celp20160830_10q.htm Table Of Contents

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, 2016

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 9, 2016, the registrant had 5,945,348 common units and 5,913,000 subordinated units outstanding.

 

DOCUMENTS INCORPORATED BY REFERENCE:     None.

 

 
 

Table Of Contents
 

 

CYPRESS ENERGY PARTNERS, L.P.

 

  Table of Contents

 

 

 

Page

 

 

 

PART I – FINANCIAL INFORMATION

 

 

 

 

ITEM 1.

Condensed Consolidated Financial Statements

5

 

 

 

 

Condensed Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015

5

 

 

 

 

Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2016 and 2015

6

 

 

 

 

Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Nine Months Ended September 30, 2016 and 2015

7

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2016 and 2015

8

 

 

 

 

Condensed Consolidated Statement of Owners’ Equity for the Nine Months Ended September 30, 2016

9

 

 

 

 

Notes to the Condensed Consolidated Financial Statements

10

 

 

 

ITEM 2.

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

35

 

 

 

ITEM 3.

Quantitative and Qualitative Disclosures about Market Risk

53

 

 

 

ITEM 4.

Controls and Procedures

53

 

 

 

PART II – OTHER INFORMATION

 

 

 

 

ITEM 1.

Legal Proceedings

54

 

 

 

ITEM 1A.

Risk Factors

54

 

 

 

ITEM 2.

Unregistered Sales of Equity Securities and Use of Proceeds

54

 

 

 

ITEM 3.

Defaults upon Senior Securities

54

 

 

 

ITEM 4.

Mine Safety Disclosures

54

 

 

 

ITEM 5.

Other Information

54

 

 

 

ITEM 6.

Exhibits

55

 

 

 

SIGNATURES

56

  

 
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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;

 

 

● 

“ Brown-PUC ” refers to Brown Integrity-PUC, LLC, a 100% owned subsidiary of Brown;

 

 

● 

“ 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;

 

 

● 

“ CEP LLC ” refers to Cypress Energy Partners, LLC, a wholly owned subsidiary of the Partnership;

 

 

● 

“ CEP-TIR ” refers to Cypress Energy Partners – TIR, LLC, an indirect subsidiary of Holdings, and an owner of 673,400 common units representing 11.3% 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 Cypress Energy GP Holdings, LLC;

 

 

● 

“ 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 former Canadian subsidiary of TIR Holdings that was amalgamated into TIR-Canada as of January 1, 2016;

 

 

● 

“ 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, 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, 2016 and December 31, 2015

(in thousands, except unit data)

 

   

September 30,

   

December 31,

 
   

2016

   

2015

 
         

(as adjusted)

ASSETS

               

Current assets:

               

Cash and cash equivalents

  $ 24,903     $ 24,150  

Trade accounts receivable, net

    43,469       48,265  

Prepaid expenses and other

    1,283       2,329  

Total current assets

    69,655       74,744  

Property and equipment:

               

Property and equipment, at cost

    22,130       23,706  

Less: Accumulated depreciation

    7,157       5,369  

Total property and equipment, net

    14,973       18,337  

Intangible assets, net

    30,378       32,486  

Goodwill

    56,932       65,273  

Other assets

    136       42  

Total assets

  $ 172,074     $ 190,882  
                 

LIABILITIES AND OWNERS' EQUITY

               

Current liabilities:

               

Accounts payable

  $ 2,553     $ 2,205  

Accounts payable - affiliates

    1,285       913  

Accrued payroll and other

    10,450       7,095  

Income taxes payable

    264       350  

Total current liabilities

    14,552       10,563  

Long-term debt

    135,555       139,129  

Deferred tax liabilities

    349       371  

Asset retirement obligations

    139       117  

Total liabilities

    150,595       150,180  
                 

Commitments and contingencies - Note 9

               
                 

Owners' equity:

               

Partners’ capital:

               

Common units (5,943,678 and 5,920,467 units outstanding at September 30, 2016 and December 31, 2015, respectively)

    (6,716 )     253  

Subordinated units (5,913,000 units outstanding at September 30, 2016 and December 31, 2015)

    51,687       59,143  

General partner

    (25,876 )     (25,876 )

Accumulated other comprehensive loss

    (2,276 )     (2,791 )

Total partners' capital

    16,819       30,729  

Non-controlling interests

    4,660       9,973  

Total owners' equity

    21,479       40,702  

Total liabilities and owners' equity

  $ 172,074     $ 190,882  

 

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, 2016 and 2015 

(in thousands, except unit and per unit data) 

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Revenues

  $ 81,806     $ 96,408     $ 227,591     $ 281,427  

Costs of services

    71,880       84,307       202,540       248,014  

Gross margin

    9,926       12,101       25,051       33,413  
                                 

Operating costs and expense:

                               

General and administrative

    5,056       6,024       16,805       17,353  

Depreciation, amortization and accretion

    1,214       1,481       3,685       4,113  

Impairments

    -       5,567       10,530       5,567  

Operating income (loss)

    3,656       (971 )     (5,969 )     6,380  
                                 

Other income (expense):

                               

Interest expense, net

    (1,641 )     (1,623 )     (4,878 )     (4,070 )

Other, net

    210       1,043       257       1,106  

Net income (loss) before income tax expense

    2,225       (1,551 )     (10,590 )     3,416  

Income tax expense

    227       89       389       371  

Net income (loss)

    1,998       (1,640 )     (10,979 )     3,045  
                                 

Net income (loss) attributable to non-controlling interests

    81       169       (4,898 )     259  

Net income (loss) attributable to partners / controlling interests

    1,917       (1,809 )     (6,081 )     2,786  
                                 

Net (loss) attributable to general partner

    (1,431 )     -       (5,366 )     (183 )

Net income (loss) attributable to limited partners

  $ 3,348     $ (1,809 )   $ (715 )   $ 2,969  
                                 

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

                               

Common unitholders

  $ 1,676     $ (905 )   $ (358 )   $ 1,485  

Subordinated unitholders

    1,672       (904 )     (357 )     1,484  
    $ 3,348     $ (1,809 )   $ (715 )   $ 2,969  
                                 

Net income (loss) per common limited partner unit:

                               

Basic

  $ 0.28     $ (0.15 )   $ (0.06 )   $ 0.25  

Diluted

  $ 0.27     $ (0.15 )   $ (0.06 )   $ 0.25  
                                 

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

  $ 0.28     $ (0.15 )   $ (0.06 )   $ 0.25  
                                 

Weighted average common units outstanding:

                               

Basic

    5,939,158       5,920,467       5,930,718       5,917,981  

Diluted

    6,158,961       5,920,467       5,930,718       5,917,981  
                                 

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, 2016 and 2015

(in thousands)

 

   

Three Months Ended September 30,

   

Nine Months Ended September 30,

 
   

2016

   

2015

   

2016

   

2015

 
                                 

Net income (loss)

  $ 1,998     $ (1,640 )   $ (10,979 )   $ 3,045  

Other comprehensive income (loss) - foreign currency translation

    (71 )     (654 )     515       (1,402 )
                                 

Comprehensive income (loss)

  $ 1,927     $ (2,294 )   $ (10,464 )   $ 1,643  
                                 

Comprehensive income (loss) attributable to non-controlling interests

    81       169       (4,898 )     (198 )

Comprehensive (loss) attributable to general partner

    (1,431 )     -       (5,366 )     -  
                                 

Comprehensive income (loss) attributable to limited partners

  $ 3,277     $ (2,463 )   $ (200 )   $ 1,841  

 

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, 2016 and 2015 

(in thousands) 

 

   

Nine Months Ended September 30,

 
   

2016

   

2015

 

Operating activities:

               

Net income (loss)

  $ (10,979 )   $ 3,045  

Adjustments to reconcile net income (loss) to net cash provided by operating activities:

               

Depreciation, amortization and accretion

    4,354       4,493  

Impairments

    10,530       5,567  

Gain (loss) on asset disposals

    (2 )     (1 )

Interest expense from debt issuance cost amortization

    426       408  

Equity-based compensation expense

    829       828  

Equity in earnings of investee

    (234 )     (81 )

Distributions from investee

    138       50  

Deferred tax benefit, net

    (39 )     (58 )

Non-cash allocated expenses

    2,866       183  

Changes in assets and liabilities:

               

Trade accounts receivable

    4,999       769  

Prepaid expenses and other

    1,053       (478 )

Accounts payable and accrued payroll and other

    3,802       8,635  

Income taxes payable

    (84 )     (167 )

Net cash provided by operating activities

    17,659       23,193  
                 

Investing activities:

               

Proceeds from fixed asset disposals

    3       2  

Acquisition of 49.9% interest in the TIR Entities (Note 3)

    -       (52,588 )

Cash paid for acquisition of 51% interest in Brown Integrity, LLC, net of cash acquired (Note 3)

    -       (10,436 )

Purchases of property and equipment

    (932 )     (1,651 )

Net cash used in investing activities

    (929 )     (64,673 )
                 

Financing activities:

               

Advances on long-term debt

    -       68,800  

Repayments of long-term debt

    (4,000 )     (5,500 )

Taxes paid related to net share settlement of equity-based compensation

    (100 )     -  

Contributions from general partner

    2,500       -  

Distributions to limited partners

    (14,439 )     (14,423 )

Distributions to non-controlling members

    (415 )     (1,567 )

Net cash provided by (used in) financing activities

    (16,454 )     47,310  
                 

Effect of exchange rates on cash

    477       (910 )
                 

Net increase in cash and cash equivalents

    753       4,920  

Cash and cash equivalents, beginning of period

    24,150       20,757  

Cash and cash equivalents, end of period

  $ 24,903     $ 25,677  
                 

Non-cash items:

               

Accrued capital expenditures

  $ 76     $ -  

 

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, 2016

(in thousands)

 

   

General Partner

   

Common Units

   

Subordinated

Units

   

Accumulated

Other

Comprehensive

Loss

   

Non-controlling Interests

   

Total Owners'

Equity

 
                                                 

Owners' equity at December 31, 2015

  $ (25,876 )   $ 253     $ 59,143     $ (2,791 )   $ 9,973     $ 40,702  

Net income (loss) for the period January 1, 2016  through September 30, 2016

    (5,366 )     (358 )     (357 )     -       (4,898 )     (10,979 )

Foreign currency translation adjustment

    -       -       -       515       -       515  

Contributions from general partner

    5,366       -       -       -       -       5,366  

Distributions to partners

    -       (7,230 )     (7,209 )     -       -       (14,439 )

Distributions to non-controlling interests

    -       -       -       -       (415 )     (415 )

Equity-based compensation

    -       719       110       -       -       829  

Taxes paid related to net share settlement of  equity-based compensation

    -       (100 )     -       -       -       (100 )
                                                 

Owners' equity at September 30, 2016

  $ (25,876 )   $ (6,716 )   $ 51,687     $ (2,276 )   $ 4,660     $ 21,479  

 

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 saltwater 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 common units were sold 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 3), we changed our reportable segments during the second quarter of 2015 by adding the IS segment (see Note 11). 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 facilities in the Permian Basin in Texas (two facilities are available by appointment only).  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 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 8).  We also own a 25% member interest in the managed SWD facility. 

 

2.  Basis of Presentation and Summary of Significant Accounting Policies

   

Basis of Presentation

 

The Unaudited Condensed Consolidated Financial Statements as of September 30, 2016 and for the three and nine months ended September 30, 2016 and 2015 include our accounts and those of our controlled subsidiaries. All significant intercompany transactions and account balances have been eliminated in consolidation. 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. The Unaudited Condensed Consolidated Balance Sheet at December 31, 2015 is derived from audited financial statements. We have made certain reclassifications to the prior period financial statements to conform with classification methods used in the current fiscal year. These reclassifications have had the effect of reducing previously reported total assets and total liabilities, as the adoption of required accounting guidance from the Financial Accounting Standards Board (“FASB”) necessitated changes in the presentation of certain assets and liabilities.

   

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, 2015 included in our Form 10-K filed with the Securities and Exchange Commission. 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 Partnership’s 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 to our audited financial statements as of and for the year ended December 31, 2015.

 

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 related to the Partnership’s net income (loss) is generally attributable to the individual partners.  Net income (loss) for financial statement purposes may differ significantly from taxable income (loss) 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 partner's tax attributes 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”) and a 51% owned and controlled subsidiary, Brown Integrity – PUC, LLC (“Brown-PUC”), both of which have elected to be taxed as corporations 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, some of which are owned by related parties. 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 values of the intangible assets and their estimated useful lives are based on an analysis of all pertinent factors including (1) the use of widely-accepted valuation approaches, such as 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, 2016 or 2015.

 

 

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 warrant) for impairment at a reporting unit level.  The reporting 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. During the second quarter of 2016 and for the nine months ended September 30, 2016, we recorded impairments of goodwill in our IS segment totaling $8.4 million (Note 5) as a result of the economic energy downturn and reduced levels of activity. There were no impairments of goodwill during the three and nine month periods ended September 30, 2015.

 

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 in our W&ES segment of $2.1 million to long-lived assets in the second quarter of 2016 and for the nine months ended September 30, 2016 (Note 5). We recorded impairments of long-lived assets for the three and nine month periods ended September 30, 2015 of $5.6 million (Note 5) in our W&ES segment.

 

New Accounting Standards

 

The Partnership has adopted the following new accounting standards issued by the Financial Accounting Standards Board (“FASB”) beginning January 1, 2016:

 

The FASB issued Accounting Standards Update (“ASU”) 2015-17 – Income Taxes in November 2015. ASU 2015-17 was issued as a part of the FASB’s initiative to reduce complexity in accounting standards. This ASU is effective for annual and interim periods beginning after December 15, 2016 with earlier application permitted as of the beginning of an annual reporting period. The Partnership has elected early application of this guidance beginning January 1, 2016. The guidance simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as noncurrent in a classified consolidated balance sheet. Therefore, the Partnership’s deferred tax assets and liabilities have been classified as noncurrent in the Unaudited Condensed Consolidated Balance Sheets for the periods presented.

 

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. The implementation of this ASU has not affected the Partnership’s financial position, results of operations or cash flows.

 

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. The Partnership adopted this ASU effective for fiscal and interim periods beginning after December 15, 2015. The adoption of this ASU has not materially impacted our financial position, results of operations or cash flows.

 

The FASB issued ASU 2015-05 – Intangibles – Goodwill and Other – Internal-Use Software in April 2015 as part of its simplification initiative. The amendments in this ASU provide guidance to customers for license fees paid in a cloud computing arrangement. The effective date for adoption of this ASU for public companies is for annual periods beginning after December 15, 2015. As a result, the Partnership adopted this guidance as of January 1, 2016 and its adoption has not materially impacted 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 long-term debt be presented on the balance sheet as a reduction of the carrying amount of the long-term debt. The Partnership has adopted this guidance beginning January 1, 2016. As a result of the adoption of this ASU, we have been required to net the Partnership’s debt issuance costs against long-term debt for all periods presented, moving the debt issuance costs from noncurrent assets to noncurrent liabilities on the Partnership’s Unaudited Condensed Consolidated Balance Sheets for the periods presented.

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

   

Other accounting guidance proposed by the FASB that may have some impact on the Unaudited Condensed Consolidated Financial Statements of the Partnership, but have not yet been adopted by the Partnership include:

 

The FASB issued ASU 2016-15 – Statement of Cash Flows in August 2016. This guidance was issued to address diversity in practice of how cash receipts and cash payments are presented and classified in the statement of cash flows. It specifically addresses eight cash flow issues with the objective of reducing the current existing diversity in practice. Specific portions of the guidance that may apply directly to the Partnership include (1) the classification of debt prepayment or debt extinguishment costs, (2) classification of contingent consideration payments made after a business combination, (3) classification of distributions received from equity method investees, and potentially (4) the classification of separately identifiable cash flows and application of the predominance principle. Current GAAP is either unclear or does not include specific guidance on the classification issues included in the ASU reflected above. These amendments are effective for fiscal years beginning after December 15, 2017, and interim periods with those fiscal years and will be retrospectively applied to each period presented. The Partnership has not yet determined the impact this guidance may have on the Unaudited Condensed Consolidated Financial Statements, but since the ASU addresses classification issues, the Partnership does not expect the adoption of this guidance to materially affect our financial position, results of operations or cash flows.

 

The FASB issued ASU 2016-09 – Compensation – Stock Compensation in March 2016. The purpose of the guidance is to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. The amendments in this ASU are effective for fiscal years beginning after December 15, 2016, and all interim periods within that year. Amendments are to be applied retrospectively or prospectively depending on the specific provision included in the ASU. Although early adoption is permitted, the Partnership has not adopted this guidance early. We are currently in the process of determining the impact this guidance may have on the Unaudited Condensed Consolidated Financial Statements of the Partnership, but do not expect the adoption of this guidance to materially affect our financial position, results of operations or cash flows.

 

The FASB issued ASU 2016-02 – Leases in February 2016. This guidance was proposed in an attempt to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing arrangements. The main difference between previous GAAP and this new guidance is the recognition on the balance sheet lease assets and lease liabilities by lessees for those leases classified as operating leases under previous GAAP. The amendments in this ASU are effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years and will be retrospectively applied to each period presented. Early application is permitted. We are currently examining the guidance provided in the ASU and determining the impact this guidance will have on our Unaudited Condensed Consolidated Financial Statements.

 

The FASB issued ASU 2014-15 – Presentation of Financial Statements – Going Concern in August 2014. ASU 2014-15 applies to all entities and is effective for the annual period ending after December 15, 2016 and for annual and interim periods thereafter and will be applied prospectively. Early application is permitted. Effectively, the application of this accounting guidance will require the Partnership’s management to assess our ability to continue as a going concern by incorporating and expanding upon certain principles that are currently in U.S. auditing standards. The amendments (1) require an evaluation every reporting period (including interim periods), (2) provide principles for considering the mitigating effect of management’s plans, (3) require certain disclosures when substantial doubt is alleviated as a result of consideration of management’s plans, (4) require an express statement and other disclosures when substantial doubt is not alleviated, and (5) require an assessment for a period of one year after the date that the financial statements are issued (or available to be issued). This guidance is intended to reduce diversity in the timing and content of footnote disclosures related to an entity’s going concern.

 

The FASB issued 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 2015, 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 applied retrospectively to each prior reporting period presented or retrospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application. We are currently evaluating the financial impact of this ASU on the Partnership, but do not anticipate that the adoption of this ASU will materially impact our financial position, results of operations or cash flows.

 

3. Acquisitions

 

Brown Integrity, LLC

   

In May 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 (Note 4). The Partnership has the right, but not the obligation, to acquire the remaining 49% of Brown in any combination of cash and/or units commencing May 1, 2017 pursuant to a formula prescribed in the purchase document. 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 (Note 11).

 

TIR Entities

 

Effective February 1, 2015, the Partnership acquired the remaining 49.9% interest in the TIR Entities previously held by affiliates of Cypress Energy Holdings, LLC (“Holdings”) for $52.6 million. We financed this acquisition with borrowings under our acquisition revolving credit facility (Note 4). 

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

   

 

4.  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 (“Working Capital Facility”), which provides up to $75.0 million in borrowing capacity to fund working capital needs and an acquisition revolving credit facility (“Acquisition Facility”), 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 on December 24, 2018.

 

Outstanding borrowings at September 30, 2016 and December 31, 2015 under the Credit Agreement were as follows:

 

 

   

September

   

December

 
      30, 2016       31, 2015  
      (in thousands)    
                 

Working Capital Facility

  $ 48,000     $ 52,000  

Acquisition Facility

    88,900       88,900  

Total borrowings

    136,900       140,900  

Debt issuance costs

    1,345       1,771  

Long-term debt

  $ 135,555     $ 139,129  

 

The carrying value of the partnership’s long-term debt approximates fair value as the borrowings under the Credit Agreement are considered to be priced at market for debt instruments having similar terms and conditions (Level 2 of the fair value hierarchy).

 

Borrowings under the Working Capital Facility are limited by a monthly borrowing base calculation as defined in the Credit Agreement. If, at any time, outstanding borrowings under the Working Capital Facility exceed the Partnership’s calculated borrowing base, a principal payment in the amount of the excess is due upon submission of the borrowing base calculation. Available borrowings under the ARCF may be limited by certain financial covenant ratios as defined in the Credit 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 leverage-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 3.54% and 4.28% for the nine months ended September 30, 2016 and 2.68% and 4.09% for the nine months ended September 30, 2015. 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, 2016 and 2015 was $1.6 million and $1.5 million, respectively, including commitment fees. Interest paid during the nine months ended September 30, 2016 and 2015 was $4.3 million and $3.3 million, respectively, including commitment fees.

 

Our Credit Agreement contains various customary affirmative and negative covenants and restrictive provisions. It 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, 2016, our total adjusted leverage ratio was 3.43 to 1.0 and our interest coverage ratio was 3.70 to 1.0, pursuant to the Credit Agreement. Without Holding's reimbursement of Partnership operating expenses and temporary waiver of the administrative fee, our adjusted leverage ratio would have been higher. 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.  With continued support from Holdings, we expect to remain in compliance with all of our financial debt covenants throughout the next twelve months. Working capital borrowings, which are fully secured by the Partnership’s net working capital, are subject to a monthly borrowing base and are excluded from the Partnership’s debt compliance ratios.

   

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 Working Capital Facility by at least $5.0 million and at least $5.0 million in lender commitments are available to be drawn under the Working Capital Facility.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

5. Impairments

 

During the second quarter of 2016, the Partnership recorded goodwill impairments in our IS segment totaling $8.4 million and property and equipment impairments at one of our SWD facilities in our W&ES segment totaling $2.1 million.

 

In the IS segment, we experienced declining revenues that accelerated in the second quarter of 2016 due to the overall depressed energy economy, including decreased new infrastructure construction, postponement of inspection and integrity activity by our E&P customers and reduced revenues and margins on completed contracts due to increased competition, among other things. The Partnership was forecasting that volumes of work and revenue would not recover to historical levels in the foreseeable future and took action in the second quarter of 2016 to adjust its cost structure through a reduction of personnel and the closing of an office location. Given those indicators of impairment in the second quarter of 2016, we performed an interim impairment assessment of the approximately $10.0 million of goodwill related to our IS segment. The IS segment is considered to be a stand-alone reporting unit for purposes of evaluating goodwill. We estimated the fair value of the reporting unit utilizing the income approach (discounted cash flows) valuation method, which is a Level 3 input as defined in ASC 820, Fair Value Measurement. Significant inputs in the valuation included projections of future revenues, anticipated operating costs and appropriate discount rates. To estimate the fair value of the reporting unit and the implied fair value of goodwill under a hypothetical acquisition of the reporting unit, we assumed a tax structure where a buyer would obtain a step-up in the tax basis of the net assets acquired. Significant assumptions used in valuing the reporting unit included revenue growth rates ranging from 2% to 5% annually and a discount rate of 17.5%. In our assessment, the carrying value of the reporting unit, including goodwill, exceeded its estimated fair value. We then determined through our hypothetical acquisition analysis that the fair value of goodwill was impaired. As a result, the Partnership recorded an impairment loss of $8.4 million in our IS segment and reduced the value of recorded goodwill to $1.6 million in the second quarter of 2016. This impairment is included in impairments on the Unaudited Condensed Consolidated Statement of Operations for the nine months ended September 30, 2016.

 

In the W&ES segment, the Partnership has experienced declining disposal volumes and revenues at certain facilities due to reduced drilling activity in the areas we service, lower commodity pricing and increasing competition. The Partnership has forecasted that volumes and revenues will not recover to historical levels in the foreseeable future absent a material increase in oil and gas commodity prices and drilling activity in Bakken region of North Dakota. Given these indicators of impairment, the Partnership compared its estimate of undiscounted future cash flows from individual facilities, and determined that its recorded value on one facility was no longer recoverable, and was therefore impaired. In the second quarter of 2016, the Partnership wrote the SWD facility assets down from its net carrying value of $2.7 million to $0.6 million and recognized impairments of the facility of $2.1 million – included in impairments on the Unaudited Condensed Consolidated Statement of Operations for the nine months ended September 30, 2016.

   

Fair value was determined using expected future cash flows using the income approach (discounted cash flow) valuation method, 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 of 15.5%. Cash flows were determined based on various assumptions including estimates of future volumes, prices, cost structure, capital maintenance requirements and salvage value. Because of the uncertainties surrounding the facilities and the market conditions, including the Partnership’s ability to generate and maintain sufficient revenues to operate its segments profitably, our estimate of expected future cash flows may change in the near term resulting in the need to record additional impairment related to our W&ES segment property and equipment.

 

During the third quarter of 2016, there existed no additional indicators of impairment that would require the Partnership to reassess or reevaluate the recorded value of its assets.

 

6. Income Taxes

 

Income tax expense reflected on the Condensed Consolidated Statements of Income for the three- and nine-month periods ended September 30, 2016 and 2015 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, partially offset by the corporate income taxes of TIR-PUC and Brown-PUC, the income taxes related to our Canadian operations, and any applicable state income and franchise taxes.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

7.  Equity Compensation

 

Our General Partner adopted a long-term incentive plan (“LTIP”) that authorized the issuance of up to 1,182,600 common 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 publicly-traded common units at each grant date, adjusted for an estimated forfeiture rate and other discounts attributable to the awarded units.  Compensation expense is amortized over the vesting period of the grant. For the nine months ended September 30, 2016 and 2015, compensation expense of $0.7 million and $0.8 million, respectively, was recorded under the LTIP.  The following table sets forth the LTIP Unit activity for the nine months ended September 30, 2016 and 2015: 

 

   

Nine Months Ended September 30,

 
   

2016

   

2015

 
                                 
           

Weighted

           

Weighted

 
           

Average

           

Average

 
           

Grant

           

Grant

 
   

Number

   

Date Fair

   

Number

   

Date Fair

 
   

of Units

   

Value / Unit

   

of Units

   

Value / Unit

 
                                 

Units at January 1

    361,698     $ 14.30       158,353     $ 18.11  

Units granted

    336,847       6.34       222,755       10.27  

Units vested and issued

    (34,023 )     (10.33 )     (7,467 )     (19.72 )

Units forfeited

    (62,951 )     (10.93 )     (19,498 )     (16.92 )

Units at September 30

    601,571       10.42       354,143       13.21  

 

Outstanding Units issued to directors vest ratably over a three-year period from the date of grant.  Units granted to employees vest over either a five-year, three-year or eighteen-month period 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. Some awards vest in full upon the occurrence of certain events as defined in the LTIP agreement.

 

Certain phantom profits interest units 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. 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 these subordinated units was $0.1 million for the nine months ended September 30, 2016 and 2015.

 

 
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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

 

8.  Related-Party Transactions

   

Transactions with SBG Energy Services, LLC (SBG Energy) and Subsidiary

 

SBG Energy was a business partner in our SWD operations in which a former board member had an ownership and management interest. This former board member resigned effective March 31, 2016. 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.

 

Omnibus Agreement and Other Support from Holdings

 

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 a quarterly administrative fee in the amount of $1.0 million 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.  For the three and nine months ended September 30, 2016, Holdings has provided sponsor support to the Partnership by waiving payment of the quarterly administrative fee.  The waiving of the administrative fee will likely continue through the end of 2016 or such earlier time that our business results improve, as determined by Holdings;

 

 

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 under the Omnibus Agreement for the three and nine months ended September 30, 2015 was $1.0 million and $3.0 million, respectively. These amounts are reflected in general and administrative in the Unaudited Condensed Consolidated Statements of Operations. Holdings has also provided the Partnership with temporary financial support during 2016. There were no payments made under the omnibus agreement for the three and nine months ended September 30, 2016.

 

To the extent that Holdings incurs expenses on behalf of the Partnership in excess of administrative expense amounts paid under the omnibus agreement, the excess is allocated to the Partnership as non-cash allocated costs. The non-cash allocated amounts are reflected as general and administrative expenses in the Unaudited Condensed Consolidated Statement of Operations and as a contribution attributable to general partner in the Unaudited Condensed Consolidated Statement of Owners’ Equity. These costs are included as a component of net loss attributable to general partner in the Unaudited Condensed Consolidated Statements of Operations. Non-cash allocated costs reflected in the Partnership’s financial statements were $0.9 million and $2.9 million, respectively, for the three and nine month periods ended September 30, 2016. Non-cash allocated expenses were $0.2 million for the nine month period ended September 30, 2015.

 

In addition to funding certain general and administrative expenses on our behalf, Holdings provided the Partnership with additional temporary financial support by contributing $0.5 million in the third quarter of 2016, and a total of $2.5 million for the nine months ended September 30, 2016 in cash, as a reimbursement of certain expenditures incurred by the Partnership. These payments are reflected as a contribution attributable to general partner in the Unaudited Condensed Consolidated Statement of Owners’ Equity and as a component of the net loss attributable to the general partner in the Unaudited Condensed Consolidated Statement of Operations for the three and nine month periods ended September 30, 2016.

 

Total support from Holdings attributable to non-cash allocated expenses and the reimbursement of certain expenditures was $1.4 million and $5.4 million, respectively, for the three- and nine-month periods ended September 30, 2016 and $0.2 million for the nine-month period ended September 30, 2015.

 

 

CYPRESS ENERGY PARTNERS, L.P.  
Notes to the Unaudited Condensed Consolidated Financial Statements

 

Other Related Party Transactions   

 

A former board member had ownership interests in entities with which the Partnership transacts business – Creek Energy Services, LLC (“Creek,” formerly Rud Transportation, LLC) and SBG Pipeline SW 3903, LLC (“3903”).  The Partnership has no ownership interest in either of these entities.  Total revenue recognized by the Partnership from Creek while it was considered a related party was $0.2 million for the three months ended September 30, 2015 and $0.1 million and $1.0 million for the nine months ended September 30, 2016 and 2015, respectively.  Accounts receivable from Creek was $0.1 million at December 31, 2015 and is included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets. Total revenue recognized by the Partnership from 3903 while it was considered a related party 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. 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.

 

The Partnership provides management services to a 25% owned investee company, Alati Arnegard, LLC (“Arnegard”).  Management fee revenue earned from Arnegard totaled $0.1 million for the three months and $0.4 million for the nine months ended September 30, 2016, respectively, and $0.2 million for the three months and $0.5 million for the nine months ended September 30, 2015, respectively.  Accounts receivable from Arnegard were $0.1 million at September 30, 2016 and December 31, 2015, and are included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets.

   

9.  Earnings per Unit and Cash Distributions

 

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 ownership 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.  See Note 8 for a description of net loss attributable to general partner. The excess or shortfall of earnings relative to distributions is allocated to the limited partners based on their respective ownership percentages.  Payments made to our unitholders are determined in relation to actual distributions declared and are not based on the net income allocations used in the calculation of net income (loss) per unit.  The following table outlines the weighted-average number of shares outstanding for the three and nine months ended September 30, 2016 and 2015:

 

 

Weighted Average Number of Units Outstanding

                 
   

Common

Units

   

Subordinated

Units

   

Total

Units

 

Three Months Ended:

                       

September 30, 2016

    5,939,158       5,913,000       11,852,158  

September 30, 2015

    5,920,467       5,913,000       11,833,467  
                         

Nine Months Ended:

                       

September 30, 2016

    5,930,718       5,913,000       11,843,718  

September 30, 2015

    5,917,981       5,913,000       11,830,981  

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

Our partnership agreement calls for minimum quarterly cash distributions.  The following table summarizes the cash distributions declared by the Partnership since our IPO.  There were no cash distributions declared or paid prior to these distributions. The Partnership currently anticipates that it will come out of subordination on the day after the February 2017 cash distribution, as long as the February 2017 cash distribution is at least $0.3875 per Unit – the minimum quarterly distribution amount defined in the partnership agreement and other requirements associated with the termination of the subordination period provided in the partnership agreement are met.

 

Payment Date

 

Per Unit Cash

Distributions

   

Total Cash

Distributions

   

Total Cash

Distributions

to Affiliates (a)

 
           

(in thousands)

 
                         

May 15, 2014 (b)

  $ 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

    0.406413       4,809       3,092  

Total 2015 Distributions

    1.625652       19,232       12,284  
                         

February 12, 2016

    0.406413       4,810       3,107  

May 13, 2016

    0.406413       4,812       3,099  

August 12, 2016

    0.406413       4,817       3,103  

November 14, 2016 (c)

    0.406413       4,819       3,105  

Total 2016 Distributions

    1.625652       19,258       12,414  
                         

Total Distributions (through November 14, 2016 since IPO)

  $ 4.355950     $ 51,554     $ 32,994  

 

 

(a)

Approximately 64.4% of the Partnership's outstanding units at September 30, 2016 are held by affiliates.

  (b) Distribution was pro-rated from the date of our IPO through March 31, 2014.
  (c) Third quarter 2016 distribution was declared and will be paid in the fourth quarter of 2016.

 

Brown made cash distributions to non-controlling members of $0.4 million in the first quarter of 2016. In addition, the TIR Entities made 2015 cash distributions of $1.6 million 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.

 

 
19

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

10.  Commitments and Contingencies

 

Security Deposits

 

The Partnership has various performance obligations which are secured with short-term security deposits of $0.5 million at September 30, 2016 and December 31, 2015, included in prepaid expenses and other on the Unaudited Condensed Consolidated Balance Sheets.

 

Employment Contract Commitments

 

The Partnership has employment agreements with certain of its executives.  The executive employment agreements are effective for a term of two-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, 2016 and December 31, 2015, the aggregate commitment for future compensation and severance was approximately $1.1 million and $1.4 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 underway.  Several multi-year audits concluded in 2015 without adjustment to the Partnership. At December 31, 2015, the Partnership had an estimated liability of $0.1 million recorded for a specific compliance audit that was settled in the first quarter of 2016. This 2015 liability is reflected in accrued payroll and other on the Unaudited Condensed Consolidated Balance Sheet.

   

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 nine months ended September 30, 2016. The Partnership has commenced litigation and settlement discussions regarding the improper termination of the agreements. (See Legal Proceedings)

 

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.

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

In September 2015, Flatland Resources I, LLC and Flatland Resources II, LLC, two of our management services customers (under common ownership) initiated a civil action in the District Court for the McKenzie County 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. The court subsequently granted CES’s motion to transfer venue to the Grand Forks County District Court. We believe that the possibility of the Partnership incurring material losses as a result of this action is remote.

 

Internal Revenue Service Audits

 

In January 2016, the Partnership received notices from the Internal Revenue Service (“IRS”) that conveyed its intent to audit the consolidated income tax return of TIR Inc. for the 2012 tax year and audit payroll and payroll tax filings of TIR Inc. for the 2013 tax year. Currently, the IRS is analyzing provided information in order to complete their audit procedures. To date, the Partnership has not been informed of any potential adjustments related to these audits and has received a preliminary no-change letter from the IRS related to the 2013 payroll audit. Based on the terms of the Partnership’s omnibus agreement with Holdings, Holdings would indemnify the Partnership for certain liabilities (including income tax liabilities) associated with the operation of assets that occurred prior to the closing of our IPO should any liabilities arise as a result of these audits. Because of this, the Partnership believes that the possibility of incurring material losses as a result of these IRS audits is remote.

 

11.  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 3) 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 to result in the creation of a new segment. 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 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 3). This segment 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. 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 (two of which are available by appointment only), 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, 2016

                                         
                                           

Revenue

  $ 75,313     $ 4,525     $ 1,968     $ -       $ 81,806  

Costs of services

    67,579       3,558       743       -         71,880  

Gross margin

    7,734       967       1,225       -         9,926  

General and administrative

    2,920       514       462       1,160  

(a)

    5,056  

Depreciation, amortization and accretion

    608       157       449       -         1,214  

Impairments

    -       -       -       -         -  

Operating income (loss)

  $ 4,206     $ 296     $ 314     $ (1,160 )       3,656  

Interest expense, net

                                      (1,641 )

Other, net

                                      210  

Net income before income tax expense

                                    $ 2,225  
                                           
                                           

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 )

 

(a)

Amount includes $0.9 million of administrative charges under the omnibus agreement previously charged to the PIS and W&ES segments

  

 

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, 2016

                                         
                                           

Revenue

  $ 209,632     $ 11,329     $ 6,630     $ -       $ 227,591  

Costs of services

    189,788       9,668       3,084       -         202,540  

Gross margin

    19,844       1,661       3,546       -         25,051  

General and administrative

    9,439       2,388       1,501       3,477  

(a)

    16,805  

Depreciation, amortization and accretion

    1,834       502       1,349       -         3,685  

Impairments

    -       8,411       2,119       -         10,530  

Operating income (loss)

  $ 8,571     $ (9,640 )   $ (1,423 )   $ (3,477 )       (5,969 )

Interest expense, net

                                      (4,878 )

Other, net

                                      257  

Net loss before income tax expense

                                    $ (10,590 )
                                           
                                           

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  
                                           

(a) Amount includes $2.9 million of administrative charges under the omnibus agreement previously charged to the PIS and W&ES segments.

 
                                           
                                           

Total Assets

                                         
                                           

September 30, 2016

  $ 123,100     $ 13,145     $ 35,096     $ 733       $ 172,074  
                                           

December 31, 2015 (as adjusted)

  $ 130,623     $ 23,097     $ 38,418     $ (1,256 )     $ 190,882  

 

 
23

Table Of Contents
 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

12. 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 of 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 financial condition 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.

 

The presentation of our Condensed Consolidating Balance Sheet as of December 31, 2015, our Condensed Consolidating Statements of Comprehensive Income (Loss) for the three and nine months ended September 30, 2015, and our Condensed Consolidating Statement of Cash Flows for the nine months ended September 30, 2015 have been updated to reflect adjustments between the Guarantors and Eliminations. These adjustments have (i) reduced the Guarantors’ notes receivable affiliates and total partners’ capital and the Parent’s investment in the Guarantors and the total partners’ capital by $1.0 million with the offset to Eliminations on the Condensed Consolidating Balance Sheet; (ii) reduced the Guarantors’ comprehensive income by $0.2 million and $0.5 million for the three and nine month periods ended September 30, 2015, respectively, with the offset to Eliminations on the Condensed Consolidating Statement of Comprehensive Income (Loss); and (iii) adjusted various offsetting items in working capital for the Guarantors and Eliminations in the Condensed Consolidating Statement of Cash Flows. These changes have had no impact on the consolidated results as previously reported.

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

 

Condensed Consolidating Balance Sheet

As of September 30, 2016 

(in thousands) 

 

   

Parent

   

Guarantors

   

Non-

Guarantors

   

Eliminations

   

Consolidated

 
                                         

ASSETS

                                       

Current assets:

                                       

Cash and cash equivalents

  $ 695     $ 20,623     $ 3,585     $ -     $ 24,903  

Trade accounts receivable, net

    -       34,531       10,818       (1,880 )     43,469  

Accounts receivable - affiliates

    -       8,002       -       (8,002 )     -  

Prepaid expenses and other

    38       1,175       70       -       1,283  

Total current assets

    733       64,331       14,473       (9,882 )     69,655  

Property and equipment:

                                       

Property and equipment, at cost

    -       19,031       3,099       -       22,130  

Less: Accumulated depreciation

    -       6,272       885       -       7,157  

Total property and equipment, net

    -       12,759       2,214       -       14,973  

Intangible assets, net

    -       24,439       5,939       -       30,378  

Goodwill

    -       53,913       3,019       -       56,932  

Investment in subsidiaries

    26,280       (331 )     -       (25,949 )     -  

Notes receivable - affiliates

    -       14,534       -       (14,534 )     -  

Other assets

    -       126       10       -       136  

Total assets

  $ 27,013     $ 169,771     $ 25,655     $ (50,365 )   $ 172,074  
                                         

LIABILITIES AND OWNERS' EQUITY

                                       

Current liabilities:

                                       

Accounts payable

  $ -     $ 2,271     $ 1,878     $ (1,596 )   $ 2,553  

Accounts payable - affiliates

    4,034       -       5,253       (8,002 )     1,285  

Accrued payroll and other

    -       9,404       1,331       (285 )     10,450  

Income taxes payable

    -       267       (3 )     -       264  

Total current liabilities

    4,034       11,942       8,459       (9,883 )     14,552  

Long-term debt

    (1,345 )     131,400       5,500       -       135,555  

Notes payable - affiliates

    -       -       14,534       (14,534 )     -  

Deferred tax liabilities

    -       13       336       -       349  

Asset retirement obligations

    -       139       -       -