  

Foreign currency translation adjustment

    -       -       -       (945 )     (457 )     (1,402 )

Acquisition of 49.9% interest in the TIR Entities (Note 4)

    (27,729 )     -       -       (981 )     (23,878 )     (52,588 )

Acquisition of 51% interest in Brown Integrity, LLC (Note 4)

    -       -       -       -       9,497       9,497  

Acquisition of 49% interest in Cypress Energy Services, LLC (Note 9)

    -       470       470       -       (940 )     -  

Contribution from general partner

    183       -       -       -       -       183  

Distributions to partners

    -       (7,214 )     (7,209 )     -       -       (14,423 )

Distributions to non-controlling interests

    (146 )     -       -       -       (1,421 )     (1,567 )

Equity-based compensation

    -       708       120       -       -       828  
                                                 

Owners' equity at September 30, 2015

  $ (25,876 )   $ 1,734     $ 60,961     $ (2,451 )   $ 9,633     $ 44,001  

 

See accompanying notes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

  Notes to the Unaudited Condensed Consolidated Financial Statements

 

1.  Organization and Operations

 

Cypress Energy Partners, L.P. (the “Partnership”) is a Delaware limited partnership formed in 2013 to provide independent pipeline inspection and integrity services to producers and pipeline companies and to provide salt water disposal (“SWD”) and other water and environmental services to U.S. onshore oil and natural gas producers and trucking companies.  Trading of our common units began January 15, 2014 on the New York Stock Exchange under the symbol “CELP.” At our Initial Public Offering (“IPO”), 4,312,500 of our outstanding 5,920,467 common units were made available to the general public. The remaining common units and 100% of the subordinated units are constructively owned by affiliates, employees and directors of the Partnership. 

 

Our business is organized into the Pipeline Inspection Services (“PIS”), Integrity Services (“IS”) and Water and Environmental Services (“W&ES”) reportable segments.  In conjunction with our acquisition of a 51% interest in Brown Integrity, LLC (see Note 4), we changed our reportable segments during the second quarter of 2015 by adding the IS segment (see Note 12). In addition, the Pipeline Inspection and Integrity Services segment was renamed Pipeline Inspection Services. PIS provides pipeline inspection and other services to energy exploration and production (“E&P”) and mid-stream companies and their vendors throughout the United States and Canada.  The inspectors of PIS perform a variety of inspection services on midstream pipelines, gathering systems and distribution systems, including data gathering and supervision of third-party construction, inspection, and maintenance and repair projects. 

 

IS provides independent integrity services to major natural gas and petroleum pipeline companies, as well as pipeline construction companies located throughout the United States. Field personnel in this segment primarily perform hydrostatic testing on newly constructed and existing natural gas and petroleum pipelines.

   

W&ES provides services to oil and natural gas producers and trucking companies through its ownership and operation of eight commercial SWD facilities in the Bakken Shale region of the Williston Basin in North Dakota and two in the Permian Basin in Texas.  All of the facilities utilize specialized equipment and remote monitoring to minimize downtime and increase efficiency for peak utilization.  These facilities also contain oil skimming processes that remove any remaining oil from water delivered to the sites.  In addition to these SWD facilities, we provide management and staffing services for a third-party SWD facility pursuant to a management agreement (see Note 9).  We also own a 25% member interest in the managed well.

 

2.  Basis of Presentation and Summary of Significant Accounting Policies

   

Basis of Presentation

 

The Unaudited Condensed Consolidated Financial Statements as of and for the three and nine months ended September 30, 2015 and 2014 include our accounts and those of our controlled subsidiaries. Investments where we do not have the ability to exercise control, but do have the ability to exercise significant influence, are accounted for using the equity method of accounting. All significant intercompany transactions and account balances have been eliminated in consolidation. The Condensed Consolidated Balance Sheet at December 31, 2014 is derived from audited financial statements.

 

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim consolidated financial information and in accordance with the rules and regulations of the Securities and Exchange Commission.  The Unaudited Condensed Consolidated Financial Statements include all adjustments considered necessary for a fair presentation of the financial position and results of operations for the interim periods presented.  Such adjustments consist only of normal recurring items, unless otherwise disclosed herein.  Accordingly, the Unaudited Condensed Consolidated Financial Statements do not include all the information and notes required by GAAP for complete consolidated financial statements.  However, we believe that the disclosures made are adequate to make the information not misleading.  These interim Unaudited Condensed Consolidated Financial Statements should be read in conjunction with our audited financial statements as of and for the year ended December 31, 2014 included in our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 8, 2015. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year.

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Use of Estimates in the Preparation of Financial Statements

 

The preparation of the Unaudited Condensed Consolidated Financial Statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in these financial statements and accompanying notes.  Actual results could differ from those estimates.

 

Significant Accounting Policies

 

Our significant accounting policies are consistent with those disclosed in Note 2 included in our Current Report on Form 8-K filed with the Securities and Exchange Commission on June 8, 2015, containing our amended Consolidated Financial Statements for the year ended December 31, 2014.

 

Income Taxes

 

A publicly-traded partnership is required to generate at least 90% of its gross income (as defined for federal income tax purposes) from certain qualifying sources.  At least 90% of our gross income has been qualifying income since our IPO.

 

As a limited partnership, we generally are not subject to federal, state or local income taxes.  The tax on the Partnership’s net income (loss) is generally borne by the individual partners.  Net income (loss) for financial statement purposes may differ significantly from taxable income of the partners as a result of differences between the tax basis and financial reporting basis of assets and liabilities and the taxable income allocation requirements under our partnership agreement.  The aggregated difference in the basis of our net assets for financial and tax reporting purposes cannot be readily determined because information regarding each partners’ tax attributes in us is not available to us. The Partnership’s Canadian activity remains taxable in Canada, as well as the activities of a wholly owned subsidiary, Tulsa Inspection Resources – PUC, LLC (“TIR-PUC”), which has elected to be taxed as a corporation for U.S. federal income tax purposes.  Consequently, the Partnership records income tax expense for our Canadian operations, our U.S. corporate operations and any state income and franchise taxes specifically applicable to the Partnership.

 

Non-controlling Interest

 

We have certain consolidated subsidiaries in which outside parties own interests. The non-controlling interest shown in our Unaudited Condensed Consolidated Financial Statements represents the other owners’ share of these entities.

 

Identifiable Intangible Assets

 

Our recorded identifiable intangible assets primarily include customer lists, trademarks and trade names.  Identifiable intangible assets with finite lives are amortized over their estimated useful lives, which is the period over which the asset is expected to contribute directly or indirectly to our future cash flows.  We have no indefinite-lived intangibles other than goodwill.  The determination of the fair value of the intangible assets and the estimated useful lives are based on an analysis of all pertinent factors including (1) the use of widely-accepted valuation approaches, the income approach, or the cost approach, (2) our expected use of the asset, (3) the expected useful life of related assets, (4) any legal, regulatory, or contractual provisions, including renewal or extension periods that would cause substantial costs or modifications to existing agreements, and (5) the effects of demand, competition, and other economic factors.  Should any of the underlying assumptions indicate that the value of the intangible assets might be impaired, we may be required to reduce the carrying value and subsequent useful life of the asset.  If the underlying assumptions governing the amortization of an intangible asset were later determined to have significantly changed, we may be required to adjust the amortization period of such asset to reflect any new estimate of its useful life.  Any write-down of the value or unfavorable change in the useful life of an intangible asset would increase expense at that time.  There were no impairments of identifiable intangible assets during the three and nine month periods ended September 30, 2015 or 2014.

   

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

   

Goodwill

 

Goodwill is not amortized, but is subject to an annual review on November 1 (or at other dates if events or changes in circumstances indicate that the carrying value of goodwill may be impaired) for impairment at a reporting unit level.  The reporting unit or units used to evaluate and measure goodwill for impairment are determined primarily from the manner in which the business is managed or operated.  A reporting unit is an operating segment or a component that is one level below an operating segment.  We have determined that PIS, IS and W&ES are the appropriate reporting units for testing goodwill impairment.  The accounting estimate relative to assessing the impairment of goodwill is a critical accounting estimate for each of our reportable segments. There were no impairments of goodwill during the three and nine month periods ended September 30, 2015 or 2014.

 

Impairments of Long-Lived Assets

 

We assess property and equipment for possible impairment whenever events or changes in circumstances indicate that the carrying value of the assets may not be recoverable. Such indicators include, among others, the nature of the asset, the projected future economic benefit of the asset, changes in regulatory and political environments and historical and future cash flow and profitability measurements. If the carrying value of an asset exceeds the future undiscounted cash flows expected from the asset, we recognize an impairment charge for the excess of carrying value of the asset over its estimated fair value. Determination as to whether and how much an asset is impaired involves management estimates on highly uncertain matters such as future commodity prices, the effects of inflation on operating expenses and the outlook for national or regional market supply and demand for the services we provide. We recorded impairments of long-lived assets for the three and nine month periods ended September 30, 2015 of $5.6 million (Note 5). There were no impairments recorded for the three and nine month periods ended September 30, 2014.

 

New Accounting Standards

 

The Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09 – Revenue from Contracts with Customers in May 2014.  ASU 2014-09 is intended to clarify the principles for recognizing revenue and develop a common standard for recognizing revenue for GAAP and International Financial Reporting Standards that is applicable to all organizations.  The Partnership was originally required to comply with this ASU beginning in 2017.  However, in August, the FASB issued ASU 2015-14 – Revenue from Contracts with Customers effectively delaying the Partnership’s implementation of this standard for one year to periods beginning after December 15, 2017. We are currently evaluating the financial impact of this ASU on the Partnership.  We do not anticipate that the adoption of this ASU will materially impact our financial position, results of operations or cash flows.

 

The FASB issued ASU 2015-03 – Interest – Imputation of Interest in April 2015. This guidance requires debt issuance costs related to our long-term debt (currently reflected as a non-current asset) to be presented on the balance sheet as a reduction of the carrying amount of the long-term debt. The Partnership will be required to comply with this ASU beginning in 2016. It requires retrospective application and we plan to adopt this guidance beginning in the first quarter of 2016. We are currently reviewing the new requirements to determine the impact this guidance will have on our Consolidated Financial Statements.

 

The FASB issued ASU 2015-06 – Earnings Per Share in April 2015. The amendments in this update specify that for purposes of calculating historical earnings per unit under the two-class method, the earnings (losses) of a transferred business before the date of a dropdown transaction should be allocated entirely to the general partner. The amendments should be applied retrospectively for all financial statements presented. This ASU will be effective for fiscal and interim periods beginning after December 15, 2015. The Partnership does not anticipate that the adoption of this ASU will materially impact our financial position, results of operations or cash flows.

 

In June 2015, the FASB issued ASU 2015-10 – Technical Corrections and Improvements. The amendments in this update represent changes to clarify the Accounting Standards Codification (“ASC”), or make minor improvements to the ASC that are not expected to have a significant effect on current accounting practice or create a significant administrative cost to the Partnership. Specifically as it relates to the Partnership, for nonrecurring fair value measurements estimated at a date during the reporting period other than the end of the reporting period, we are required to clearly indicate that the fair value information presented is not as of the period’s end, as well as the date or period that the measurement was determined. The effective date of this guidance varies based on the amendments in the ASU, however, the fair value portion of the ASU referred to above was effective upon its issuance.

 

Business Combinations – ASU 2015-16 was issued by the FASB in September 2015. Essentially, the amendments in the ASU require that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This will require the Partnership to disclose, by line item, current period earnings adjustments to amounts that otherwise would have been recorded in previous reporting periods as if the adjustment(s) had been recognized as of the acquisition date beginning with fiscal periods after December 15, 2015.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

    

3.  Initial Public Offering

 

On January 21, 2014, the Partnership completed its IPO consisting of 4,312,500 common units, representing limited partner interests in the Partnership at a price to the public of $20.00 per common unit ($18.70 per common unit, net of underwriting discounts, commissions and fees) which included a 562,500 unit over-allotment option that was exercised by the underwriters.  We received proceeds of $80.2 million from the IPO, after deducting underwriting discounts and structuring fees.  The net proceeds from the IPO were distributed to Cypress Energy Holdings II, LLC (“Holdings II”), a wholly owned subsidiary of Cypress Energy Holdings, LLC (“Holdings”), as reimbursement for certain capital expenditures it incurred with respect to assets contributed to us.

 

Total incurred deferred offering costs of $2.9 million were charged to Owners’ Equity against the proceeds of the IPO.  The Partnership incurred $0.4 million of offering costs during the nine months ended September 30, 2014 that were expensed as incurred.  No offering costs were incurred during the three or nine month periods ended September 30, 2015.  These non-recurring costs are reflected as offering costs in the Unaudited Condensed Consolidated Statements of Operations for the nine months ended September 30, 2014.

 

In connection with the IPO, Holdings II conveyed a 100% interest in Cypress Energy Partners, LLC ("CEP LLC") in exchange for a 47.8% limited partner interest in the Partnership and the right to receive the proceeds of the IPO. In addition, affiliates of Holdings, conveyed an aggregate 50.1% interest in Tulsa Inspection Resources, LLC (“TIR LLC”), Tulsa Inspection Resources – Nondestructive Examination, LLC and Tulsa Inspection Resources Holdings, LLC (collectively, the “TIR Entities”) to the Partnership in exchange for an aggregate 15.7% limited partner interest in the Partnership. The Partnership subsequently acquired the remaining 49.9% interest in the TIR Entities (Note 4).

 

4. Acquisitions

 

Brown Integrity, LLC

 

 

On May 6, 2015, the Partnership acquired a 51% interest in Brown Integrity, LLC (“Brown”), a hydrostatic testing integrity services business for $10.4 million (net of cash acquired) financed through the Partnership’s credit facilities.  In addition, provisions in the purchase agreement provide for earn-out payments totaling up to $9.5 million dependent upon Brown’s achieving certain financial milestones over a two-year period post-acquisition. Based on actual results since acquisition and forecasted results through the remainder of the earn-out period, we have not recorded a liability for the contingent consideration associated with this earn-out as it is currently considered remote that an earn-out will be earned and paid. The Partnership also has the right, but not the obligation, to acquire the remaining 49% of Brown commencing May 1, 2017 pursuant to a formula that would yield a maximum additional purchase price of $28.0 million in any combination of cash and Partnership units. The effective date of the transaction was May 1, 2015.

 

The acquisition of Brown qualified as a business combination and was accounted for under the acquisition method of accounting. We have recognized amounts for identified tangible and intangible assets acquired and liabilities assumed at their estimated acquisition date fair values based on discounted cash flow projections, estimated replacement cost and other valuation techniques. The Partnership used an estimate of replacement cost, based on comparable market prices, to value the acquired property and equipment and utilized discounted cash flows to value the intangible assets. Key assumptions used in the valuations included projections of future operating results and the Partnership’s estimated weighted average cost of capital. Due to the unobservable nature of these inputs, these estimates are considered Level 3 fair value estimates.

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

   

The preliminary allocated purchase price and assessment of the fair value of the assets acquired and liabilities assumed as of the purchase date were as follows:

 

   

(in thousands)

 
         

Cash

  $ 175  

Accounts receivable

    3,229  

Other current assets

    108  

Property and equipment

    2,578  

Intangible assets:

       

Customer relationships

    3,128  

Trade names and trademarks

    2,049  

Non-competition agreements

    143  

Goodwill

    9,992  

Fair value of assets acquired

    21,402  

Fair value of current liabilities

    1,294  

Fair value of non-controlling interests

    9,497  

Purchase price

  $ 10,611  

 

Intangible assets will be amortized on a straight-line basis over periods ranging from 5 – 10 years. Goodwill represents the excess of the purchase price and the fair value of non-controlling interests over the fair value of identified tangible and intangible assets less the fair value of liabilities assumed. The Partnership believes that the locations, synergies created, and the projected future cash flows of Brown merit the recognition of this asset. The goodwill is fully deductible for income tax purposes by our partners. 

 

Summarized as reported and pro forma information for the three and nine month periods ended September 30, 2015 and 2014 follows:

 

   

Three months ended September 30,

   

Nine months ended September 30,

 
   

2015

   

2014

   

2015

   

2014

 
    (in thousands)  
                                 

Revenues - as reported

  $ 96,408     $ 111,016     $ 281,427     $ 302,261  

Revenues - pro forma

    96,408       114,824       285,659       310,660  
                                 
                                 

Net income (loss) - as reported

  $ (1,640 )   $ 5,097     $ 3,045     $ 13,543  

Net income (loss) - pro forma

    (1,640 )     5,365       2,381       14,040  

 

These pro forma results are for comparative purposes only and may not be indicative of the results that would have occurred had the acquisition happened as of the beginning of the periods presented or results that may be attained in the future.

 

The operating results of Brown are included in our Integrity Services segment which was created during the second quarter of 2015 in conjunction with the Brown acquisition (see Note 12).

 

TIR Entities

 

Effective February 1, 2015, the Partnership acquired the remaining 49.9% interest in the TIR Entities previously held by affiliates of Holdings for $52.6 million. We financed this acquisition with borrowings under our acquisition revolving credit facility (see Note 6). The amount paid in excess of the previously recorded non-controlling interest in the TIR Entities has been reflected in the Unaudited Condensed Consolidated Statement of Owners’ Equity as a distribution to the general partner.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

5.  Impairments

 

During the three month period ended September 30, 2015, the Partnership recorded impairments of property and equipment at four of its SWD facilities. At each of these facilities, the Partnership has experienced declining disposal volumes and revenues due to lower commodity pricing and increasing competition. The Partnership is forecasting that volumes and revenues at these facilities will not recover to historical levels in the foreseeable future. Given these indicators of impairment, the Partnership compared its estimate of undiscounted future cash flows from the facilities, and determined they were no longer recoverable and were therefore impaired.

 

The Partnership wrote the facility assets down from their net carrying value of $7.3 million to their estimated fair value of $1.7 million and recognized impairments of the facilities totaling $5.6 million which is included in impairments on the Unaudited Condensed Consolidated Statement of Operations for the three and nine month periods ended September 30, 2015. The following table shows the impaired property and equipment by category.

 

Land improvements

  $ 339  

Buildings and leasehold improvements

    489  

Facilities, wells and equipment

    5,974  
      6,802  

Accumulated depreciation

    (1,236 )

Impairment of facilities

  $ 5,567  

 

Fair value was determined using expected future cash flows, which is a Level 3 input as defined in ASC 820, Fair Value Measurement.  The cash flows are those expected to be generated by market participants, discounted for a risk adjusted estimated fair market cost of capital.  Because of the uncertainties surrounding the facilities and the market conditions, including the Partnership’s ability to generate and maintain sufficient revenues to operate the facilities profitably, our estimate of expected future cash flows may change in the near term resulting in the need to further adjust our determination of fair value.

 

6.  Credit Agreement

 

The Partnership is party to a credit agreement (as amended, the “Credit Agreement”) that provides up to $200.0 million in borrowing capacity, subject to certain limitations. The Credit Agreement includes a working capital revolving credit facility (“WCRCF”), which provides up to $75.0 million in borrowing capacity to fund working capital needs and an acquisition revolving credit facility (“ARCF”), which provides up to $125.0 million in borrowing capacity to fund acquisitions and expansion projects. In addition, the credit agreement provides for an accordion feature that allows us to increase the availability under the facilities by an additional $125.0 million. The Credit Agreement matures December 24, 2018.

 

At September 30, 2015 and December 31, 2014, outstanding borrowings under the credit agreement totaled $140.9 million and $77.6 million, respectively. Borrowings under the WCRCF totaled $52.0 and $50.0 million at September 30, 2015 and December 31, 2014, respectively. Borrowings under the WCRCF are limited by a monthly borrowing base calculation as defined in the Credit Agreement.  If, at any time, outstanding borrowings under the WCRCF exceed the Partnership’s calculated borrowing base, principal in the amount of the excess is due upon submission of the borrowing base calculation.  Borrowings under the ARCF totaled $88.9 million and $27.6 million at September 30, 2015 and December 31, 2014, respectively. Available borrowings under the ARCF may be limited by certain financial covenant ratios as defined in the agreement. The obligations under our Credit Agreement are secured by a first priority lien on substantially all assets of the Partnership.

           

All borrowings under the Credit Agreement bear interest, at our option, on a leveraged based grid pricing at (i) a base rate plus a margin of 1.25% to 2.75% per annum (“Base Rate Borrowing”) or (ii) an adjusted LIBOR rate plus a margin of 2.25% to 3.75% per annum (“LIBOR Borrowings”).  The applicable margin is determined based on the leverage ratio of the Partnership, as defined in the credit agreement.  Generally, the interest rate on credit agreement borrowings ranged between 2.68% and 4.09% for the nine months ended September 30, 2015 and 2.65% and 3.50% for the nine months ended September 30, 2014.  Interest on Base Rate Borrowings is payable monthly.  Interest on LIBOR Borrowings is paid upon maturity of the underlying LIBOR contract, but no less often than quarterly.  Commitment fees are charged at a rate of 0.50% on any unused credit and are payable quarterly.  Interest paid during the three months ended September 30, 2015 and 2014 was $1.5 million and $0.5 million, respectively, including commitment fees. Interest paid during the nine months ended September 30, 2015 and 2014 was $3.3 million and $1.7 million, respectively, including commitment fees.

 

Our Credit Agreement contains various customary affirmative and negative covenants and restrictive provisions.  Our Credit Agreement also requires maintenance of certain financial covenants, including a combined total adjusted leverage ratio (as defined in our Credit Agreement) of not more than 4.0 to 1.0 and an interest coverage ratio (as defined in our Credit Agreement) of not less than 3.0 to 1.0.  At September 30, 2015, our total adjusted leverage ratio was 2.55 to 1.0 and our interest coverage ratio was 6.05 to 1.0, pursuant to the Credit Agreement.  Upon the occurrence and during the continuation of an event of default, subject to the terms and conditions of our Credit Agreement, the lenders may declare any outstanding principal of our Credit Agreement debt, together with accrued and unpaid interest, to be immediately due and payable and may exercise the other remedies set forth or referred to in our Credit Agreement. We expect to remain in compliance with all of our financial debt covenants throughout the next twelve months.

   

 

In addition, our Credit Agreement restricts our ability to make distributions on, or redeem or repurchase, our equity interests.  However, we may make distributions of available cash so long as, both at the time of the distribution and after giving effect to the distribution, no default exists under our Credit Agreement, the borrowers and the guarantors are in compliance with the financial covenants, the borrowing base (which includes 100% of cash on hand) exceeds the amount of outstanding credit extensions under the WCRCF by at least $5.0 million and at least $5.0 million in lender commitments are available to be drawn under the WCRCF.

 

On May 4, 2015, the Partnership and the Partnership’s lenders entered into Amendment No. 2 to the Credit Agreement (“Amendment”), which amended the Credit Agreement to, among other matters, (i) allow each of Tulsa Inspection Resources – Canada ULC and Foley Inspection Services ULC to join the Credit Agreement as an additional borrower under the Credit Agreement, and (ii) amend certain other provisions of the Credit Agreement as more specifically set forth in the Amendment.

 

7. Income Taxes

 

Income tax expense reflected on the Unaudited Condensed Consolidated Statements of Operations for the three and nine month periods ended September 30, 2015 and 2014 differs from an expected statutory rate of 35% primarily due to the non-taxable nature of partnership earnings for both U.S. federal and, in most cases, state income tax purposes, offset by the corporate income taxes of TIR-PUC, the income taxes related to our Canadian operations and any applicable state income taxes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

8.  Equity Compensation

 

Effective at the closing of the IPO, our General Partner adopted a long-term incentive plan (“LTIP”) that authorized up to 1,182,600 units representing 10% of the initial outstanding units.  Certain directors and employees of the Partnership have been awarded Phantom Restricted Units (“Units”) under the terms of the LTIP.  The fair value of the awards issued is determined based on the quoted market value of the publically traded common units at each grant date, adjusted for a forfeiture rate, and other discounts attributable to the awarded units.  This valuation is considered a Level 3 valuation under the fair value measurement hierarchy.  Compensation expense is amortized over the vesting period of the grant.  Prior to January 1, 2015, Holdings reimbursed the Partnership for the direct expense of the awards and allocated the expense to us through the annual administrative fee provided for under the terms of the omnibus agreement (Note 9).  For the nine months ended September 30, 2015 and 2014, compensation expense of $0.8 million and $0.3 million, respectively, was recorded under the LTIP.  The following table sets forth the LTIP Unit activity for the nine months ended September 30, 2015 and 2014:

 

   

Nine Months Ended September 30,

 
   

2015

   

2014

 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Number

   

Date Fair

   

Number

   

Date Fair

 
   

of Units

   

Value / Unit

   

of Units

   

Value / Unit

 
                                 

Units at January 1

    158,353     $ 18.11       -     $ -  

Units granted

    222,755       10.27       171,380       17.99  

Units vested and issued

    (7,467

)

    (19.72

)

    -       -  

Units forfeited

    (19,498

)

    (16.92

)

    (19,911

)

    (16.78

)

Units at September 30

    354,143       13.21       151,469       18.15  

 

 

Outstanding Units issued to directors vest ratably over a three year period from the date of grant.  Units granted to employees vest over either five year, three year or eighteen month periods from the date of grant. For the five year awards, one third vests at the end of the third year, one third at the end of the fourth year and one third at the end of the fifth year. The eighteen month awards vest 100% at the end of the vesting period. Certain Units issued in the third quarter of 2015 vest 100% at the end of three years if certain performance measures are met as outlined in the performance award grant. Some of the awards vest in full upon the occurrence of certain events as defined in the LTIP agreement.

 

In conjunction with the IPO, phantom profits interest units previously issued under a previous LTIP were exchanged for 44,250 Units under the Partnership’s LTIP.  Vesting under all of the exchanged awards was retroactive to the initial grant date.  The awards are considered for all purposes to have been granted under the Partnership’s LTIP. 

 

In addition, at IPO, certain profits interest units previously issued were converted into 44,451 subordinated units of the Partnership outside of the LTIP.  Vesting for the subordinated units is retroactive to the initial grant date.  Compensation expense associated with the subordinated units was $0.1 million and $0.3 million for the nine months ended September 30, 2015 and 2014, respectively.  The exchange of the phantom profits interest units and the profits interest units resulted in the reversal of the existing equity compensation liability of $0.1 million in the first quarter of 2014 as the new awards were accounted for as equity.

 

9.  Related-Party Transactions

   

Transactions with SBG Energy Services, LLC (SBG Energy) and Subsidiaries.

 

SBG Energy is a business partner in our SWD operations in which a current board member has an ownership and management interest. Effective June 1, 2015, an affiliate of SBG Energy assigned and transferred its 49% membership interest in Cypress Energy Services, LLC (“CES LLC”) to the Partnership for one dollar (the “CES Transaction”). As a result, the Partnership now owns 100% of CES LLC. Because we already controlled and consolidated CES LLC in our Consolidated Financial Statements, the previously recorded non-controlling interest in CES LLC has been reflected in the Unaudited Condensed Consolidated Statement of Owners’ Equity as an increase in equity of $0.9 million for our common and subordinated unitholders.

 

The CES Transaction was completed in conjunction with another transaction with SBG Energy effective July 1, 2015. On that date, the Partnership waived its rights to purchase and its rights of first refusal related to certain SWD assets pursuant to a previous option agreement with SBG Energy in exchange for $1.0 million. The $1.0 million payment has been reflected as other income on the Unaudited Condensed Consolidated Statements of Operations for the three and nine months ended September 30, 2015.

 

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Omnibus Agreement

 

Effective as of the closing of the IPO, we entered into an omnibus agreement with Holdings and other related parties. The omnibus agreement, as amended in February 2015, governs the following matters, among other things:

  

 

our payment of an annual administrative fee in the amount of $4.04 million and $4.0 million for the years ended December 31, 2015 and 2014, respectively, to be paid in quarterly installments (pro-rated in 2014 from the IPO date) to Holdings for providing certain partnership overhead services, including certain executive management services by certain officers of our General Partner, and payroll services for substantially all employees required to manage and operate our businesses.  This fee also includes the incremental general and administrative expenses we incur as a result of being a publicly traded partnership;

 

 

our right of first offer on Holdings’ and its subsidiaries’ assets used in, and entities primarily engaged in, providing SWD and other water and environmental services; and

 

 

indemnification of us by Holdings for certain environmental and other liabilities, including events and conditions associated with the operation of assets that occurred prior to the closing of the IPO and our obligation to indemnify Holdings for events and conditions associated with the operation of our assets that occur after the closing of the IPO and for environmental liabilities related to our assets to the extent Holdings is not required to indemnify us.

 

So long as Holdings controls our General Partner, the omnibus agreement will remain in full force and effect, unless we and Holdings agree to terminate it sooner.  If Holdings ceases to control our General Partner, either party may terminate the omnibus agreement, provided that the indemnification obligations will remain in full force and effect in accordance with their terms.  We and Holdings may agree to amend the omnibus agreement; however, amendments will also require the approval of the Conflicts Committee of our Board of Directors.

   

The amount charged by Holdings for the nine months ended September 30, 2015 and 2014 was $3.03 million and $2.8 million, respectively. The amount charged by Holdings for the three months ended September 30, 2015 and 2014 was $1.01 million and $1.0 million, respectively. These amounts are reflected in general and administrative in the Unaudited Condensed Consolidated Statements of Operations. In addition to the expense charged under the omnibus agreement, Holdings incurred general and administrative expenses on our behalf totaling $0.2 million. These expenses are reflected as general and administrative in the Unaudited Condensed Consolidated Statement of Operations for the three and nine month periods ended September 30, 2015 and as an equity contribution in the Unaudited Condensed Consolidated Statement of Owner’s Equity.

  

Other Related Party Transactions

   

A current board member has an ownership interest in entities with which the Partnership transacts business – Rud Transportation, LLC (“Rud”) and SBG Pipeline SW 3903, LLC (“3903”).  Total revenue recognized by the Partnership from Rud was $0.2 million and $0.4 million for the three months and $1.0 million and $1.8 million for the nine months ended September 30, 2015 and 2014, respectively.  Accounts receivable from Rud was $0.2 million and $0.3 million at September 30, 2015 and December 31, 2014, respectively, and is included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets. Total revenue recognized by the Partnership from 3903 was $0.5 million for the nine months ended September 30, 2015, prior to the sale of the ownership interest to an unrelated third party effective June 30, 2015. There were no revenues received from 3903 for the nine months ended September 30, 2014.  Accounts receivable from 3903 was $0.1 million at December 31, 2014 and is included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets.

 

The Partnership provides management services to a 25% owned investee company, Alati Arnegard, LLC (“Arnegard”).  Management fee revenue earned from Arnegard totaled $0.2 million and $0.5 million for the three and nine months ended September 30, 2015 and 2014, respectively.  Accounts receivable from Arnegard was less than $0.1 million at September 30, 2015 and $0.1 million at December 31, 2014, and is included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets.

   

CES LLC outsources staffing and payroll services to an unconsolidated affiliated entity, Cypress Energy Management – Bakken Operations, LLC (“CEM-BO”).  CEM-BO was owned 49% by SBG Energy. Effective June 1, 2015, Holdings acquired the 49% ownership interest of CEM-BO and now owns 100% of CEM-BO.  Total employee related costs paid to CEM-BO was $1.2 million for the nine months ended September 30, 2015 (prior to the 49% acquisition) and $0.8 million and $2.5 million for the three and nine months ended September 30, 2014, respectively.  Included in accounts payable on the Unaudited Condensed Consolidated Balance Sheets was a payable to CEM-BO of $0.2 million at December 31, 2014.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

10.  Earnings per Unit and Cash Distributions

 

Subsequent to the IPO, the Partnership presents earnings per unit information in accordance with ASC Topic 260 – Earnings Per Share.

 

Net income (loss) per unit applicable to limited partners (including subordinated unitholders) is computed by dividing net income (loss) attributable to limited partners, after deducting the General Partner’s incentive distributions, if any, by the weighted-average number of outstanding common and subordinated units.  Diluted net income (loss) per common unit includes the dilutive impact of unvested Units granted under the LTIP.  Our net income (loss) attributable to limited partners is allocated to the common and subordinated unitholders in accordance with their respective partnership percentages, after giving effect to priority income allocations for incentive distributions and other adjustments, if any, to our General Partner, pursuant to our partnership agreement.  Net income (loss) per unit is only calculated for the Partnership subsequent to the IPO as no units were outstanding prior to January 21, 2014.  The excess or shortfall of earnings relative to distributions is allocated to the limited partners based on their respective ownership interests.  Payments made to our unitholders are determined in relation to actual distributions declared and are not based on the net income (loss) allocations used in the calculation of net income (loss) per unit.  For the three months ended September 30, 2015, the weighted-average number of units outstanding was 11,833,467, comprised of 5,920,467 common units and 5,913,000 subordinated units. For the nine months ended September 30, 2015, the weighted-average number of units outstanding was 11,830,981, comprised of 5,917,981 common units and 5,913,000 subordinated units. For the three and nine month periods ended September 30, 2014, the weighted-average number of units outstanding was 11,826,000, comprised of 5,913,000 common units and 5,913,000 subordinated units.

 

In addition to the common and subordinated units, we have also identified incentive distribution rights as participating securities and use the two-class method when calculating the net income (loss) per unit applicable to limited partners, which is based on the weighted-average number of units outstanding during the period.

 

Our partnership agreement calls for minimum quarterly cash distributions.  The following table summarizes the cash distributions declared and paid by the Partnership since our IPO.  There were no cash distributions declared or paid prior to these distributions.

 

                   

Total Cash

 
   

Per Unit Cash

   

Total Cash

   

Distributions

 

Payment Date

 

Distributions

   

Distributions

   

to Affiliates (c)

 
           

(in thousands)

         
                         

May 15, 2014 (a)

  $ 0.301389     $ 3,565     $ 2,264  

August 14, 2014

    0.396844       4,693       2,980  

November 14, 2014

    0.406413       4,806       3,052  

Total 2014 Distributions

    1.104646       13,064       8,296  
                         

February 14, 2015

    0.406413       4,806       3,052  

May 14, 2015

    0.406413       4,808       3,053  

August 14, 2015

    0.406413       4,809       3,087  

November 13, 2015 (b)

    0.406413       4,809       3,092  

Total 2015 Distributions (through November 13, 2015)

    1.625652       19,232       12,284  
                         

Total Distributions (through November 13, 2015) since IPO

  $ 2.730298     $ 32,296     $ 20,580  

 

(a)     Distribution was pro-rated from the date of our IPO through March 31, 2014.

(b)     Third quarter 2015 distribution was declared and paid in the fourth quarter of 2015.  

(c)     Approximately 64.3% of the Partnership's outstanding units at September 30, 2015 are held by affiliates.

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

In addition, the TIR Entities made cash distributions of $1.6 million during the nine month period ended September 30, 2015 to the non-controlling members of the TIR Entities prior to the Partnership’s acquisition of the remaining 49.9% interest effective February 1, 2015. During the three and nine month periods ended September 30, 2014, the TIR Entities made cash distributions of $1.5 million and $2.8 million to the non-controlling members of the TIR Entities, respectively.

 

11.  Commitments and Contingencies

 

Letters of Credit

 

The Partnership has various performance obligations which are secured with short-term security deposits of $0.5 million at September 30, 2015 and December 31, 2014, included in prepaid expenses and other on the Unaudited Condensed Consolidated Balance Sheets.

 

Employment Contract Commitments

 

The Partnership has employment agreements with certain executives.  The executive employment agreements are effective for a term of three-to-five years from the commencement date, after which time they will continue on an “at-will” basis.  These agreements provide for minimum annual compensation, adjusted for annual increases as authorized by the Board of Directors.  Certain agreements provide for severance payments in the event of specified termination of employment.  At September 30, 2015 and December 31, 2014, the aggregate commitment for future compensation and severance was approximately $1.5 million and $0.9 million, respectively.

   

Compliance Audit Contingencies

 

Certain customer master service agreements (“MSA’s”) offer our customers the opportunity to perform periodic compliance audits, which include the examination of the accuracy of our invoices.  Should our invoices be determined to be inconsistent with the MSA, or inaccurate, the MSA’s may provide the customer the right to receive a credit or refund for any overcharges identified.  At any given time, we may have multiple audits ongoing.  Through September 30, 2015, several ongoing audits in the current year have concluded without adjustment to the Partnership. At September 30, 2015 and December 31, 2014, the Partnership recognized an estimated liability of $0.2 million associated with the probable settlement of ongoing customer audits of charges originally approved by customer representatives. These liabilities are reflected in accrued payroll and other on the Unaudited Condensed Consolidated Balance Sheets.

   

Management Service Contracts

   

The Partnership has historically provided management services for non-owned SWD facilities under contractual arrangements. Principals of two of these management services contract customers (under common control) approached the Partnership about selling their interest in the managed SWD facilities to the Partnership. Due to a number of factors, including the depressed energy economy and the proposed asking price for these facilities, the Partnership was unwilling to enter into a purchase agreement for the facilities. Subsequently, in May 2015, the Partnership was notified by these principals that they were terminating the management contracts related to these two facilities. While management of the Partnership believes that the parties do not have the right to terminate the agreements pursuant to the terms of the agreements, the termination of these agreements has resulted in a reduction of management fee revenue and corresponding labor costs associated with staffing the facilities. Management fee revenues related to these contracts totaled $0.3 million for the nine month period ended September 30, 2015. The Partnership did not record any revenue related to these contracts during the three months ended September 30, 2015. Revenues related to these contracts were $0.4 million and $1.1 million for the three and nine month periods ended September 30, 2014, respectively. The Partnership has commenced litigation and settlement discussions regarding the improper termination of the agreements. (See Legal Proceedings.)

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Legal Proceedings

 

On July 3, 2014, a group of former minority shareholders of Tulsa Inspection Resources, Inc. (“TIR Inc.”, the predecessor of the TIR Entities), formerly an Oklahoma corporation, filed a civil action in the United States District Court for the Northern District of Oklahoma against TIR LLC, members of TIR LLC, and certain affiliates of TIR LLC’s members. TIR LLC is the successor in interest to TIR Inc., resulting from a merger between the entities that closed in December 2013 (the “TIR Merger”). The former shareholders of TIR Inc. claim that they did not receive sufficient value for their shares in the TIR Merger and are seeking rescission of the TIR Merger or, alternatively, compensatory and punitive damages. The Partnership is not named as a defendant in this civil action. TIR LLC and the other defendants have been advised by counsel that the action lacks merit. We believe that the possibility of the Partnership incurring material losses as a result of this action is remote. In addition, the Partnership anticipates no disruption in its business operations related to this action.

 

On September 11, 2015, two of our management services customers (under common ownership) initiated a civil action in the District Court for the Northwestern Judicial District of the State of North Dakota against CES LLC. The customers claim that CES LLC breached the management agreements and interfered with their business relationships, and seek to rescind the management agreements and recover any damages. The customers initiated this lawsuit upon dismissal from federal court due to lack of jurisdiction of CES LLC’s lawsuit against the customers seeking to enforce the management agreements. CES LLC subsequently filed an answer and counterclaims, as well as a third party complaint against the principal of the customers seeking to enforce the management agreements and other injunctive relief, as well as monetary damages. We believe that the possibility of the Partnership incurring material losses as a result of this action is remote.

 

12.  Reportable Segments

   

The Partnership’s operations consist of three reportable segments: (i) Pipeline Inspection Services (“PIS”), (ii) Integrity Services (“IS”) and (iii) Water and Environmental Services (“W&ES”).  In conjunction with the Brown acquisition (Note 4) in the second quarter of 2015, we created the IS segment. The economic characteristics of Brown were sufficiently dissimilar from our existing Pipeline Inspection and Integrity Services segment resulting in the creation of a new segment. As a result, the Pipeline Inspection and Integrity Services segment was renamed Pipeline Inspection Services.

 

PIS – This segment represents our pipeline inspection services operations.  We aggregate these operating entities for reporting purposes as they have similar economic characteristics, including centralized management and processing.  This segment provides independent inspection and integrity services to various energy, public utility and pipeline companies.  The inspectors in this segment perform a variety of inspection services on midstream pipelines, gathering systems and distribution systems, including data gathering and supervision of third-party construction, inspection and maintenance and repair projects.  Our results in this segment are driven primarily by the number and type of inspectors performing services for customers and the fees charged for those services, which depend on the nature and duration of the project.

 

IS – This segment includes the acquired operations of Brown Integrity, LLC (Note 4). This segment provides independent hydro-testing integrity services to major natural gas and petroleum pipeline companies, as well as pipeline construction companies located throughout the United States. Field personnel in this segment primarily perform hydrostatic testing on newly constructed and existing natural gas and petroleum pipelines. Results in this segment are driven primarily by field personnel performing services for customers and the fees charged for those services, which depend on the nature, scope and duration of the project.

 

W&ES – This segment includes the operations of ten SWD facilities, fees related to the management of third party SWD facilities, as well as an equity ownership in one managed facility.  We aggregate these operating entities for reporting purposes as they have similar economic characteristics and have centralized management and processing.  Segment results are driven primarily by the volumes of produced water and flowback water we inject into our SWD facilities and the fees we charge for our services.  These fees are charged on a per barrel basis and vary based on the quantity and type of saltwater disposed, competitive dynamics and operating costs.  In addition, for minimal marginal cost, we generate revenue by selling residual oil we recover from the disposed water.

 

Other – These amounts represent corporate and overhead items not specifically allocable to the other reportable segments

 

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

The following tables show operating income (loss) by reportable segment and a reconciliation of segment operating income (loss) to net income (loss) before income tax expense.

 

   

PIS

   

IS

   

W&ES

   

Other

   

Total

 
   

(in thousands)

 
                                         

Three months ended September 30, 2015

                                       
                                         

Revenue

  $ 87,757     $ 5,173     $ 3,478     $ -     $ 96,408  

Costs of services

    79,205       3,643       1,459       -       84,307  

Gross margin

    8,552       1,530       2,019       -       12,101  

General and administrative

    4,140       913       792       179       6,024  

Depreciation, amortization and accretion

    630       157       694       -       1,481  

Impairments

    -       -       5,567       -       5,567  

Operating income (loss)

  $ 3,782     $ 460     $ (5,034 )   $ (179 )     (971 )

Interest expense, net

                                    (1,623 )

Other, net

                                    1,043  

Net loss before income tax expense

                                  $ (1,551 )
                                         
                                         

Three months ended September 30, 2014

                                       
                                         

Revenue

  $ 105,048     $ -     $ 5,968     $ -     $ 111,016  

Costs of services

    95,244       -       2,491       -       97,735  

Gross margin

    9,804       -       3,477       -       13,281  

General and administrative

    4,633       -       804       -       5,437  

Depreciation, amortization and accretion

    634       -       948       -       1,582  

Operating income

  $ 4,537     $ -     $ 1,725     $ -       6,262  

Interest expense, net

                                    (795 )

Other, net

                                    43  

Net income before income tax expense

                                  $ 5,510  

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

   

PIS

   

IS

   

W&ES

   

Other

   

Total

 
   

(in thousands)

 
                                         

Nine months ended September 30, 2015

                                       
                                         

Revenue

  $ 261,072     $ 8,651     $ 11,704     $ -     $ 281,427  

Costs of services

    236,680       6,437       4,897       -       248,014  

Gross margin

    24,392       2,214       6,807       -       33,413  

General and administrative

    12,721       1,476       2,522       634       17,353  

Depreciation, amortization and accretion

    1,884       262       1,967       -       4,113  

Impairments

    -       -       5,567       -       5,567  

Operating income (loss)

  $ 9,787     $ 476     $ (3,249 )   $ (634 )     6,380  

Interest expense, net

                                    (4,070 )

Other, net

                                    1,106  

Net income before income tax expense

                                  $ 3,416  
                                         
                                         

Nine months ended September 30, 2014

                                       
                                         

Revenue

  $ 285,038     $ -     $ 17,223     $ -     $ 302,261  

Costs of services

    258,725       -       6,532       -       265,257  

Gross margin

    26,313       -       10,691       -       37,004  

General and administrative

    13,129       -       2,229       -       15,358  

Depreciation, amortization and accretion

    1,905       -       2,814       -       4,719  

Operating income

  $ 11,279     $ -     $ 5,648     $ -       16,927  

Interest expense, net

                                    (2,352 )

Offering costs

                                    (446 )

Other, net

                                    68  

Net income before income tax expense

                                  $ 14,197  
                                         
                                         

Total Assets

                                       
                                         

September 30, 2015

  $ 140,835     $ 22,471     $ 40,780     $ 1,627     $ 205,713  
                                         

December 31, 2014

  $ 136,224     $ -     $ 50,296     $ 3,322     $ 189,842  

 

 
23

Table Of Contents
 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

13. Condensed Consolidating Financial Information

 

The following financial information reflects consolidating financial information of the Partnership and its wholly owned guarantor subsidiaries and non-guarantor subsidiaries for the periods indicated. The information is presented in accordance with the requirements of Rule 3-10 under the SEC’s Regulation S-X. The financial information may not necessarily be indicative of financial position, results of operations or cash flows had the guarantor subsidiaries or non-guarantor subsidiaries operated as independent entities. The Partnership has not presented separate financial and narrative information for each of the guarantor subsidiaries or non-guarantor subsidiaries because it believes such financial and narrative information would not provide any additional information that would be material in evaluating the sufficiency of the guarantor subsidiaries and non-guarantor subsidiaries. The Partnership anticipates issuing debt securities that will be fully and unconditionally guaranteed by the guarantor subsidiaries. These debt securities will be jointly and severally guaranteed by the guarantor subsidiaries. There are no restrictions on the Partnership’s ability to obtain cash dividends or other distributions of funds from the guarantor subsidiaries.

 

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Balance Sheets

As of September 30, 2015 

(in thousands) 

 

                   

Non-

                 
   

Parent

   

Guarantors

   

Guarantors

   

Eliminations

   

Consolidated

 
                                         

ASSETS

                                       

Current assets:

                                       

Cash and cash equivalents

  $ 70     $ 21,762     $ 3,845     $ -     $ 25,677  

Trade accounts receivable, net

    -       47,768       9,401       (699 )     56,470  

Receivables from affiliates

    -       4,529       -       (4,464 )     65  

Deferred tax assets

    -       2       34       -       36  

Prepaid expenses and other

    -       2,678       403       (38 )     3,043  

Total current assets

    70       76,739       13,683       (5,201 )     85,291  

Property and equipment:

                                       

Property and equipment, at cost

    -       21,763       2,752       -       24,515  

Less: Accumulated depreciation

    -       4,385       286       -       4,671  

Total property and equipment, net

    -       17,378       2,466       -       19,844  

Intangible assets, net

    -       26,704       6,575       -       33,279  

Goodwill

    -       53,913       11,410       -       65,323  

Investment in subsidiaries

    45,319       9,771       -       (55,090 )     -  

Notes receivable - affiliates

    -       14,522       -       (14,522 )     -  

Debt issuance costs, net

    1,910       -       -       -       1,910  

Other assets

    -       56       10       -       66  

Total assets

  $ 47,299     $ 199,083     $ 34,144     $ (74,813 )   $ 205,713  
                                         

LIABILITIES AND OWNERS' EQUITY

                                       

Current liabilities:

                                       

Accounts payable

  $ -     $ 907     $ 2,265     $ -     $ 3,172  

Accounts payable - affiliates

    353       -       4,098       (4,451 )     -  

Accrued payroll and other

    1       16,119       1,389       (712 )     16,797  

Income taxes payable

    -       417       -       (38 )     379  

Total current liabilities

    354       17,443       7,752       (5,201 )     20,348  

Long-term debt

    -       135,400       5,500       -       140,900  

Notes payable - affiliates

    -       -       13,635       (13,635 )