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RNF > SEC Filings for RNF > Form 10-K on 18-Mar-2013All Recent SEC Filings

Show all filings for RENTECH NITROGEN PARTNERS, L.P. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for RENTECH NITROGEN PARTNERS, L.P.


18-Mar-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition, results of operations and cash flows in conjunction with the financial statements and related notes included elsewhere in this report. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of a number of factors, including, but not limited to, those set forth under Part I-Item 1A "Risk Factors," "Forward-Looking Statements" and elsewhere in this report.

OVERVIEW

We are a Delaware limited partnership formed in July 2011 by Rentech, a publicly traded provider of clean energy solutions and nitrogen fertilizer, to own, operate and expand our fertilizer business. We own and operate two fertilizer facilities: our East Dubuque Facility and our Pasadena Facility. Our East Dubuque Facility, which Rentech acquired in 2006, is located in East Dubuque, Illinois, and has been in operation since 1965. We produce primarily ammonia and UAN at our East Dubuque Facility, using natural gas as the facility's primary feedstock. Our Pasadena Facility, which we acquired in November 2012, is located in Pasadena, Texas, and has been in operation since the 1940s. In 2011, our Pasadena Facility was retrofitted to produce ammonium sulfate. We produce ammonium sulfate, ammonium thiosulfate and sulfuric acid at our Pasadena Facility, using ammonia and sulfur as the facility's primary feedstocks.

Our East Dubuque Facility is located in the center of the Mid Corn Belt, the largest market in the United States for direct application of nitrogen fertilizer products. The Mid Corn Belt includes the States of Illinois, Indiana, Iowa, Missouri, Nebraska and Ohio. The States of Illinois and Iowa have been the top two corn producing states in the United States for the last 20 years according to the USDA. We consider the market for our East Dubuque Facility to be comprised of the States of Illinois, Iowa and Wisconsin.

Our East Dubuque Facility's core market consists of the area located within an estimated 200-mile radius of the facility. In most instances, our customers take delivery of our nitrogen products at our East Dubuque Facility and then arrange and pay to transport them to their final destinations by truck. To the extent our products are picked up at our East Dubuque Facility, we do not incur any shipping costs, in contrast to nitrogen fertilizer producers located outside of the facility's core market that must incur transportation and storage costs to transport their products to, and sell their products in, our market. In addition, our East Dubuque Facility does not maintain a fleet of trucks and, unlike some of our major competitors, our East Dubuque Facility does not maintain a fleet of rail cars because the facility's customers generally are located close to the facility and prefer to be responsible for transportation. Having no need to maintain a fleet of trucks or rail cars lowers the East Dubuque Facility's fixed costs. The combination of the East Dubuque Facility's proximity to its customers and our storage capacity at the facility also allows for better timing of the pick-up and application of the facility's products, as nitrogen fertilizer product shipments from more distant locations have a greater risk of missing the short periods of favorable weather conditions during which the application of nitrogen fertilizer may occur.

The Pasadena Facility is the largest producer of synthetic ammonium sulfate and the third largest overall producer of ammonium sulfate in North America. We believe that our ammonium sulfate has several characteristics that distinguish it from competing products. In general, the ammonium sulfate that is available for sale in our industry is a byproduct of other processes and does not have certain characteristics valued by customers. Our ammonium sulfate is sized to the specifications preferred by customers and may more easily be blended with other fertilizer products. We also believe that our ammonium sulfate has a longer shelf-life, is more stable and is more easily transported and stored than many other competing products.

Our Pasadena Facility is located on the Houston Ship Channel with access to transportation at favorable prices. The facility has two deep-water docks and access to the Mississippi waterway system and key international waterways. The facility is also connected to key domestic railways which permit the efficient, cost-effective distribution of its products west of the Mississippi River. Our Pasadena Facility's distributors purchase our products at our facility and then arrange and pay to transport them to their final destinations by truck, rail car or vessel. Our Pasadena Facility's products are sold primarily through distributors to customers in the U.S. and in Brazil, and are applied to many types of crops including soybeans, potatoes, cotton, canola, alfalfa, corn and wheat. We believe that the diversification of the geographic markets and applications for this facility's products should improve the stability of our overall results. Ammonium sulfate prices and margins generally have been less volatile than the prices and margins for the products of the East Dubuque Facility.


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While we experience seasonality in our domestic sales of ammonium sulfate and ammonium thiosulfate, our sales internationally offset a portion of this seasonal impact in our total revenues. Further, we adjust the sales prices of these products seasonally in order to facilitate distribution of the products throughout the year. We operate the ammonium sulfate plant at our Pasadena Facility throughout the year to the extent that there is available on-site storage capacity for this product. We have 60,000 tons of storage capacity for ammonium sulfate at the facility, and an arrangement with IOC that permits us to store 32,000 tons of ammonium sulfate at IOC-controlled terminals. We manage the storage capacity by distributing the product through IOC to customers in both domestic and offshore markets throughout the year. If storage capacity becomes insufficient, we would be forced to cease production of the product until such capacity becomes available. Our Pasadena Facility's fertilizer products are sold both on the spot market for immediate delivery and, to a much lesser extent, under product prepayment contracts for future delivery at fixed prices. The amount of products we sell under product prepayment contracts is highly variable. As of December 31, 2012, there were approximately 6,300 tons of ammonium sulfate sold under product prepayment contracts.

The Pasadena Facility purchases ammonia as a feedstock at contractual prices based on the monthly Tampa Index market, while the East Dubuque Facility sells ammonia at prevailing prices in the Mid Corn Belt, which are typically significantly higher than Tampa ammonia prices.

For further information concerning our potential financing needs and related risks, see Part I-Item 1 "Business," and Part I- Item 1A "Risk Factors".

Factors Affecting Comparability of Financial Information

Our historical results of operations for the periods presented may not be comparable with our results of operations for subsequent periods for the reasons discussed below.

Agrifos Acquisition

The operations of RNPLLC are only included in our historical results of operations from the closing date of the Agrifos Acquisition, which was November 1, 2012. Two months of revenues from RNPLLC accounted for approximately 14% of our revenues for the calendar year ended December 31, 2012. We would expect the percentage of revenues to increase significantly for a full year. As a result of the Agrifos Acquisition, we now produce three new products: ammonium sulfate, ammonium thiosulfate and sulfuric acid. In addition, as a result of the Agrifos Acquisition, we obtained a more diverse geographic area into which our products are sold. We also expect (i) general and administrative expenses as well as sales-related expenses to increase due to the integration of RNPLLC's operations, (ii) depreciation and amortization expenses to increase due to the increase in fixed and intangible assets, which were recorded at fair value on the date of the Agrifos Acquisition, and (iii) interest expense to increase due to the $155.0 million term loan used to finance a significant portion of the purchase price for the Agrifos Acquisition. As a result, our results of operations for the periods prior to and after the closing date of the Agrifos Acquisition may not be comparable.

Corporate Allocations

Prior to the closing of our initial public offering, REMC was consolidated with Rentech's operations following its acquisition by Rentech in 2006. Our consolidated financial statements included elsewhere in this report reflect REMC on a stand-alone or "carve-out" basis from Rentech for periods prior to our initial public offering. In the consolidated financial statements, corporate overhead costs incurred by Rentech on behalf of REMC were allocated to REMC and are reflected in operating expenses. These costs include the following:

compensation of human resources, legal, information systems, accounting and finance, investor relations and other Rentech personnel, which were allocated to REMC based on the estimated amount of time spent by the Rentech personnel on work for REMC;

stock-based compensation of REMC personnel, all of which was allocated to REMC;

third-party hosting costs for accounting and financial reporting software, which were allocated to REMC based on the estimated proportion of such costs that related to REMC transactions;

audit and tax services expenses, which were allocated to REMC based on an estimate of the time spent by third-party providers on REMC audit and tax matters;

income taxes, which were allocated to REMC on a hypothetical separate tax return basis;

capital costs of accounting and financial reporting software, which were allocated to REMC based on an estimate of the time the software was used by REMC personnel; and

amortization of the original issue discount and the loss on the early extinguishment of debt relating to REMC's former credit agreement, all of which was allocated to REMC.


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For the fiscal years ended September 30, 2011 and 2010, the total operating expenses incurred by Rentech and allocated to REMC were approximately $2.0 million and $1.4 million, respectively. See Note 2 to the financial statements.

REMC and Rentech entered into a management services agreement on April 26, 2006 and amended that agreement on July 29, 2011. As compensation for Rentech's management services, REMC paid Rentech the actual corporate overhead costs incurred by Rentech on behalf of REMC, including, without limitation, compensation expenses for Rentech personnel providing services to REMC, stock-based and incentive bonus compensation expenses of REMC personnel, legal, audit, accounting and tax services expenses, income tax expenses and software expenses. The management services agreement terminated in accordance with its terms at the closing of our initial public offering and, upon its termination, REMC was required to pay Rentech any corporate overhead costs owed by REMC under the agreement. The amount of these corporate overhead costs was approximately $19.4 million, which primarily represent estimated income taxes attributable to REMC.

On November 9, 2011, the closing date of our initial public offering, we, our general partner and Rentech entered into a services agreement, pursuant to which we and our general partner obtain certain management and other services from Rentech. Our consolidated financial statements following our initial public offering reflect the impact of the reimbursements we are required to make to Rentech under the services agreement instead of those used for purposes of preparing REMC's stand-alone financial statements. Under the services agreement, we, our general partner and our operating subsidiaries are obligated to reimburse Rentech for (i) all costs, if any, incurred by Rentech or its affiliates in connection with the employment of its employees who are seconded to us and who provide us services under the agreement on a full-time basis, but excluding share-based compensation; (ii) a prorated share of costs incurred by Rentech or its affiliates in connection with the employment of its employees, excluding seconded personnel, who provide us services under the agreement on a part-time basis, but excluding share-based compensation, and such prorated share shall be determined by Rentech on a commercially reasonable basis, based on the estimated percent of total working time that such personnel are engaged in performing services for us; (iii) a prorated share of certain administrative costs, in accordance with the agreement, including office costs, services by outside vendors, other general and administrative costs; and (iv) any taxes (other than income taxes, gross receipt taxes and similar taxes) incurred by Rentech or its affiliates for the services provided under the agreement.

Publicly Traded Limited Partnership Expenses

Our general and administrative expenses have increased due to the costs of operating as a publicly traded limited partnership, including costs associated with SEC reporting requirements, annual and quarterly reports to unitholders, tax return and Schedule K-1 preparation and distribution, work performed by our independent auditors, investor relations activities and registrar and transfer agent services. Our consolidated financial statements following our initial public offering reflect the impact of this expense, which affect the comparability of our post-offering results with our financial statements from periods prior to the closing of our initial public offering.

Expansion Projects

As discussed in Part I-Item 1A "Business-Our East Dubuque Facility-Expansion Projects" and "Business-Our Pasadena Facility -Expansion Projects," we have commenced or are evaluating potential projects to expand the production capabilities at our facilities. To the extent that we proceed with and complete one or more of these expansion projects, we expect to incur significant costs and expenses for the construction and development of such projects. We expect to finance the costs and expenses of the various expansion projects with indebtedness, which will significantly increase our interest expense. We also expect our depreciation expense to increase from additional assets placed into service from the projects. As a result, our results of operations for periods prior to, during and after the construction of any expansion project may not be comparable.

Key Industry Factors

Supply and Demand

Our earnings and cash flow from operations are significantly affected by nitrogen fertilizer product prices. The price at which we ultimately sell our nitrogen fertilizer products depends on numerous factors, including the global supply and demand for nitrogen fertilizer products which, in turn, depends on, among other factors, world grain demand and prices, inventory and production levels, changes in world population, the cost and availability of natural gas, ammonia and sulfur in various regions of the world, the cost and availability of fertilizer transportation infrastructure, weather conditions, the availability of imports and the extent of government intervention in agriculture markets. Nitrogen fertilizer prices are also affected by local factors, including weather and soil conditions, local market conditions and the operating levels of competing facilities. Construction of new facilities or the expansion or upgrade of our competitors' existing facilities, international political and economic developments and other factors are likely to continue to play an important role in nitrogen fertilizer industry economics. These factors can impact, among other things, the level of inventories in the market, resulting in price volatility and a reduction in product margins. In addition, demand for fertilizers is affected by the aggregate crop planting decisions and fertilizer application rate decisions of individual farmers. Individual farmers make planting decisions based largely on the prospective profitability of a harvest, while the specific varieties and amounts of fertilizer they apply depend on factors including crop prices, their current liquidity, soil conditions, weather patterns and the types of crops planted. Moreover, the industry typically experiences seasonal fluctuations in demand for nitrogen fertilizer products.


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Natural Gas Prices

Natural gas is the primary feedstock for the production of nitrogen fertilizers at our East Dubuque Facility, accounting for approximately 64% of the production costs for ammonia in the calendar year ended December 31, 2012. Over the last five years, United States natural gas reserves have increased significantly due to, among other factors, advances in extracting shale gas, which have reduced and stabilized natural gas prices, providing North America with a cost advantage over Europe. As a result, our competitive position and that of other North American nitrogen fertilizer producers have been positively impacted.

We historically have purchased natural gas in the spot market, through the use of forward purchase contracts, or a combination of both. We historically have used forward purchase contracts to lock in pricing for a portion of our East Dubuque Facility's natural gas requirements. These forward purchase contracts are generally either fixed-price or index-price, short-term in nature and for a fixed supply quantity. We are able to purchase natural gas at competitive prices due to our East Dubuque Facility's connection to Nicor Inc.'s distribution system and its proximity to the Northern Natural Gas interstate pipeline system. Over the past several years, natural gas prices have experienced significant fluctuations, which has had an impact on our East Dubuque Facility's cost of producing nitrogen fertilizer. During the calendar year ended December 31, 2012, the three months ended December 31, 2011 and the fiscal years ended September 30, 2011 and 2010, we spent approximately $38.3 million, $10.8 million, $49.2 million and $50.5 million, respectively, on natural gas in cost of sales, which equaled an average cost per MMBtu of approximately $3.59, $4.75, $4.66 and $4.79, respectively.

Ammonia Prices

Ammonia, along with sulfuric acid, are the primary feedstocks for the production of ammonium sulfate at our Pasadena Facility, accounting for 69% and 31%, respectively, of the raw material costs for ammonium sulfate. Ammonia pricing is based on a published Tampa, Florida market index. The Tampa index is commonly used in annual contracts for both the agricultural and industrial sectors, and is based on the most recent major industry transactions in the Tampa market. Pricing considerations for ammonia incorporate international supply-demand, ocean freight and production factors. Over the past several years, ammonia prices have experienced large fluctuations. During the period from May 2011, the time when our Pasadena Facility began to produce ammonium sulfate, through the beginning of March 2013, the low and high prices for a short ton of ammonia were $363 and $653, respectively. During the calendar year ended December 31, 2012, our Pasadena Facility spent approximately $74.8 million on ammonia. During the calendar year ended December 31, 2012, 75% of the sulfuric acid used in our Pasadena Facility's production of ammonium sulfate was produced at our Pasadena Facility.

Sulfur Prices

Sulfur is the primary feedstock for the production of sulfuric acid at our Pasadena Facility, accounting for 100% of the raw material costs for sulfuric acid. Our contracts with the major suppliers of sulfur to our Pasadena Facility generally have a term of one year. Once pricing for the first quarter of a year is negotiated, the price then fluctuates up or down each subsequent quarter based on changes to a Tampa index that is set on a quarterly basis through negotiations between large industry producers and consumers. Over the past several years, sulfur prices have experienced significant fluctuations. During the period from May 2011 through the beginning of March 2013, the low and high prices for a short ton of sulfur was $134 and $196, respectively. During the calendar year ended December 31, 2012, our Pasadena Facility spent approximately $26.0 million on sulfur.

Transportation Costs

Costs for transporting nitrogen fertilizer can be significant relative to its selling price. For example, ammonia is costly to transport because it is a toxic gas at ambient temperatures and therefore must be transported under refrigeration in specialized equipment. The United States imported an average of over 50% of its annual fertilizer needs between 1999 and 2009 according to the USDA. Therefore, nitrogen fertilizer prices in North America are influenced by the cost to transport product from exporting countries, granting an advantage to local producers who ship over shorter distances.


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The price of our East Dubuque Facility's nitrogen fertilizer products is impacted by our transportation cost advantage over out-of-region competitors serving our East Dubuque Facility's core market. In most instances, our East Dubuque Facility's customers purchase our nitrogen products at the facility and then arrange and pay to transport them to their final destinations by truck. To the extent our products are picked up at the facility, we do not incur any shipping costs, in contrast to nitrogen fertilizer producers outside of our East Dubuque Facility's core market that must incur transportation and storage costs to transport their products to, and sell their products in, our market. Accordingly, we may offer our East Dubuque Facility's nitrogen fertilizers at market prices that factor in the storage and transportation costs of out-of-region producers without having incurred such costs. In addition, we do not maintain a fleet of trucks and, unlike some of our major competitors, we do not maintain a fleet of rail cars, which lowers our fixed costs.

Our Pasadena Facility is located on the Houston Ship Channel with access to transportation at favorable prices by barge, truck or rail. The facility has two deep-water docks and access to the Mississippi waterway system and international waterways. The docks at the facility are suitable for loading and unloading bulk or liquid barges with payloads of up to 35,000 tons. The facility is also connected to key domestic railways which permit the efficient, cost-effective distribution of its products west of the Mississippi River. Our location on the Houston Ship Channel allows our distributors or us to use low cost barge and vessel when selling products and purchasing feedstocks. Our Pasadena Facility's distributors purchase our products at our facility and then arrange and pay to transport them to their final destinations by truck, rail car or vessel.

Key Operational Factors

Product Prepayment Contracts

We enter into product prepayment contracts committing our East Dubuque Facility's customers to purchase the facility's nitrogen fertilizer products at a later date. To a lesser extent, we also enter into product prepayment contracts for our Pasadena Facility's products. These customers pay a portion of the contract price for our products shortly after entering into such contracts and the remaining balance of the contract price prior to picking up or delivery of the products. We recognize revenue when products are picked-up or delivered and the customer takes title. The cash received from product prepayments increases our operating cash flow in the quarter in which the cash is received, but may effectively reduce our operating cash flow in a subsequent quarter if the cash was received in a quarter prior to the one in which the revenue is recorded. Our policy is to purchase under fixed-price forward contracts approximately enough natural gas to manufacture the products that have been sold by our East Dubuque Facility under product prepayment contracts for later delivery, effectively fixing most of the gross margin on pre-sold product. Our earnings and operating cash flow in future periods may be affected by the degree to which we continue this practice or seek to maximize our gross margins by more opportunistically timing product sales and natural gas purchases.

Facility Reliability

Consistent, safe and reliable operations at our facilities are critical to our financial performance and results of operations. Unplanned shutdowns of our facilities may result in lost margin opportunity, increased maintenance expense, a temporary increase in working capital investment and reduced inventory available for sale. The financial impact of planned shutdowns, including facility turnarounds, is mitigated through a diligent planning process that takes into account the availability of resources to perform the needed maintenance, feedstock logistics and other factors. Our facilities generally undergo a facility turnaround every two years. Turnarounds at our East Dubuque Facility typically last 18 to 25 days and cost approximately $3.0 to $5.0 million per turnaround, and turnarounds at our Pasadena Facility generally last between 14 to 25 days and cost approximately $1.0 to $4.0 million per turnaround. These costs are expensed as incurred. Our East Dubuque Facility underwent a turnaround in October 2009 at a cost of approximately $4.0 million and in September and October of 2011 at a cost of approximately $7.5 million. Our Pasadena Facility underwent a turnaround in March and April of 2011 at a cost of approximately $4.5 million. We intend to alternate the year in which a turnaround occurs at each facility, so that both facilities do not experience a turnaround in the same year.

In many cases, we also perform significant maintenance capital projects at our facilities during a turnaround to minimize disruption to our operations. These capital projects are undertaken during turnarounds to minimize disruption to our operations, but are capitalized as property, plant and equipment rather than expensed as turnaround costs. Our East Dubuque Facility's maintenance capital expenditures for such projects were $24.5 million and $9.9 million for the fiscal years ended September 30, 2011 and 2010, respectively. Our East Dubuque Facility's maintenance capital expenditures totaled approximately $7.9 million, $2.5 million and $2.7 million for the calendar year ended December 31, 2012 and the three months ended December 31, 2011 and 2010, respectively. As part of the 2011 turnaround, our East Dubuque Facility completed a significant maintenance capital project to replace our existing steam methane reformer tubes, which had been operational since 1980, and made other capital improvements to our facility. Our Pasadena Facility's maintenance capital expenditures were approximately $4.6 million for the calendar year ended December 31, 2012, which included maintenance on the facility's sulfuric acid plant. See "-Liquidity and Capital Resources-Capital Expenditures."


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Factors Affecting Results of Operations

Revenues

We generate revenue primarily from sales of nitrogen fertilizer products. We generate revenue from sales of nitrogen fertilizer products manufactured at our East Dubuque Facility and used primarily in corn production. Our East Dubuque Facility is designed to produce ammonia, UAN, liquid and granular urea, nitric acid and CO2 using natural gas as a feedstock. We also generate revenue from . . .

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