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CELP > SEC Filings for CELP > Form 10-Q on 14-May-2014All Recent SEC Filings

Show all filings for CYPRESS ENERGY PARTNERS, L.P.

Form 10-Q for CYPRESS ENERGY PARTNERS, L.P.


14-May-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion contains forward-looking statements that reflect our future plans, estimates, beliefs and expected performance. The forward-looking statements are dependent upon events, risks and uncertainties that may be outside our control, including among other things, the risk factors discussed in the IPO prospectus, "Item 1A. Risk Factors" of our Annual Report on Form 10-K for the year ended December 31, 2013 and this Quarterly Report on Form 10-Q. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, market prices for oil and natural gas, production volumes, capital expenditures, weather, economic and competitive conditions, regulatory changes and other uncertainties, as well as those factors discussed below and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2013 and this Quarterly Report on Form 10-Q, all of which are difficult to predict. In light of these risks, uncertainties and assumptions, the forward-looking events discussed may not occur. See "Cautionary Statements Regarding Forward-Looking Statements" in the front of this Quarterly Report on Form 10-Q.

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains a discussion of our business, including a general overview of our properties, our results of operations, our liquidity and capital resources, and our quantitative and qualitative disclosures about market risk. At the closing of our IPO on January 21, 2014, Cypress LLC and a 50.1% interest in the TIR Entities were contributed to us and became our Water and Environmental Services segment and our Pipeline Inspection and Integrity Services segment, respectively. On June 26, 2013, Cypress Holdings indirectly acquired a controlling interest in the TIR Entities. The contribution of the TIR Entities was treated for accounting purposes as a combination of entities under common control and the results of the TIR Entities are included in our financial statements for periods subsequent to June 26, 2013. Accordingly, there is no operating results and discussion and analysis for the Pipeline Inspection and Integrity Services segment for the quarter ended March 31, 2013. The financial information for our Water and Environmental Services and Pipeline Inspection and Integrity Services segments included in "Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations" should be read in conjunction with the interim financial statements and related notes included elsewhere in this report and prepared in accordance with accounting principles generally accepted in the United States of America and our audited financial statements as well as the audited financial statements of Cypress Energy Partners, LLC as of December 31, 2013 and 2012 and for the years ended December 31, 2013 and 2012 and for the period from June 1, 2011(Inception) to December 31, 2011, the audited combined financial statements of the Tulsa Inspection Resources Entities as of and for the year ended December 31, 2013, the audited consolidated financial statements of Tulsa Inspection Resources, Inc. as of and for the years ended December 31, 2012 and 2011, Management's Discussion and Analysis of Financial Condition and Results of Operations and Risk Factors included in our Annual Report on Form 10-K for the year ended December 31, 2013.

Overview

We are a growth-oriented master limited partnership formed in September 2013. We provide saltwater disposal and other water and environmental services to U.S. onshore oil and natural gas producers and trucking companies through our Water and Environmental Services segment. The Water and Environmental Services segment is comprised of the historical operations of Cypress LLC, with the exception of one saltwater disposal ("SWD') facility and a permit which were not contributed to us. We own and operate nine SWD facilities, seven of which are in the Bakken Shale region of the Williston Basin in North Dakota and two of which are in the Permian Basin in west Texas. We also manage four other SWD facilities in the Bakken Shale region. Our Water and Environmental Services segment customers are oil and natural gas exploration and production companies and trucking companies operating in the regions that we serve. We also provide independent pipeline inspection and integrity services to various energy, public utility and pipeline companies through our Pipeline Inspection and Integrity Services segment. The Pipeline Inspection and Integrity Services segment is comprised of the historical operations of the TIR Entities. In both of these business segments, we work closely with our customers to help them comply with increasingly complex and strict environmental and safety rules and regulations applicable to production and pipeline operations, and reduce their operating costs.

Our Initial Public Offering and Restructuring

On January 21, 2014, the Partnership completed its initial public offering ("IPO") of 4,312,500 common units representing limited partner interests in the Partnership at a price to the public of $20.00 per common unit ($18.70 per common unit, net of underwriting discounts and commissions) which included a 562,500 unit over-allotment option that was exercised by the underwriters. The initial yield was 7.75% with a first year estimate of distributable cash flow per unit of $1.55 for the full calendar year of 2014. We received net proceeds of approximately $80.2 million from the IPO, after deducting underwriting discounts and structuring fees. The net proceeds from the IPO were distributed to Cypress Energy Holdings II, LLC ("Holdings II"), as reimbursement for certain capital expenditures it incurred with respect to assets contributed to us. Holdings II is owned 100% by Cypress Holdings.

At the closing of the IPO, Holdings II conveyed its 100% member interest in Cypress LLC to the Partnership in exchange for (a) an aggregate 47.8% interest in the Partnership, and (b) the right to receive the proceeds of the IPO. Holdings II subsequently conveyed a 0.4% interest in the Partnership to certain members of management. Prior to the contribution of Cypress LLC to the Partnership, but subsequent to December 31, 2013, Cypress LLC distributed its 100% member interest in four limited liability companies, only one of which had operating activities, to Cypress Holdings. One of the distributed entities, SBG Sheridan Facility LLC, contains the assets and liabilities of an SWD facility that was previously operational but has been non-operational since June 2013 and is undergoing repair work. The historical operating results of these distributed entities were previously included in the historical financial results of Cypress
LLC. The historical results of the Partnership and our Water and Environmental Services segment have been recast to exclude the results of the Sheridan facility as if the distribution occurred at the beginning of the earliest period presented.


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Affiliates of Holdings II, conveyed an aggregate 50.1% interest in the TIR Entities to the Partnership in exchange for an aggregate 11.4% ownership in the Partnership. The Partnership subsequently conveyed its interest in the TIR Entities to Cypress LLC.

Omnibus Agreement

Effective as of the closing of our IPO, we are party to an omnibus agreement with Cypress Holdings, CEM, Cypress LLC, our general partner, CEP-TIR, the TIR Entities, Charles C. Stephenson, Jr. and Cynthia Field that govern the following matters, among other things:

our payment of an annual administrative fee initially in the amount of $4.0 million to be paid in quarterly installments to Cypress Holdings for providing us with certain partnership overhead services, including for certain executive management services by certain officers of our general partner, and compensation expense, including stock-based compensation, for all employees required to manage and operate our business. This fee also includes the incremental general and administrative expenses we incur as a result of being a publicly traded partnership;

limitations on the amount of indebtedness CEP-TIR may incur under our credit agreement and the allocation of certain interest expenses to the TIR Entities;

our right of first offer on Cypress Holdings' and its subsidiaries' assets used in, and entities primarily engaged in, providing saltwater disposal and other water and environmental services and pipeline inspection and integrity services, including the remaining interest in the TIR Entities; and

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

So long as Cypress Holdings controls our general partner, the omnibus agreement will remain in full force and effect, unless we and Cypress Holdings agree to terminate it sooner. If Cypress 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 Cypress Holdings may agree to amend the omnibus agreement; however, amendments that the general partner determines are adverse to our unitholders will also require the approval of the conflicts committee.

Water and Environmental Services Segment

We generate revenue in our Water and Environmental Services segment primarily by treating flowback and produced water and injecting the saltwater into our SWD facilities. Our results in the Water and Environmental Services segment 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 under contracts that are short-term in nature 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 flowback and produced water. Through our 51.0% ownership interest in CES, we also generate revenue managing SWD facilities for a fee. Revenues in this segment are recognized when the service is performed and collectability of fees is reasonably assured.

The volumes of saltwater disposed at our SWD facilities are driven by water volumes generated from existing oil and natural gas wells during their useful lives and development drilling and production volumes from the wells located near our facilities. Producers' willingness to engage in new drilling is determined by a number of factors, the most important of which are the prevailing and projected prices of oil, natural gas and NGLs, the cost to drill and operate a well, the availability and cost of capital and environmental and governmental regulations. We generally expect the level of drilling to positively correlate with long-term trends in prices of oil, natural gas and NGLs. Similarly, oil and natural gas production levels nationally and regionally generally tend to positively correlate with drilling activity. The past winter was one of the most severe on record and it impacted many of our oil and gas customers' production that in turn impacted our SWD volumes, particularly in the Bakken Shale region.

Approximately 29% of our revenue for the three months ended March 31, 2014 in our Water and Environmental Services segment was derived from sales of residual oil recovered during the saltwater treatment process. Our ability to recover sufficient volumes of residual oil is dependent upon the residual oil content in the saltwater we treat, which is, among other things, a function of water type, chemistry, source and temperature. Generally, where outside temperatures are lower, there is less residual oil content and separation is more difficult. Thus, our residual oil recovery during the winter season is lower than our recovery during the summer season in North Dakota. Additionally, residual oil content will decrease if, among other things, producers begin recovering higher levels of residual oil in saltwater prior to delivering such saltwater to us for treatment.


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Pipeline Inspection and Integrity Services Segment

We generate revenue in our Pipeline Inspection and Integrity Services segment, primarily by providing inspection and integrity 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 the Pipeline Inspection and Integrity Services segment are driven primarily by the number of inspectors that perform services for our customers and the fees that we charge for those services, which depend on the type and number of inspectors used on a particular project, the nature of the project and the duration of the project. The number of inspectors engaged on projects is driven by the type of project, prevailing market rates, the age and condition of customers' midstream pipelines, gathering systems and distribution systems and the legal and regulatory requirements relating to the inspection and maintenance of those assets. We charge our inspectors' services out to customers on a per project basis, including per diem charges, mileage and other reimbursement items.

The amount of revenue we generate in our Pipeline Inspection and Integrity Services segment depends primarily on the number of inspectors that perform services for our customers.

Outlook

After an unusually harsh winter that negatively impacted our customers and our SWD volumes, we have seen sequential improvement following the end of the quarter. Additionally, we have been awarded several new Master Service Agreements with new customers in our Pipeline Inspection & Integrity Segment and expect the impact to be reflected in higher inspector headcounts and revenues in future quarters.

We continue to evaluate a number of potential acquisition opportunities in both of our segments. The combination of organic growth and new acquisition opportunities will influence our future distributions. We continue to expect to meet our distribution forecast for the year ending December 31, 2014 (on pro-rated basis) as contained in the IPO prospectus.

Results of Operations

Factors Impacting Comparability

The historical results of operations for the periods presented may not be comparable, either to each other or to our future results of operations, for the reasons described below:

At the closing of the IPO, we acquired a 50.1% interest in each of the TIR Entities with Cypress Holdings and certain affiliates continuing to hold the remaining 49.9% interest ("Retained Interest"). As a result, our distributable cash flow does not include distributions on the interest in these entities not held by the Partnership. The non-controlling interest of the non-controlling members of the TIR Entities are reduced by certain interest charges as outlined in the omnibus agreement. The contribution of the TIR Entities to the Partnership has been treated as a reorganization of entities under common control. Accordingly, the results of operations and assets and liabilities of the TIR Entities will be included in the historical financial information of the Partnership for periods from June 27, 2013 through January 20, 2014, the date Cypress Holdings obtained control of the TIR Entities.

Historical results of Cypress LLC, as presented in our Annual Report on Form 10-K for the year ended December 31, 2013, included results of an SWD facility located in Sheridan County, Montana and a permit relating to a potential SWD facility that was distributed to Cypress Holdings prior to the closing of our IPO ("Non-contributed Properties"). The distribution of these properties has been treated as a reorganization of entities under common control. Accordingly, the historical results of these Non-contributed Properties are not reflected in the historical financial information of the Partnership or in the results of operations of our Water and Environmental Services segment included herein.

The effective date of the acquisition of our 51% ownership of CES was October 1, 2013; accordingly, the financial data presented below does not reflect the results of operations of CES for the three months ended March 31, 2013.

General and administrative expenses will increase as a result of operating as a publicly traded partnership. At the closing of the IPO, Cypress LLC, the Partnership and other affiliates entered into an omnibus agreement with Cypress Holdings. Among other things, the agreement calls for an annual administrative fee to be paid by the Partnership in the amount of $4.0 million. The fee will be paid in quarterly installments to Cypress Holdings for providing the Partnership with certain overhead services, including executive management services by certain officers of our general partner, compensation expense, including stock-based compensation expense, for employees required to manage and operate our business as well as the costs of operating as a publicly traded partnership, including costs associated with SEC reporting requirements, tax return and Schedule K-1 preparation and distribution, independent auditor fees, investor relations activities and registrar and transfer agent fees.

Interest expense will not be comparable between the periods presented as a result of our new credit agreement entered into in December 2013 that resulted in more favorable credit terms as compared to previous periods. Borrowings under the credit agreement were used to, among other things, refinance outstanding obligations of the TIR Entities which had significantly higher interest rates.

We incurred and expensed non-recurring costs associated with our IPO totaling $0.4 million for the three months ended March 31, 2014.


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