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HCLP > SEC Filings for HCLP > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for HI-CRUSH PARTNERS LP

Form 10-Q for HI-CRUSH PARTNERS LP


13-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion of our historical performance, financial condition and future prospects in conjunction with our unaudited condensed financial statements and accompanying notes in "Item 1. Financial Statements" contained herein and our predecessor's audited financial statements as of December 31, 2010 and 2011, included in our prospectus relating to our initial public offering, as filed with the Securities and Exchange Commission on August 15, 2012. The information provided below supplements, but does not form part of, our unaudited condensed financial statements or our predecessor's financial statements. This discussion contains forward-looking statements that are based on the views and beliefs of our management, as well as assumptions and estimates made by our management. Actual results could differ materially from such forward-looking statements as a result of various risk factors, including those that may not be in the control of management. See "Forward-Looking Statements" on page 30. All amounts are presented in thousands except tonnage or per unit data, or where otherwise noted.

Overview

We are a Delaware limited partnership that was formed on May 8, 2012 to acquire selected sand reserves and related processing and transportation facilities of Hi-Crush Proppants LLC, our sponsor. In connection with the completion of our initial public offering on August 16, 2012, our sponsor contributed its ownership interest in entities that comprised its sand excavation, processing and logistics facilities in Wyeville, Wisconsin via a contribution, assumption and assignment agreement. Such operations comprised substantially all of our sponsor's operating assets at the time of the contribution, however our sponsor did retain net assets associated with its sand excavation and processing facility in Augusta, Wisconsin. While the Augusta facility did have significant property, plant and equipment, it had not yet begun producing and selling frac sand under long-term take-or-pay contracts, and therefore had no significant historical results of operations reflected in our sponsor's financial statements.

We are a domestic producer of premium monocrystalline sand, a specialized mineral that is used as a proppant to enhance the recovery rates of hydrocarbons from oil and natural gas wells. Our reserves consist of "Northern White" sand, a resource existing predominately in Wisconsin and limited portions of the upper Midwest region of the United States, which is highly valued as a preferred proppant because it exceeds all American Petroleum Institute ("API") specifications. The Wyeville facilities and operations contributed to us by our sponsor are comprised of a 561-acre facility with integrated rail infrastructure, which enables us to process and cost-effectively deliver approximately 1,600,000 tons of frac sand per year. Substantially all of our frac sand production is sold to leading investment grade-rated pressure pumping service providers under long-term, take-or-pay contracts that require our customers to pay a specified price for a specified volume of frac sand each month.

In May 2012, Hi-Crush Operating LLC ("Hi-Crush"), a subsidiary of Hi-Crush Partners LP (the "Partnership"), entered into a supply agreement for frac sand with Baker Hughes Oilfield Operations, Inc. ("Baker Hughes"). On September 19, 2012, Baker Hughes provided notice that it was terminating the contract. The Partnership believes that Baker Hughes' termination was wrongful and a direct effort to circumvent its binding purchase obligations under the supply agreement. The Partnership engaged in discussions with Baker Hughes after receiving the notice, but the parties were unable to reach a mutually satisfactory resolution of the matter. On November 12, 2012, Hi-Crush formally terminated the supply agreement and filed suit in the State District Court of Harris County, Texas against Baker Hughes seeking damages for Baker Hughes' prior wrongful termination of the supply agreement. The Partnership intends to vigorously enforce its rights under the supply agreement against Baker Hughes. The Partnership cannot provide assurance, however, as to the outcome of this lawsuit. We are in active discussions with existing and new customers to replace the volumes previously allocated to Baker Hughes under the terminated Supply Agreement.

In connection with our initial public offering and our sponsor's contribution of the Wyeville facility and operations, we entered into the following agreements:

Services Agreements: Effective August 16, 2012, we entered into a services agreement with Hi-Crush Services LLC, pursuant to which Hi-Crush Services provides certain management and administrative services to our general partner in connection with operating our business. Under this agreement, we reimburse Hi-Crush Services, on a monthly basis, for the allocable expenses that it incurs in its performance of the specified services. These expenses include, among other things, salary, bonus, incentive compensation, rent and other administrative expenses for individuals and entities that perform services for us or on our behalf. In addition, effective August 16, 2012, we entered into an agreement with our sponsor, pursuant to which the sponsor provides maintenance and capital spares to us in connection with the ongoing maintenance of our Wyeville facility. Our sponsor will bill us for the approximate cost of such items.

Omnibus Agreement: On August 20, 2012, we entered into an omnibus agreement with both our general partner and our sponsor. Pursuant to the terms of this agreement, our sponsor will indemnify us and our subsidiaries for certain liabilities over specified periods of time, including but not limited to certain liabilities relating to (a) environmental matters pertaining to the period prior to our initial public offering and the contribution of the Wyeville assets from our sponsor, provided that such indemnity is capped at $7,500 in aggregate,
(b) federal, state and local tax liabilities pertaining to the period prior to our initial public offering and the contribution of the Wyeville assets from our sponsor, (c) inadequate permits or licenses related to the contributed assets, and (d) any losses, costs or damages incurred by us that are attributable to our sponsor's ownership and operation of such assets prior to our initial public offering and our sponsor's contribution of such assets. In addition, we have agreed to indemnify our sponsor from any losses, costs or damages it incurs that are attributable to our ownership and operation of the contributed assets following the closing of the initial public offering, subject to similar limitations as on our sponsor's indemnity obligations to us.

The omnibus agreement provides that we will assign to our sponsor all of our rights and obligations under our long-term take-or-pay contract with a customer to our sponsor as of May 1, 2013, and our sponsor will be obligated to accept such

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assignment and assume our obligations under such contract. Pursuant to the terms of that contract, such assignment will not relieve us of any liability under that contract, but the sponsor will be obligated to provide certain indemnities to us in connection with any losses incurred under the contract following the date of the assignment.

In addition, the omnibus agreement also grants us, for a period of three years, a right of first offer on our sponsor's sand reserves and any related assets that have been or will be constructed on its current acreage in Augusta, Wisconsin, in the event our sponsor proposes to transfer such reserves and assets to a third party other than in connection with a sale of all or substantially all of its assets.

Long-Term Incentive Plan: On August 21, 2012, our general partner adopted the Hi-Crush Partners LP Long-Term Incentive Plan for employees, consultants and directors of the general partner and those of its affiliates, including our sponsor, who perform services on our behalf. This plan consists of restricted units, unit options, phantom units, unit payments, unit appreciation rights, other equity-based awards, distribution equivalent rights, and performance awards. The number of our common units that may be delivered pursuant to awards under the plan is limited to 1,364,035 units. Any common units withheld to satisfy exercise prices or minimum tax withholding obligations are available for delivery under other plan awards.

Credit Agreement: On August 21, 2012, in connection with the closing our initial public offering, we entered into a credit agreement providing for a new four-year $100,000 senior secured revolving credit facility. This credit facility is available to fund working capital and general corporate purposes, including the making of certain restricted payments permitted therein. The credit facility has an accordion feature that allows us to increase the available revolving capacity under the facility up to an aggregate amount of $200,000, subject to our receiving increased commitments applicable lenders and the satisfaction of certain other conditions. Borrowings under the credit facility are secured by substantially all of our assets.

For additional information regarding our credit facility, see Note 7 of the Notes to Unaudited Condensed Consolidated Financial Statements included under

Part I, Item 1 of this Form 10-Q.

Basis of Presentation

The following discussion of our historical performance and financial condition is derived from our unaudited condensed financial statements and the historical financial statements of our sponsor, Hi-Crush Proppants LLC, which is our accounting predecessor for financial reporting purposes. Our sponsor contributed some but not all of its assets and liabilities to us in connection with our initial public offering. Accordingly, the historical predecessor financial results discussed below include capital expenditures and other costs related to assets that were not contributed to us, as well as long-term debt and related expenses that were retained by our sponsor. For additional information about the assets and liabilities reflected in our sponsor's historical financial statements that were not contributed to us in connection with our offering, please read our unaudited pro forma financial statements and the notes to those financial statements provided in our prospectus relating to our initial public offering, as filed with the Securities and Exchange Commission on August 15, 2012.

In addition to the factors discussed above relating to the contribution of some, but not all of the net assets of the Wyeville operations, there are a number of factors that impact the comparability of our sponsor's historical results of operations and cash flows, as well as why such results will not be indicative of future results of operations and cash flows, including:

our Wyeville facility did not generate sales until we commenced operations in July 2011;

we completed an expansion of our Wyeville facility in March 2012, which significantly increased our production capacity. In connection with this incremental capacity, additional contracted volumes to two new customers began shipping in May 2012;

effective July 2012, we terminated certain royalty agreements for a one-time cash payment of $14,000, which has resulted in a reduction of our ongoing royalty costs to $2.50 per ton of sand delivered at our on-site rail facility and paid for by our customers;

our predecessor began incurring incremental general and administrative expenses in the second quarter of 2012 associated with the initial public offering;

effective with becoming a publicly traded partnership in August 2012, we have begun to incur incremental general and administrative expenses, the nature of which were not previously incurred as a non-public entity; and

we expect to incur additional general and administrative expenses as a result of our sponsor's allocation of costs associated with its expanded infrastructure, including management and other key positions, which were hired in anticipation of our initial public offering.

Unless otherwise indicated, references in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" to "Hi-Crush Partners LP," "we," "our," "us" or like terms when used to reference operations or matters prior to August 16, 2012, refer to the business and results of operations of Hi-Crush Proppants LLC, our sponsor and accounting predecessor. Otherwise, those terms refer to Hi-Crush Partners LP and its subsidiaries following its initial public offering and the formation transactions described in the "Overview' section.

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Our Assets and Operations

We own and operate the Wyeville facility, which is located in Monroe County, Wisconsin and, as of December 31, 2011, contained 48.4 million tons of proven recoverable sand reserves of mesh sizes we currently have contracted to sell. We acquired the Wyeville acreage and commenced construction of the Wyeville facility in January 2011. We completed construction of the Wyeville facility and commenced sand excavation and processing in June 2011 with an initial plant processing capacity of 950,000 tons per year, and customer shipments were initiated in July 2011. As of December 31, 2011, we had 730,000 tons per year subject to existing long-term, take-or-pay contracts. We completed an expansion in March 2012 that increased our annual expected processing capacity to approximately 1,600,000 tons per year and supported the expansion by signing contracts that increased annual contracted volumes to 1,460,000 tons. From the Wyeville in-service date to September 30, 2012, we have processed and sold 1,246,391 tons of frac sand.

How We Generate Revenue

We generate revenue by excavating, processing and producing frac sand, which we sell to our customers primarily under fixed price take-or-pay contracts, with current terms expiring between 2014 and 2017. During the period from July 21, 2011 through April 30, 2012, we delivered frac sand under such contracts to two customers. Using the capacity provided by the Wyeville expansion, we commenced shipments to two additional customers under similar contracts beginning May 1, 2012. The Baker Hughes contract was terminated on November 12, 2012. See above under "Overview." Each contract defines the minimum volume of frac sand that the customer is required to purchase monthly and annually, the volume that we are required to make available, the technical specifications of the product, the price per ton and liquidated damages in the event either we or the customer fails to meet minimum requirements. Prices in our current contracts are fixed for the entire term of the contracts. As a result, our revenue over the duration of these contracts may not follow broader industry pricing trends. Occasionally, if we have excess production and market conditions are favorable, we may elect to sell frac sand in spot market transactions. These contracts had a weighted average remaining life of 4.4 years as of September 30, 2012. After giving effect to the termination of the Baker Hughes contract on November 12, 2012, our contracts had a weighted average remaining life of 3.3 years.

Due to sustained freezing temperatures in our area of operation during winter months, it is industry practice to halt excavation activities and operation of the wet plant during those months. As a result, we excavate and wash sand in excess of current delivery requirements during the months when those facilities are operational. This excess sand is placed in stockpiles that feed the dry plant and fill customer orders throughout the winter months.

Costs of Conducting Our Business

The principal expenses involved in operating our business are excavation costs, labor, utilities, maintenance and royalties.

We have a contract with a third party to excavate raw frac sand, deliver the raw frac sand to our processing facility and move the sand from our wet plant to our dry plant. We pay a fixed price, with the exception of a fuel charge based on the price of diesel fuel, of $2.09 per ton excavated and delivered without regard to the amount of sand excavated that meets API specifications. Accordingly, we incur excavation costs with respect to the excavation of sand and other materials from which we ultimately do not derive revenue (rejected materials), and for sand which is still to be processed through the dry plant and not yet sold.

Labor costs associated with employees at our processing facility represent the most significant cost of converting raw frac sand to finished product. We incur utility costs in connection with the operation of our processing facility, primarily electricity and natural gas, which are both susceptible to fluctuations. Our facilities require periodic scheduled maintenance to ensure efficient operation and to minimize downtime.

Excavation costs, direct and indirect labor, utilities and maintenance costs are capitalized as a component of inventory and are reflected in cost of goods sold when inventory is sold.

We initially paid royalties to third parties at an aggregate rate of $6.15 per ton of sand excavated, delivered at our on-site rail facility and paid for by our customers. Effective July 2012, we terminated a certain royalty agreement for a one-time cash payment of $14,000, which will reduce our ongoing royalty costs to $2.50 per ton of sand excavated, delivered and paid for.

Each customer takes delivery of purchased product when it is loaded on rail cars at our facility. As a result we generally do not incur shipping expenses.

We incur general and administrative costs related to our corporate operations. Under our partnership agreement and the services agreements with our sponsor and our general partner, our sponsor has discretion to determine, in good faith, the proper allocation of costs and expenses to us for its services, including expenses incurred by our general partner and its affiliates on our behalf. Our sponsor currently intends to allocate its general and administrative costs proportionately based on tonnage shipped from facilities and

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operations that are provided the services underlying such costs. However, since our Wyeville operations represent the only facility that has made meaningful shipments to date, the allocation of these costs for the 2012 period, subsequent to our initial public offering, was based on management's best estimate of time and effort spent on the respective operations and facilities. Under these agreements, we reimburse our sponsor for all direct and indirect costs incurred on our behalf.

How We Evaluate Our Operations

Gross Profit and Production Costs

Price per ton excavated is fixed, and royalties are generally fixed based on tons excavated, delivered and paid for. Given this largely fixed cost base, coupled with the fact that the majority of our processing capacity at the Wyeville facility is contracted for sale under our existing fixed price, take-or-pay contracts with our customers for the remainder of 2012 and through the second quarter of 2014, our gross profit will primarily be affected by our ability to control other direct and indirect costs associated with processing frac sand. We also use production costs, which we define as costs of goods sold, excluding depreciation and depletion to measure our financial performance. We believe production cost is a meaningful measure because it provides a measure of operating performance that is unaffected by historical cost basis.

As a result, production volumes, costs of goods sold per ton, production costs per ton and gross profit are key metrics used by management to evaluate our results of operations.

EBITDA, Distributable Cash Flow and Production Costs

We view EBITDA as an important indicator of performance. We define EBITDA as net income plus depreciation and depletion and interest and debt expense, net of interest income. Although our sponsor had not historically quantified distributable cash flow, effective with the date on which the Wyeville net assets and operations were contributed to us by our sponsor, we use distributable cash flow to evaluate whether we are generating sufficient cash flow to support distributions to our unitholders. We define distributable cash flow as EBITDA less cash paid for interest expense and maintenance and replacement capital expenditures, including accrual for reserve replacement, plus accretion of asset retirement obligations. Distributable cash flow will not reflect changes in working capital balances. EBITDA is a supplemental measure utilized by our management and other users of our financial statements such as investors, commercial banks, research analysts and others, to assess the financial performance of our assets without regard to financing methods, capital structure or historical cost basis. Distributable cash flow is a supplemental measure used to measure the ability of our assets to generate cash sufficient to support our indebtedness and make cash distributions to our unitholders.

We define production costs as costs of goods sold, excluding depreciation and depletion. We believe production costs is a meaningful measure because it provides a measure of operating performance that is unaffected by historical cost basis.

Note Regarding Non-GAAP Financial Measures

Production costs, EBITDA and distributable cash flow are not financial measures presented in accordance with GAAP. We believe that the presentation of these non-GAAP financial measures will provide useful information to investors in assessing our financial condition and results of operations. Costs of goods sold is the GAAP measure most directly comparable to production costs, net income is the GAAP measure most directly comparable to EBITDA and distributable cash flow. Our non-GAAP financial measures should not be considered as alternatives to the most directly comparable GAAP financial measure. Each of these non-GAAP financial measures has important limitations as analytical tools because they exclude some but not all items that affect the most directly comparable GAAP financial measures. You should not consider production costs, EBITDA or distributable cash flow in isolation or as substitutes for analysis of our results as reported under GAAP. Because production costs, EBITDA and distributable cash flow may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.

The following table presents a reconciliation of EBITDA and distributable cash flow to the most directly comparable GAAP financial measure, as applicable, for each of the periods indicated.

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                                                                 Three months ended September 30,                                               Nine months ended September 30,
                                                                     2012                                   2011                                   2012                                    2011
                                                Period from                       Period from                                  Period from                       Period from
                                              July 1 through                   August 16 through                            January 1 through                 August 16 through
                                                 August 15                       September 30                                   August 15                       September 30
                                               (Predecessor)                      (Successor)           (Predecessor)         (Predecessor)                      (Successor)           (Predecessor)
Reconciliation of EBITDA and Distributable
Cash Flow to Net Income:

Net income                                   $           7,069                $             9,109      $         3,793     $             25,020              $             9,109      $         3,146

Taxes                                                       -                                  -                    -                        -                                -                    -
Depreciation and depletion                                 421                                395                  306                    1,089                              395                  306
Interest expense, net                                      855                                 80                  760                    3,240                               80                  760

EBITDA                                       $           8,345                $             9,584      $         4,859     $             29,349              $             9,584      $         4,212

Less: Cash interest paid                                                                      (43 )                                                                          (43 )
Maintenance and replacement capital
expenditures, including accrual for
reserve replacement (1)                                                                      (258 )                                                                         (258 )
Add: Accrecton of asset retirement
obligation                                                                                      3                                                                              3

Distributable Cash Flow (2)                                                   $             9,286                                                            $             9,286

(1) Maintenance and replacement capital expenditures, including accrual for reserve replacement, was determined based on an estimated reserve replacement cost of $1.35 per ton sold during the period from August 16 through September 30, 2012. Such expenditures include those associated with the replacement of equipment and sand reserves, to the extent that such expenditures are made to maintain our long-term operating capacity. The amount presented does not represent an actual reserve account or requirement to spend the capital.

(2) Consistent with our intention to pay a prorated distribution for the period from the completion of our initial public offering through September 30, 2012, this represents distributable cash flow for the same period. As such, it does not reflect the amount of cash flow that would have been available for distribution over an entire fiscal quarter.

The following table presents a reconciliation of production costs to the most directly comparable GAAP financial measure, on a historical basis for each of the periods indicated.

                                                      Three months ended September 30,                                                   Nine months ended September 30,
                                                        2012                                    2011                                      2012                                      2011
                                      Period from                 Period from                                           Period from                   Period from
                                    July 1 through             August 16 through                                     January 1 through             August 16 through
. . .
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