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Section 1: 10-Q (QUARTERLY REPORT)

celp-10q_063017.htm
 

 

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 June 30, 2017

 

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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,”  “smaller reporting company,” and "emerging growth company"  in Rule 12b-2 of the Exchange Act.

  

Large accelerated filer  ☐ Accelerated filer   Non-accelerated filer   Smaller reporting company   Emerging growth company  ☒
  (Do not check if a smaller reporting company)  

  

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period fro complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ☒

 

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 August 7, 2017, the registrant had 11,882,794 common units outstanding.

  

DOCUMENTS INCORPORATED BY REFERENCE:        None.

  

 

 

 

 

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 June 30, 2017 and December 31, 2016   5
       
  Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2017 and 2016   6
       
  Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2017 and 2016   7
       
  Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2017 and 2016   8
       
  Condensed Consolidated Statement of Owners’ Equity for the Six Months Ended June 30, 2017   9
       
  Notes to the Condensed Consolidated Financial Statements   10
       
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations   34
       
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk   55
       
ITEM 4. Controls and Procedures   55
       
PART II – OTHER INFORMATION    
     
ITEM 1. Legal Proceedings   56
       
ITEM 1A. Risk Factors   56
       
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds   56
       
ITEM 3. Defaults upon Senior Securities   56
       
ITEM 4. Mine Safety Disclosures   56
       
ITEM 5. Other Information   56
       
ITEM 6. Exhibits   57
       
SIGNATURES   58

 

2

 

 

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;

 

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

  

  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 5,610,549 common units representing 47.2% of our outstanding common 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” refers collectively to TIR LLC and its subsidiaries, TIR-Canada, and TIR-NDE, all wholly owned subsidiaries of CEP LLC;

 

  TIR LLC” refers to Tulsa Inspection Resources, LLC;

  

  TIR-Canada” refers to Tulsa Inspection Resources – Canada ULC;

  

  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.

  

3

 

 

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, 2016 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. 

 

4

 

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. Unaudited Condensed Consolidated Financial Statements

 

CYPRESS ENERGY PARTNERS, L.P.
Unaudited Condensed Consolidated Balance Sheets
As of June 30, 2017 and December 31, 2016
(in thousands, except unit data)
 
    June 30,      December 31,   
    2017     2016  
             
 ASSETS                
 Current assets:                
 Cash and cash equivalents   $ 22,467     $ 26,693  
 Trade accounts receivable, net     43,293       38,482  
 Prepaid expenses and other     1,633       1,042  
 Total current assets     67,393       66,217  
 Property and equipment:                
 Property and equipment, at cost     20,019       22,459  
 Less:  Accumulated depreciation     7,977       7,840  
 Total property and equipment, net     12,042       14,619  
 Intangible assets, net     26,880       29,624  
 Goodwill     55,371       56,903  
 Other assets     204       149  
 Total assets   $ 161,890     $ 167,512  
                 
 LIABILITIES AND OWNERS’ EQUITY                
 Current liabilities:                
 Accounts payable   $ 2,434     $ 1,690  
 Accounts payable - affiliates     2,298       1,638  
 Accrued payroll and other     10,702       7,585  
 Income taxes payable     209       1,011  
 Total current liabilities     15,643       11,924  
 Long-term debt     135,993       135,699  
 Deferred tax liabilities           362  
 Asset retirement obligations     161       139  
 Total liabilities     151,797       148,124  
                 
 Commitments and contingencies - Note 9                
                 
 Owners’ equity:                
 Partners’ capital:                
  Common units (11,882,794 and 5,945,348 units outstanding at June 30, 2017 and December 31, 2016, respectively)     34,747       (7,722 )
Subordinated units (5,913,000 units outstanding at December 31, 2016)           50,474  
General partner     (25,876 )     (25,876 )
Accumulated other comprehensive loss     (2,518 )     (2,538 )
 Total partners’ capital     6,353       14,338  
 Noncontrolling interests     3,740       5,050  
 Total owners’ equity     10,093       19,388  
 Total liabilities and owners’ equity   $ 161,890     $ 167,512  

 

 See accompanying notes. 

 

5

 

 

CYPRESS ENERGY PARTNERS, L.P.
Unaudited Condensed Consolidated Statements of Operations
For the Three and Six Months Ended June 30, 2017 and 2016
(in thousands, except unit and per unit data)
                         
    Three Months Ended June 30,     Six Months Ended June 30,  
    2017     2016     2017     2016  
                         
 Revenues   $ 74,567     $ 72,311     $ 139,289     $ 145,785  
 Costs of services     65,958       64,946       124,351       130,660  
 Gross margin     8,609       7,365       14,938       15,125  
                                 
 Operating costs, expenses and other:                                
 General and administrative     5,329       5,560       10,439       11,749  
 Depreciation, amortization and accretion     1,206       1,246       2,377       2,471  
 Impairments           10,530       3,598       10,530  
 (Gains) losses on asset disposals and insurance recoveries, net     (113 )           (113 )      
 Operating income (loss)     2,187       (9,971 )     (1,363 )     (9,625 )
                                 
 Other (expense) income:                                
 Interest expense, net     (1,795 )     (1,619 )     (3,504 )     (3,237 )
 Foreign currency gains     267             267        
 Other, net     60       24       105       47  
 Net income (loss) before income tax expense     719       (11,566 )     (4,495 )     (12,815 )
 Income tax expense (benefit)     222       50       (71 )     162  
 Net income (loss)     497       (11,616 )     (4,424 )     (12,977 )
                                 
 Net loss attributable to noncontrolling interests     (133 )     (4,612 )     (1,298 )     (4,979 )
 Net income (loss) attributable to partners / controlling interests     630       (7,004 )     (3,126 )     (7,998 )
                                 
 Net loss attributable to general partner     (829 )     (2,967 )     (1,750 )     (3,935 )
 Net income (loss) attributable to limited partners   $ 1,459     $ (4,037 )   $ (1,376 )   $ (4,063 )
                                 
 Net income (loss) attributable to limited partners allocated to:                                
 Common unitholders   $ 1,459     $ (2,021 )   $ (1,376 )   $ (2,034 )
 Subordinated unitholders           (2,016 )           (2,029 )
    $ 1,459     $ (4,037 )   $ (1,376 )   $ (4,063 )
                                 
 Net income (loss) per common limited partner unit                                
 Basic   $ 0.12     $ (0.34 )   $ (0.13 )   $ (0.34 )
 Diluted   $ 0.12     $ (0.34 )   $ (0.13 )   $ (0.34 )
                                 
 Net loss per subordinated limited partner unit - basic and diluted   $     $ (0.34 )   $     $ (0.34 )
                                 
  Weighted average common units outstanding                                
 Basic     11,880,452       5,929,735       10,404,026       5,926,451  
 Diluted     12,002,538       5,929,735       10,404,026       5,926,451  
                                 
 Weighted average subordinated units outstanding - basic and diluted           5,913,000       1,470,083       5,913,000  

 

 See accompanying notes. 

 

6

 

 

CYPRESS ENERGY PARTNERS, L.P.
Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss)
For the Three and Six Months Ended June 30, 2017 and 2016
(in thousands)
                         
    Three Months Ended June 30,     Six Months Ended June 30,  
    2017     2016     2017     2016  
                         
 Net income (loss)   $ 497     $ (11,616 )   $ (4,424 )   $ (12,977 )
 Other comprehensive income (loss) - foreign currency translation     (42 )     (2 )     20       586  
                                 
 Comprehensive income (loss)   $ 455     $ (11,618 )   $ (4,404 )   $ (12,391 )
                                 
 Comprehensive loss attributable to noncontrolling interests     (133 )     (4,612 )     (1,298 )     (4,979 )
 Comprehensive loss attributable to general partner     (829 )     (2,967 )     (1,750 )     (3,935 )
                                 
 Comprehensive income (loss) attributable to limited partners   $ 1,417     $ (4,039 )   $ (1,356 )   $ (3,477 )

 

 See accompanying notes. 

 

7

 

 

CYPRESS ENERGY PARTNERS, L.P.
Unaudited Condensed Consolidated Statements of Cash Flows
For the Six Months Ended June 30, 2017 and 2016
(in thousands)
    Six Months Ended June 30,  
    2017     2016  
 Operating activities:                
 Net loss   $ (4,424 )   $ (12,977 )
 Adjustments to reconcile net loss to net cash provided by operating activities:                
 Depreciation, amortization and accretion     2,913       2,907  
 Impairments     3,598       10,530  
 (Gains) losses on asset disposals and insurance recoveries     (308 )     (2 )
 Interest expense from debt issuance cost amortization     294       282  
 Equity-based compensation expense     766       507  
 Equity in earnings of investee     (57 )     (30 )
 Distributions from investee           63  
 Deferred tax benefit, net     (358 )     (12 )
 Non-cash allocated expenses     1,750       1,935  
 Foreign currency gains     (267 )      
 Changes in assets and liabilities:                
 Trade accounts receivable     (4,727 )     1,746  
 Prepaid expenses and other     (586 )     913  
 Accounts payable and accrued payroll and other     3,920       6,206  
 Income taxes payable     (802 )     (318 )
 Net cash provided by operating activities     1,712       11,750  
                 
 Investing activities:                
 Proceeds from fixed asset disposals, including insurance proceeds     1,578       4  
 Purchase of property and equipment     (380 )     (644 )
 Net cash provided by (used in) investing activities     1,198       (640 )
                 
 Financing activities:                
 Repayment of long-term debt           (4,000 )
 Taxes paid related to net share settlement of equity-based compensation     (77 )     (47 )
 Contribution attributable to general partner           2,000  
 Distributions to limited partners     (7,318 )     (9,622 )
 Distributions to noncontrolling members     (12 )     (367 )
 Net cash used in financing activities     (7,407 )     (12,036 )
                 
 Effect of exchange rates on cash     271       392  
                 
 Net decrease in cash and cash equivalents     (4,226 )     (534 )
 Cash and cash equivalents, beginning of period     26,693       24,150  
 Cash and cash equivalents, end of period   $ 22,467     $ 23,616  
                 
 Non-cash items:                
 Changes in accounts payable excluded from capital expenditures   $ 473     $ 188  

 

 See accompanying notes. 

 

8

 

 

CYPRESS ENERGY PARTNERS, L.P.
Unaudited Condensed Consolidated Statement of Owners’ Equity
For the Six Months Ended June 30, 2017
(in thousands)
 
    General
Partner 
    Common
Units 
    Subordinated Units      Accumulated Other Comprehensive Loss      Noncontrolling Interests      Total Owners’
Equity 
 
                                                 
Owners’ equity at December 31, 2016   $ (25,876 )   $ (7,722 )   $ 50,474     $ (2,538 )   $ 5,050     $ 19,388  
Net loss for the period January 1, 2017 through June 30, 2017     (1,750 )     (1,376 )                 (1,298 )     (4,424 )
Foreign currency translation adjustment                       20             20  
Contributions attributable to general partner     1,750                               1,750  
Distributions to partners           (4,913 )     (2,405 )                 (7,318 )
Distributions to noncontrolling interests                             (12 )     (12 )
Conversion of Subordinated Units to Common Units           48,111       (48,111 )                  
Equity-based compensation           724       42                   766  
Taxes paid related to net share settlement of equity-based compensation           (77 )                       (77 )
                                                 
 Owners’ equity at June 30, 2017   $ (25,876 )   $ 34,747     $     $ (2,518 )   $ 3,740     $ 10,093  

 

 See accompanying notes.

 

9

 

 

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, public utility companies, and pipeline companies and to provide salt water disposal (“SWD”) and other water and environmental services to U.S. onshore oil and natural gas producers and trucking companies. Trading of our common units began January 15, 2014 on the New York Stock Exchange under the symbol “CELP.”

  

Our business is organized into the Pipeline Inspection Services (“PIS”), Integrity Services (“IS”), and Water and Environmental Services (“W&ES”) segments. PIS provides pipeline inspection and other services to energy exploration and production (“E&P”) companies, public utility companies, and midstream 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 and to 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 SWD facilities in the Permian Basin in Texas. All of the facilities utilize specialized equipment and remote monitoring to minimize downtime and increase efficiency for peak utilization. These facilities also contain oil skimming processes that remove oil from water delivered to the sites. In addition to these SWD facilities, we provide management and staffing services for an SWD facility pursuant to a management agreement (see Note 7). We also own a 25% member interest in this managed SWD facility.

 

2. Basis of Presentation and Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Unaudited Condensed Consolidated Financial Statements as of June 30, 2017 and for the six months ended June 30, 2017 and 2016 include our accounts and those of our controlled subsidiaries. Investments over which we exercise significant influence, but do not control, are accounted for using the equity method of accounting. All significant intercompany transactions and account balances have been eliminated in consolidation. The Unaudited Condensed Consolidated Balance Sheet at December 31, 2016 is derived from audited financial statements.

  

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States (“GAAP”) for interim consolidated financial information and in accordance with the rules and regulations of the Securities and Exchange Commission. The Unaudited Condensed Consolidated Financial Statements include all adjustments considered necessary for a fair presentation of the consolidated financial position and consolidated 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 of 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, 2016 included in our Form 10-K. The results of operations for interim periods are not necessarily indicative of the results to be expected for a full year.

 

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, 2016 included in our Form 10-K.

 

10

 

 

CYPRESS ENERGY PARTNERS, L.P. 

Notes to the Unaudited Condensed Consolidated Financial Statements 

 

Accounts Receivable and Allowance for Bad Debts

 

We grant unsecured credit to customers under normal industry standards and terms, and have established policies and procedures that allow for an evaluation of each customer’s creditworthiness. The Partnership determines allowances for bad debts based on management’s assessment of the creditworthiness of the customers. Trade receivables are written off against the allowance when deemed uncollectible. Recoveries of trade receivables previously written off are recorded when cash is received. In the first quarter of 2017, we received $0.3 million on accounts receivable previously reserved, which we recorded as a reduction to general and administrative expense in our Unaudited Consolidated Statements of Operations.

 

Income Taxes

 

As a limited partnership, we generally are not subject to federal, state, or local income taxes. The tax on our net income is generally borne by 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 income of Tulsa Inspection Resources – Canada, ULC, our Canadian subsidiary, is taxable in Canada. Tulsa Inspection Resources – PUC, LLC, a subsidiary of our PIS segment that performs pipeline inspection services for utility customers, and Brown Integrity – PUC, LLC, a 51% owned subsidiary, have elected to be taxed as corporations for U.S. federal income tax purposes, and therefore, these subsidiaries are subject to U.S. federal and state income tax. The amounts recognized as income tax expense (benefit), income taxes payable, and deferred tax liabilities in our Unaudited Condensed Consolidated Financial Statements represent the Canadian and U.S. taxes referred to above, as well as partnership-level taxes levied by various states, most notably franchise taxes assessed by the state of Texas.

 

As a publicly-traded partnership, we are subject to a statutory requirement that 90% of our total gross income classify as “qualifying income” (as defined by the Internal Revenue Code, related Treasury Regulations, and Internal Revenue Service pronouncements), determined on a calendar-year basis. If our qualifying income does not meet this statutory requirement, we could be taxed as a corporation for federal and state income tax purposes. Our income has met the statutory qualifying income requirement for each year since our IPO.

 

Noncontrolling Interest

 

We own a 51% interest in Brown Integrity, LLC (“Brown”) and a 49% interest in CF Inspection Management, LLC (“CF Inspection”). The accounts of these subsidiaries are included in our Unaudited Condensed Consolidated Financial Statements. The portion of the net income (loss) of these entities that is attributable to outside owners is reported in net income (loss) attributable to noncontrolling interest in our Unaudited Condensed Consolidated Statements of Operations, and the portion of the net assets of these entities that is attributable to outside owners is reported in noncontrolling interests in our Unaudited Condensed Consolidated Balance Sheets.

 

Property and Equipment

 

Property and equipment consists of land, land and leasehold improvements, buildings, facilities, wells and related equipment, computer and office equipment, and vehicles. We record property and equipment at cost. Costs of renewals and improvements that substantially extend the useful lives of the assets are capitalized. Maintenance and repairs are expensed as incurred. We depreciate property and equipment on a straight-line basis over the estimated useful lives of the assets. Upon retirement or disposition of an asset, we remove the cost and related accumulated depreciation from the balance sheet and report the resulting gain or loss, if any, in the Unaudited Condensed Consolidated Statement of Operations.

 

We review property and equipment for impairment whenever events or circumstances indicate that the asset group to which they relate may be impaired. To perform an impairment assessment, we first determine whether the cash flows expected to be generated from the asset group exceed the carrying value of the asset group. If such estimated cash flows do not exceed the carrying value of the asset group, we reduce the carrying value of the asset group to its fair value and record a corresponding impairment loss.

  

11

 

  

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements 

 

Identifiable Intangible Assets

 

Our intangible assets consist primarily of customer relationships, trade names, and our database of inspectors. We recorded these intangible assets as part of our accounting for the acquisitions of businesses, and we amortize these assets on a straight-line basis over their estimated useful lives, which typically range from 5 – 20 years.

 

We review our intangible assets for impairment whenever events or circumstances indicate that the asset group to which they relate may be impaired. To perform an impairment assessment, we first determine whether the cash flows expected to be generated from the asset group exceed the carrying value of the asset group. If such estimated cash flows do not exceed the carrying value of the asset group, we reduce the carrying values of the assets to their fair values and record a corresponding impairment loss.

 

Goodwill

 

Goodwill is not amortized, but is subject to an annual review for impairment on November 1 (or at other dates if events or changes in circumstances indicate that the carrying value of goodwill may be impaired) 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. We have determined that our PIS, IS, and W&ES segments are the appropriate reporting units for testing goodwill impairment.

  

To perform a goodwill impairment assessment, we perform an analysis to assess whether it is more likely than not that the fair value of the reporting unit exceeds its carrying value. If we determine that it is more likely than not that the carrying value of the reporting unit exceeds its fair value, we reduce the carrying value of goodwill and record a corresponding impairment expense.

 

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.

 

Accrued Payroll and Other

 

Accrued payroll and other on our Unaudited Condensed Consolidated Balance Sheets includes the following:

 

    June 30, 2017     December 31, 2016  
    (in thousands)  
             
Accrued payroll   $ 8,854     $ 5,594  
Customer deposits     1,469       1,361  
Other     379       630  
    $ 10,702     $ 7, 585  

 

Foreign Currency Translation

 

Our Unaudited Condensed Consolidated Financial Statements are reported in U.S. dollars. We translate our Canadian-dollar-denominated assets and liabilities into U.S. dollars at the exchange rate in effect at the balance sheet date. We translate our Canadian-dollar-denominated revenues and expenses into U.S. dollars at the average exchange rate in effect during the period.

 

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements 

 

Our Unaudited Condensed Consolidated Balance Sheet at June 30, 2017 includes $2.5 million of accumulated other comprehensive loss associated with accumulated currency translation adjustments, all of which relate to our Canadian operations. If at some point in the future, we were to sell or substantially liquidate our Canadian operations, we would reclassify the balance in accumulated other comprehensive loss to other accounts within Partners’ capital, which would be reported in the Unaudited Condensed Consolidated Statement of Operations as a reduction to net income.

 

Our Canadian subsidiary has certain payables to our U.S.-based subsidiaries. These intercompany payables and receivables among our consolidated subsidiaries are eliminated in our Unaudited Condensed Consolidated Balance Sheets. Beginning April 1, 2017, and relating to the scale back of our Canadian operations due to the loss of a significant portion of our Canadian inspection business activity (see Note 3), we report currency translation adjustments on these intercompany payables and receivables within foreign currency gains in our Unaudited Condensed Consolidated Statements of Operations, with offsetting amounts reported within other comprehensive income (loss) in our Unaudited Condensed Consolidated Statements of Comprehensive Income (Loss).

 

Subordination

 

With the payment of the 2016 fourth quarter distribution and the fulfillment of other requirements associated with the termination of the subordination period, the Partnership emerged from subordination effective February 14, 2017, and the 5,913,000 subordinated units converted into common units on a one-for-one basis.

 

New Accounting Standards

 

In 2017, the Partnership adopted the following new accounting standards issued by the Financial Accounting Standards Board (“FASB”):

 

The FASB issued Accounting Standards Update (“ASU”) 2016-09 – Compensation – Stock Compensation in March 2016. This ASU gives entities the option to account for forfeitures of share-based awards when the forfeitures occur (previously, entities were required to estimate future forfeitures and reduce their share-based compensation expense accordingly). We adopted this new standard on January 1, 2017 and elected to account for forfeitures when they occur. The adoption of this ASU had no significant effect on our Unaudited Condensed Consolidated Financial Statements.

  

The FASB issued ASU 2017-04 – Intangibles – Goodwill and Other in January 2017. The objective of this guidance is to simplify how an entity is required to calculate the amounts of goodwill impairments. We adopted this new standard effective January 1, 2017 in order to simplify the measurement process any future impairments of goodwill. Under the new standard, we perform a goodwill impairment test by comparing the fair value of a reporting unit to its carrying amount. If the carrying amount exceeds the reporting unit’s fair value, we record a goodwill impairment charge for the excess (not exceeding the carrying value of the reporting unit’s goodwill).

 

Other accounting guidance proposed by the FASB that may impact our Unaudited Condensed Consolidated Financial Statements, which we have not yet adopted, includes:

 

The FASB issued ASU 2016-02 – Leases in February 2016. This guidance attempts to increase transparency and comparability among organizations by recognizing certain 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 of certain 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. Early adoption 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 2014-09 – Revenue from Contracts with Customers in May 2014. ASU 2014-09 is intended to clarify the principles for recognizing revenue and to develop a common standard for recognizing revenue for GAAP and International Financial Reporting Standards that is applicable to all organizations. We will be required to adopt this standard in 2018 and to apply its provisions either retrospectively to each prior reporting period presented or prospectively with the cumulative effect of initially applying the ASU recognized at the date of initial application (modified retrospective method). Although we continue to evaluate the financial impact of this ASU on the Partnership, we currently plan to adopt this standard utilizing the modified retrospective method and do not anticipate that the adoption of this ASU will materially impact our financial position, results of operations or cash flows.

 

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CYPRESS ENERGY PARTNERS, L.P. 

Notes to the Unaudited Condensed Consolidated Financial Statements 

 

3. Impairments

 

In the first quarter of 2017, the largest customer of TIR-Canada, the Canadian subsidiary of our PIS segment, completed a bid process and selected different service providers for its inspection projects. During the six months ended June 30, 2017, pipeline inspection services to this customer accounted for approximately $18.8 million of revenue and $1.3 million of gross margin, which represented approximately 89% of the revenues and 94% of the gross margin of our Canadian operations (and approximately 14% of our consolidated revenues and 9% of our consolidated gross margin for the six months ended June 30, 2017). In consideration of the loss of this contract, we recorded impairments to the carrying values of certain intangible assets of $1.3 million in the first quarter of 2017. Of this amount, $1.1 million related to customer relationships and $0.2 million related to trade names. Based on discounted cash flow calculations, which represent Level 3 non-recurring fair value adjustments, we concluded the fair value of the customer relationships and trade names was zero, and thus, have written off the full amounts. We continue to perform inspection and integrity work for customers in Canada (including integrity work for the customer referred to above).

 

In the first quarter of 2017, we recorded an impairment of $0.7 million to the property, plant and equipment at one of our SWD facilities. We have temporarily shut down the operations at this facility because of low volumes due to competition in the area and due to low levels of exploration and production activity near the facility. Because of the decline in revenues and the temporary shutdown of the facility, we performed a discounted cash flow calculation, which represents a Level 3 non-recurring fair value adjustment, concluding that the fair value of the facility was limited to the fair value of the land. As such, we recorded an impairment to reduce the carrying value of the facility to $0.1 million in the first quarter of 2017, all of which is attributable to land.

 

In the first quarter of 2017, we recorded an impairment of $1.6 million to the goodwill of our Integrity Services segment. Revenues of this segment were lower than we had expected for the first quarter of 2017. In addition, for this segment, the level of bidding activity for work is typically high in March and April, once customers have finalized their budgets for the upcoming year. While we won bids on a number of projects and our backlog began to improve, the improvement in the backlog had been slower than we had originally anticipated and we revised downward our expectations of the near-term operating results of the segment. For our goodwill impairment assessment, we calculated an estimated fair value of the Integrity Services segment using a discounted cash flow analysis. We prepared two calculations of cash flows for the next twelve months, one of which represented our estimate of the high end of the range of probable cash flows and the other of which represented our estimate of the low range of probable cash flows. We estimated cash flows for the following four years assuming a 2% increase in each succeeding year, to account for estimated inflation, and calculated a terminal value using a Gordon Growth model. We then discounted the future cash flows at a discount rate of 18%. The mid-point of the estimated fair values produced by these two calculations indicated that a full impairment of the value of the goodwill of the Integrity Services segment was warranted. These calculations represent Level 3 non-recurring fair value measurements. If anticipated operating results in this segment do not meet expectations, it is possible that finite-lived intangibles may also become impaired in the future.

 

In January 2017, a lightning strike at our Orla SWD facility initiated a fire that effectively destroyed the surface equipment at the facility. As a result, we wrote off the net book value of the surface equipment ($1.3 million) of the facility and recorded a receivable in prepaid expenses and other on our Unaudited Condensed Consolidated Balance Sheet related to a property insurance policy we carried on the property. In May 2017, we received $1.6 million of insurance proceeds. We recorded a gain of $0.3 million in gain (loss) on asset disposals and insurance recoveries, net on our Unaudited Condensed Consolidated Statement of Operations in the second quarter of 2017 for the difference between the proceeds received and the net book value of the property that was destroyed. During the six months ended June 30, 2017 we incurred approximately $0.2 million of temporary setup costs associated with this incident that are not recoverable through insurance. These expenses were originally recorded in costs of services in the first quarter of 2017 and have been reclassified to gain (loss) on asset disposals and insurance recoveries, net in our Condensed Consolidated Statement of Operations for the six months ended June 30, 2017 in connection with the receipt of the insurance proceeds. We have also incurred certain cleanup costs associated with the incident that are recoverable from insurance policies, and we have recorded a receivable of $0.2 million within prepaid expenses and other on our Condensed Consolidated Balance Sheet at June 30, 2017 related to the expected recovery from these insurance policies.

 

In July 2017, a lightning strike at our Grassy Butte SWD facility initiated a fire that effectively destroyed the surface equipment at the facility. As a result of previously-recorded impairments, the net book value of the property, plant and equipment at this facility was $0 at the time of the fire. We believe that the property damage associated with the lightning strike and fire is covered by insurance, although we do not yet know the extent or timing of any insurance reimbursement for the losses incurred at this facility.  Any such insurance recoveries will be recorded as gains in the periods in which they are received.

 

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

4. Credit Agreement

 

We are 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 if lenders agree to increase their commitments. The Credit Agreement matures December 24, 2018.

 

Outstanding borrowings at June 30, 2017 and December 31, 2016 under the Credit Agreement were as follows:

 

    June 30, 2017     December 31, 2016  
    (in thousands)  
             
 Working Capital Facility   $ 48,000     $ 48,000  
 Acquisition Facility     88,900       88,900  
 Total borrowings     136,900       136,900  
 Debt issuance costs     (907     (1,201
 Long-term debt   $ 135,993     $ 135,699  

 

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 our 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 Acquisition Facility 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 of our assets.

 

All borrowings under the Credit Agreement bear interest, at our option, on a leveraged based grid pricing at (i) a base rate plus a margin of 1.25% to 2.75% per annum (“Base Rate Borrowing”) or (ii) an adjusted LIBOR rate plus a margin of 2.25% to 3.75% per annum (“LIBOR Borrowings”). The applicable margin is determined based on the leverage ratio of the Partnership, as defined in the Credit Agreement. Generally, the interest rate on our Credit Agreement borrowings ranged between 3.90% and 4.97% for the six months ended June 30, 2017 and 3.54% and 4.22% for the six months ended June 30, 2016. 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 June 30, 2017 and 2016 was $1.7 million and $1.4 million, respectively, including commitment fees. Interest paid during the six months ended June 30, 2017 and 2016 was $3.3 million and $2.7 million, respectively, including commitment fees.

 

Our Credit Agreement contains various customary affirmative and negative covenants and restrictive provisions. Our Credit Agreement also requires maintenance of certain financial covenants, including a combined total adjusted leverage ratio (as defined in our Credit Agreement) of not more than 4.0 to 1.0 and an interest coverage ratio (as defined in our Credit Agreement) of not less than 3.0 to 1.0. At June 30, 2017, our combined total adjusted leverage ratio was 3.57 to 1.0 and our interest coverage ratio was 3.46 to 1.0, pursuant to the Credit Agreement. Upon the occurrence and during the continuation of an event of default, subject to the terms and conditions of our Credit Agreement, the lenders may declare any outstanding principal of our Credit Agreement debt, together with accrued and unpaid interest, to be immediately due and payable and may exercise the other remedies set forth or referred to in our Credit Agreement. We were in compliance with all debt covenants as of June 30, 2017 and expect to remain in compliance with all of our financial debt covenants for the next twelve months following the filing of this Form 10-Q. Working capital borrowings, which are fully secured by our net working capital, are subject to a monthly borrowing base and are excluded from our 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. Income Taxes

 

The income tax expense (benefit) reported in our Unaudited Condensed Consolidated Statements of Operations for the three and six months ended June 30, 2017 and 2016 differs from the statutory tax rate of 35% due to the fact that, as a partnership, we are generally not subject to U.S. federal income taxes. Our income tax provision relates primarily to our corporate subsidiaries that service public utility customers, which are subject to U.S. federal and state income taxes, our Canadian subsidiary, which is subject to Canadian federal and provincial income taxes, and to certain other state income taxes, including the Texas franchise tax.

 

6. Equity Compensation

 

Our General Partner has adopted a long-term incentive plan (“LTIP”) that authorizes 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 is determined based on the quoted market value of the publicly-traded common units at each grant date, adjusted for certain discounts. Compensation expense is recorded on a straight-line basis over the vesting period of the grant. We recorded expense of $0.8 million and $0.5 million during the six months ended June 30, 2017 and 2016, respectively related to the Unit awards.

 

The following table summarizes the LTIP Unit activity for the six months ended June 30, 2017 and 2016:

 

    Six Months Ended June 30,  
    2017     2016  
                         
       Number  
 of Units
       Weighted
 Average
 Grant
 Date Fair
 Value / Unit
       Number  
 of Units
       Weighted
 Average
 Grant
 Date Fair
 Value / Unit
 
                                 
 Units at January 1     573,902     $ 9.86       361,698     $ 14.30  
 Units granted     246,200     $ 7.15       334,256     $ 6.34  
 Units vested and issued     (30,657 )   $ 15.99       (25,657 )   $ 8.45  
 Units forfeited     (21,802 )   $ 8.21       (42,403 )   $ 11.12  
 Units at June 30     767,643     $ 8.79       627,894     $ 10.51  

 

The majority of the awards vest in three tranches, with one-third of the units vesting three years from the grant date, one-third vesting four years from the grant date, and one-third vesting five years from the grant date. However, certain of the awards have different, and typically shorter, vesting periods. For two of the grants, which total 77,495 units, vesting is contingent upon the recipient meeting certain performance targets. Distributions are not paid on unvested Units during the vesting period. Total unearned compensation associated with the Unit awards was $4.3 million at June 30, 2017, and the awards had an average remaining life of 2.48 years.

 

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

7. Related-Party Transactions

 

Omnibus Agreement and Other Support from Holdings

 

We are party to an omnibus agreement with Holdings and other related parties. The omnibus agreement 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 expense we incur as a result of being a publicly-traded partnership. For the three and six months ended June 30, 2017 and 2016, Holdings has provided sponsor support to the Partnership by waiving payment of the quarterly administrative fee;

 

  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 affiliates of Holdings control our General Partner, the omnibus agreement will remain in effect, unless we and Holdings agree to terminate it sooner. If affiliates of Holdings cease 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.

 

Holdings incurred expenses of $0.8 million and $0.9 million on our behalf during the three months ended June 30, 2017 and 2016, respectively and $1.8 million and $1.9 million on our behalf during the six months ended June 30, 2017 and 2016, respectively. These expenses are reported within general and administrative in the accompanying Unaudited Condensed Consolidated Statements of Operations and as contribution from general partner in the accompanying Unaudited Condensed Consolidated Statement of Owners’ Equity.

 

In addition to funding certain general and administrative expense on our behalf, during the second quarter of 2016, Holdings contributed $2.0 million in cash attributable to the General Partner as a reimbursement of certain expenditures previously incurred by the Partnership. This payment was recorded as an equity contribution and is reflected as a component of the net loss attributable to the general partner in the Unaudited Condensed Consolidated Statement of Operations for the three and six month periods ended June 30, 2016.

 

Alati Arnegard, LLC

 

We provide management services to a 25% owned entity, Alati Arnegard, LLC (“Arnegard”). Management fee revenue earned from Arnegard totaled $0.1 million for the three month periods ended June 30, 2017 and 2016 and $0.3 million for the six month periods ended June 30, 2017 and 2016 and is recorded in other, net on the Unaudited Condensed Consolidated Statements of Operations. Accounts receivable from Arnegard were $0.2 million and $0.1 million at June 30, 2017 and December 31, 2016, respectively, and are included in trade accounts receivable, net in the Unaudited Condensed Consolidated Balance Sheets.

 

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

 

8. Earnings per Unit and Cash Distributions

 

Our net income (loss) is attributable and allocable to several types of owners. Income attributable to noncontrolling interests represents 49% of the income of Brown and 51% of the income of CF Inspection. Income attributable to the general partner includes expenses incurred by Holdings and not charged to us. Income attributable to common and subordinated units represents the remaining net income (loss), after consideration of amounts attributable to noncontrolling interests and to the general partner; such amounts were allocated to common and subordinated units ratably based on the weighted-average number of such units outstanding during the relevant time period. In February 2017, all of the outstanding subordinated units converted into common units. Since the subordinated units did not share in the distribution of cash generated subsequent to December 31, 2016, we did not allocate any income or loss after that date to the subordinated units.

 

Diluted net income (loss) per common and subordinated unit includes the dilutive impact of unvested unit awards granted as share-based compensation to employees and directors. Such awards had no dilutive effect during the three months ended June 30, 2016 and the six months ended June 30, 2017 and 2016, as we incurred net losses attributable to limited partners during those periods.

 

The following table summarizes the cash distributions declared and paid to our limited partners since our IPO.

 

                Total Cash  
    Per Unit Cash     Total Cash     Distributions  
Payment Date   Distributions     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     0.406413       4,819       3,105  
 Total 2016 Distributions     1.625652       19,258       12,414  
                         
 February 13, 2017     0.406413       4,823       3,107  
 May 15, 2017     0.210000       2,495       1,606  
 August 14, 2017 (c)     0.210000       2,495       1,607  
      0.826413       9,813       6,320  
                         
 Total Distributions (through August 14, 2017 since IPO)   $ 5.182363     $ 61,367     $ 39,314  

 

(a) Approximately 64.4% of the Partnership’s outstanding units at June 30, 2017 were held by affiliates.
(b) Distribution was pro-rated from the date of our IPO through March 31, 2014.
(c) Second quarter 2017 distribution was declared and will be paid in the third quarter of 2017.

 

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

9. Commitments and Contingencies

 

Security Deposits

 

We have various performance obligations which are secured with short-term security deposits of $0.5 million at June 30, 2017 and December 31, 2016, included in prepaid expenses and other on the Unaudited Condensed Consolidated Balance Sheets.

 

Employment Contract Commitments

 

We have employment agreements with certain members of management. These agreements provide for minimum annual compensation for specified terms, after which employment will continue on an “at will” basis. Certain agreements provide for severance payments in the event of specified termination of employment. At June 30, 2017, the aggregate commitment for future compensation and severance was approximately $0.9 million.

 

Compliance Audit Contingencies

 

Certain customer master service agreements (“MSAs”) 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 MSAs, the MSAs 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 outstanding. At June 30, 2017, the Partnership had an estimated liability of $0.1 million recorded for such contingencies.

 

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 (the “District Court”) 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 of the entities. The former shareholders of TIR Inc. claim that they did not receive sufficient value for their shares and are seeking compensatory and punitive damages. We believe that the possibility of the Partnership incurring material losses as a result of this action is remote. All claims against TIR LLC have been resolved by the District Court in TIR LLC’s favor, subject to appeal to the United States Court of Appeals for the Tenth Circuit, and Plaintiffs have abandoned their claim for rescission of the merger. The remaining claims, none of which are asserted against the Partnership nor any subsidiary of the Partnership including TIR LLC, are set for trial beginning September 5, 2017.

 

Internal Revenue Service Audit

 

In January 2016, we received notice from the Internal Revenue Service (“IRS”) that conveyed its intent to audit the consolidated income tax return of one of our predecessor entities for the 2012 tax year. Although this audit is not yet complete, we believe, based on correspondence from the IRS, that any adjustments related to this income tax audit should not be material. Additionally, based on the terms of our omnibus agreement with Holdings, Holdings would indemnify us 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, we believe that the possibility of incurring material losses as a result of this IRS audit is remote.

 

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CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

10. Reportable Segments

 

Our operations consist of three reportable segments: (i) PIS, (ii) IS and (iii) W&ES.

 

PIS – This segment represents our pipeline inspection services operations. This segment provides independent inspection and integrity services to various energy, public utility, and pipeline companies. The inspectors in this segment perform a variety of inspection services on midstream pipelines, gathering 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 projects.

 

IS – This segment provides independent hydro-testing integrity services to major natural gas and petroleum pipeline companies, and to 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 projects.

 

W&ES – This segment includes the operations of ten SWD facilities and an ownership interest in one managed facility. Segment results are driven primarily by the volumes of 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 general and administrative expense not specifically allocable to our reportable segments.

 

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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 June 30, 2017                                        
                                         
Revenues   $ 70,154     $ 2,397     $ 2,016     $     $ 74,567  
Costs of services     63,384       1,969       605             65,958  
Gross margin     6,770       428       1,411             8,609  
General and administrative     3,065       517       575       1,172       5,329  
Depreciation, amortization and accretion     579       157       470             1,206  
(Gains) losses on asset disposals and insurance recoveries, net     18             (131 )           (113 )
Operating income (loss)   $ 3,108     $ (246 )   $ 497     $ (1,172 )     2,187  
Interest expense, net                                     (1,795 )
Foreign currency gains                                     267  
Other, net                                     60  
Net income before income tax expense                                   $ 719  
                                         
Three months ended June 30, 2016                                        
                                         
Revenues   $ 67,610     $ 2,546     $ 2,155     $     $ 72,311  
Costs of services     61,365       2,378       1,203             64,946  
Gross margin     6,245       168       952             7,365  
General and administrative     3,079       883       483       1,115       5,560  
Depreciation, amortization and accretion     609       186       451             1,246  
Impairments           8,411       2,119             10,530  
Operating income (loss)   $ 2,557     $ (9,312 )   $ (2,101 )   $ (1,115 )     (9,971 )
Interest expense, net                                     (1,619 )
Other, net                                     24  
Net loss before income tax expense                                   $ (11,566 )

 

21

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

    PIS     IS     W&ES     Other     Total  
    (in thousands)  
                               
Six months ended June 30, 2017                                        
                                         
Revenues   $ 132,302     $ 3,093     $ 3,894     $     $ 139,289  
Costs of services     119,985       2,873       1,493             124,351  
Gross margin     12,317       220       2,401             14,938  
General and administrative     6,319       963       793       2,364       10,439  
Depreciation, amortization and accretion     1,178       314       885             2,377  
Impairments     1,329       1,581       688             3,598  
(Gains) losses on asset disposals and insurance recoveries, net     18             (131 )           (113 )
Operating income (loss)   $ 3,473     $ (2,638 )   $ 166     $ (2,364 )     (1,363 )
Interest expense, net                                     (3,504 )
Foreign currency gains                                     267  
Other, net                                     105  
Net loss before income tax expense                                   $ (4,495 )
                                         
Six months ended June 30, 2016                                        
                                         
Revenues   $ 134,319     $ 6,804     $ 4,662     $     $ 145,785  
Costs of services     122,209       6,110       2,341             130,660  
Gross margin     12,110       694       2,321             15,125  
General and administrative     6,519       1,874       1,039       2,317       11,749  
Depreciation, amortization and accretion     1,226       345       900             2,471  
Impairments           8,411       2,119             10,530  
Operating income (loss)   $ 4,365     $ (9,936 )   $ (1,737 )   $ (2,317 )     (9,625 )
Interest expense, net                                     (3,237 )
Other, net                                     47  
Net loss before income tax expense                                   $ (12,815 )
                                         
Total Assets                                        
                                         
June 30, 2017   $ 123,138     $ 9,544     $ 38,902     $ (9,694 )   $ 161,890  
                                         
December 31, 2016   $ 124,840     $ 12,079     $ 38,141     $ (7,548 )   $ 167,512  

 

22

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

11. Condensed Consolidating Financial Information

 

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

 

23

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Balance Sheet
 As of June 30, 2017
 (in thousands)
                     
             Non-            
    Parent   Guarantors   Guarantors   Eliminations   Consolidated  
ASSETS                                        
Current assets:                                        
Cash and cash equivalents   $ 676     $ 15,058     $ 6,733     $     $ 22,467  
Trade accounts receivable, net           38,857       5,524       (1,088 )     43,293  
Accounts receivable - affiliates           15,106             (15,106 )      
Prepaid expenses and other     75       1,486       72             1,633  
Total current assets     751       70,507       12,329       (16,194 )     67,393  
Property and equipment:                                        
Property and equipment, at cost           17,017       3,002             20,019  
Less: Accumulated depreciation           6,704       1,273             7,977  
Total property and equipment, net           10,313       1,729             12,042  
Intangible assets, net           22,744       4,136             26,880  
Goodwill           53,914       1,457             55,371  
Investment in subsidiaries     23,685       (3,264 )           (20,421 )      
Notes receivable - affiliates           13,719             (13,719 )      
Other assets           179       25             204  
Total assets   $ 24,436     $ 168,112     $ 19,676     $ (50,334 )   $ 161,890  
                                         
LIABILITIES AND OWNERS’ EQUITY                                        
Current liabilities:                                        
Accounts payable   $ 152     $ 2,550     $ 766     $ (1,034 )   $ 2,434  
Accounts payable - affiliates     11,357             6,047       (15,106 )     2,298  
Accrued payroll and other           10,330       426       (54 )     10,702  
Income taxes payable           141       68             209  
Total current liabilities     11,509       13,021       7,307       (16,194 )     15,643  
Long-term debt     (907 )     131,400       5,500             135,993  
Notes payable - affiliates                 13,719       (13,719 )      
Asset retirement obligations           161                   161  
Total liabilities     10,602       144,582       26,526       (29,913 )     151,797  
                                         
Owners’ equity:                                        
Total partners’ capital     10,094       19,790       (6,850 )     (16,681 )     6,353  
Non-controlling interests     3,740       3,740             (3,740 )     3,740  
Total owners’ equity     13,834       23,530       (6,850 )     (20,421 )     10,093  
Total liabilities and owners’ equity   $ 24,436     $ 168,112     $ 19,676     $ (50,334 )   $ 161,890  

 

24

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Balance Sheet
As of December 31, 2016
(in thousands)
                     
              Non-        
       Parent        Guarantors        Guarantors        Eliminations        Consolidated  
                                         
ASSETS                                        
Current assets:                                        
Cash and cash equivalents   $ 695     $ 20,251     $ 5,747     $     $ 26,693  
Trade accounts receivable, net           33,046       6,125       (689 )     38,482  
Accounts receivable - affiliates           12,622             (12,622 )      
Prepaid expenses and other           996       46             1,042  
Total current assets     695       66,915       11,918       (13,311 )     66,217  
Property and equipment:                                        
Property and equipment, at cost           19,366       3,093             22,459  
Less: Accumulated depreciation           6,798       1,042             7,840  
Total property and equipment, net           12,568       2,051             14,619  
Intangible assets, net           23,875       5,749             29,624  
Goodwill           53,914       2,989             56,903  
Investment in subsidiaries     29,454       (417 )           (29,037 )      
Notes receivable - affiliates           13,662             (13,662 )      
Other assets           139       10             149  
Total assets   $ 30,149     $ 170,656     $ 22,717     $ (56,010 )   $ 167,512  
                                         
LIABILITIES AND OWNERS’ EQUITY                                        
Current liabilities:                                        
Accounts payable   $     $ 1,653     $ 712     $ (675 )   $ 1,690  
Accounts payable - affiliates     8,860             5,400       (12,622 )     1,638  
Accrued payroll and other     15       7,082       503       (15 )     7,585  
Income taxes payable           967       44             1,011  
Total current liabilities     8,875       9,702       6,659       (13,312 )     11,924  
Long-term debt     (1,201 )     131,400       5,500             135,699  
Notes payable - affiliates                 13,662       (13,662 )      
Deferred tax liabilities           8       354             362  
Asset retirement obligations           139                   139  
Total liabilities     7,674       141,249       26,175       (26,974 )     148,124  
                                         
Owners’ equity:                                        
Total partners’ capital     17,425       24,357       (3,458 )     (23,986 )     14,338  
Non-controlling interests     5,050       5,050             (5,050 )     5,050  
Total owners’ equity     22,475       29,407       (3,458 )     (29,036 )     19,388  
Total liabilities and owners’ equity   $ 30,149     $ 170,656     $ 22,717     $ (56,010 )   $ 167,512  

 

25

 

 

CYPRESS ENERGY PARTNERS, L.P.

Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Operations
For the Three Months Ended June 30, 2017
(in thousands)
                     Non-                  
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                                         
Revenues   $     $ 65,464     $ 11,390     $ (2,287 )   $ 74,567  
Costs of services           57,662       10,583       (2,287 )     65,958  
Gross margin           7,802       807             8,609  
                                         
Operating costs, expenses and other:                                        
General and administrative     1,173       3,344       812             5,329  
Depreciation, amortization and accretion           1,049       157             1,206  
Impairments                              
(Gains) losses on asset disposals and insurance recoveries, net           (120 )     7             (113 )
Operating income (loss)     (1,173 )     3,529       (169 )           2,187  
                                         
Other (expense) income:                                        
Equity earnings (loss) in subsidiaries     1,749       (392 )           (1,357 )      
Interest expense, net     (228 )     (1,380 )     (187 )           (1,795 )
Foreign currency gains                 197       70       267  
Other, net           59       1             60  
Net income (loss) before income tax expense     348       1,816       (158 )     (1,287 )     719  
Income tax expense           200       22             222  
Net income (loss)     348       1,616       (180 )     (1,287 )     497  
                                         
Net loss attributable to noncontrolling interests           (133 )                 (133 )
Net income (loss) attributable to partners / controlling interests     348       1,749       (180 )     (1,287 )     630  
                                         
Net loss attributable to general partner     (829 )                       (829 )
Net income (loss) attributable to limited partners   $ 1,177     $ 1,749     $ (180 )   $ (1,287 )   $ 1,459  

 

26

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Operations

For the Three Months Ended June 30, 2016

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Revenues   $     $ 64,025     $ 12,310     $ (4,024 )   $ 72,311  
Costs of services           57,257       11,713       (4,024 )     64,946  
Gross margin           6,768       597             7,365  
                                         
Operating costs and expense:                                        
General and administrative     1,115       3,118       1,327             5,560  
Depreciation, amortization and accretion           1,032       214             1,246  
Impairments           2,119       8,411             10,530  
Operating (loss)     (1,115 )     499       (9,355 )           (9,971 )
                                         
Other income (expense):                                        
Equity earnings (loss) in subsidiaries     (5,562 )     (9,415 )           14,977        
Interest expense, net     (222 )     (1,190 )     (207 )           (1,619 )
Other, net           19       5             24  
Net income (loss) before income tax expense     (6,899 )     (10,087 )     (9,557 )     14,977       (11,566 )
Income tax expense (benefit)           87       (37 )           50  
Net income (loss)     (6,899 )     (10,174 )     (9,520 )     14,977       (11,616 )
                                         
Net (loss) attributable to non-controlling interests           (4,612 )                 (4,612 )
Net income (loss) attributable to controlling interests     (6,899 )     (5,562 )     (9,520 )     14,977       (7,004 )
                                         
Net (loss) attributable to general partner     (2,967 )                       (2,967 )
Net income (loss) attributable to limited partners   $ (3,932 )   $ (5,562 )   $ (9,520 )   $ 14,977     $ (4,037 )

 

27

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Operations

For the Six Months Ended June 30, 2017

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Revenues   $     $ 115,133     $ 27,810     $ (3,654 )   $ 139,289  
Costs of services           101,761       26,244       (3,654 )     124,351  
Gross margin           13,372       1,566             14,938  
                                         
Operating costs, expenses and other:                                        
General and administrative     2,365       6,358       1,716             10,439  
Depreciation, amortization and accretion           2,044       333             2,377  
Impairments           688       2,910             3,598  
(Gains) losses on asset disposals and insurance recoveries, net           (120 )     7             (113 )
Operating income (loss)     (2,365 )     4,402       (3,400 )           (1,363 )
                                         
Other (expense) income:                                        
Equity earnings (loss) in subsidiaries     82       (2,890 )           2,808        
Interest expense, net     (453 )     (2,668 )     (383 )           (3,504 )
Foreign currency gains                 197       70       267  
Other, net           96       9             105  
Net income (loss) before income tax expense     (2,736 )     (1,060 )     (3,577 )     2,878       (4,495 )
Income tax expense (benefit)           156       (227 )           (71 )
Net income (loss)     (2,736 )     (1,216 )     (3,350 )     2,878       (4,424 )
                                         
Net loss attributable to noncontrolling interests           (1,298 )                 (1,298 )
Net income (loss) attributable to partners / controlling interests     (2,736 )     82       (3,350 )     2,878       (3,126 )
                                         
Net loss attributable to general partner     (1,750 )                       (1,750 )
Net income (loss) attributable to limited partners   $ (986 )   $ 82     $ (3,350 )   $ 2,878     $ (1,376 )

 

28

 

 

CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Operations

For the Six Months Ended June 30, 2016

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Revenues   $     $ 126,197     $ 26,194     $ (6,606 )   $ 145,785  
Costs of services           112,688       24,578       (6,606 )     130,660  
Gross margin           13,509       1,616             15,125  
                                         
Operating costs and expense:                                        
General and administrative     2,317       6,696       2,736             11,749  
Depreciation, amortization and accretion           2,070       401             2,471  
Impairments           2,119       8,411             10,530  
Operating (loss)     (2,317 )     2,624       (9,932 )           (9,625 )
                                         
Other income (expense):                                        
Equity earnings (loss) in subsidiaries     (5,094 )     (10,164 )           15,258        
Interest expense, net     (440 )     (2,381 )     (416 )           (3,237 )
Other, net           38       9             47  
Net income (loss) before income tax expense     (7,851 )     (9,883 )     (10,339 )     15,258       (12,815 )
Income tax expense           190       (28 )           162  
Net income (loss)     (7,851 )     (10,073 )     (10,311 )     15,258       (12,977 )
                                         
Net (loss) attributable to non-controlling interests           (4,979 )                 (4,979 )
Net income (loss) attributable to controlling interests     (7,851 )     (5,094 )     (10,311 )     15,258       (7,998 )
                                         
Net (loss) attributable to general partner     (3,935 )                       (3,935 )
Net income (loss) attributable to limited partners   $ (3,916 )   $ (5,094 )   $ (10,311 )   $ 15,258     $ (4,063 )

 

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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Three Months Ended June 30, 2017

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Net income (loss)   $ 348     $ 1,616     $ (180 )   $ (1,287 )   $ 497  
Other comprehensive income (loss) - Foreign currency translation           (3 )     (39 )           (42 )
                                         
Comprehensive income (loss)   $ 348     $ 1,613     $ (219 )   $ (1,287 )   $ 455  
                                         
Comprehensive loss attributable to noncontrolling interests           (133 )                 (133 )
Comprehensive loss attributable to general partner     (829 )                       (829 )
Comprehensive income (loss) attributable to limited partners   $ 1,177     $ 1,746     $ (219 )   $ (1,287 )   $ 1,417  

 

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Three Months Ended June 30, 2016

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Net income (loss)   $ (6,899 )   $ (10,174 )   $ (9,520 )   $ 14,977     $ (11,616 )
Other comprehensive loss - Foreign currency translation                 (2 )           (2 )
                                         
Comprehensive income (loss)   $ (6,899 )   $ (10,174 )   $ (9,522 )   $ 14,977     $ (11,618 )
                                         
Comprehensive loss attributable to noncontrolling interests           (4,612 )                 (4,612 )
Comprehensive loss attributable to general partner     (2,967 )                       (2,967 )
Comprehensive income (loss) attributable to limited partners   $ (3,932 )   $ (5,562 )   $ (9,522 )   $ 14,977     $ (4,039 )

 

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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Six Months Ended June 30, 2017

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Net income (loss)   $ (2,736 )   $ (1,216 )   $ (3,350 )   $ 2,878     $ (4,424 )
Other comprehensive income - Foreign currency translation           (59 )     79           20  
                                         
Comprehensive income (loss)   $ (2,736 )   $ (1,275 )   $ (3,271 )   $ 2,878     $ (4,404 )
                                         
Comprehensive loss attributable to noncontrolling interests           (1,298 )                 (1,298 )
Comprehensive loss attributable to general partner     (1,750 )                       (1,750 )
Comprehensive income (loss) attributable to limited partners   $ (986 )   $ 23     $ (3,271 )   $ 2,878     $ (1,356 )

 

Condensed Consolidating Statement of Comprehensive Income (Loss)

For the Six Months Ended June 30, 2016

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Net income (loss)   $ (7,851 )   $ (10,073 )   $ (10,311 )   $ 15,258     $ (12,977 )
Other comprehensive income - Foreign currency translation           192       394             586  
                                         
Comprehensive income (loss)   $ (7,851 )   $ (9,881 )   $ (9,917 )   $ 15,258     $ (12,391 )
                                         
Comprehensive loss attributable to non-controlling interests           (4,979 )                 (4,979 )
Comprehensive loss attributable to general partner     (3,935 )                       (3,935 )
Comprehensive income (loss) attributable to controlling interests   $ (3,916 )   $ (4,902 )   $ (9,917 )   $ 15,258     $ (3,477 )

 

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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Cash Flows

For the Six Months Ended June 30, 2017

(in thousands)

 

    Parent     Guarantors     Non-
Guarantors
    Eliminations     Consolidated  
                               
Operating activities:                                        
Net income (loss)   $ (2,736 )   $ (1,216 )   $ (3,350 )   $ 2,878     $ (4,424 )
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:                                        
Depreciation, amortization and accretion           2,311       602             2,913  
Impairments           688       2,910             3,598  
(Gain) loss on asset disposal           (315 )     7             (308 )
Interest expense from debt issuance cost amortization     294                         294  
Equity-based compensation expense     766                         766  
Equity in earnings of investee           (57 )                 (57 )
Equity earnings in subsidiaries     (82 )     2,890             (2,808 )      
Deferred tax benefit, net           (8 )     (350 )           (358 )
Non-cash allocated expenses     1,750                         1,750  
Foreign currency gains                 (197 )     (70 )     (267 )
Changes in assets and liabilities:                                        
Trade accounts receivable           (5,811 )     685       399       (4,727 )
Receivables from affiliates           (2,484 )           2,484        
Prepaid expenses and other     (73 )     (529 )     (40 )     56       (586 )
Accounts payable and accrued payroll and other     2,634       3,672       553       (2,939 )     3,920  
Income taxes payable           (826 )     24             (802 )
Net cash provided by (used in) operating activities     2,553       (1,685 )     844             1,712  
                                         
Investing activities:                                        
Proceeds from fixed asset disposals           1,576       2             1,578  
Purchases of property and equipment           (380 )                 (380 )
Net cash provided by investing activities           1,196       2             1,198  
                                         
Financing activities:                                        
Taxes paid related to net share settlement of equity-based compensation     (77 )                       (77 )
Distributions from subsidiaries     4,823       (4,812 )     (11 )            
Distributions to limited partners     (7,318 )                       (7,318 )
Distributions to non-controlling members                 (12 )           (12 )
Net cash used in financing activities     (2,572 )     (4,812 )     (23 )           (7,407 )
                                         
Effects of exchange rates on cash           108       163             271  
                                         
Net increase (decrease) in cash and cash equivalents     (19 )     (5,193 )     986             (4,226 )
Cash and cash equivalents, beginning of period     695       20,251       5,747             26,693  
Cash and cash equivalents, end of period   $ 676     $ 15,058     $ 6,733     $     $ 22,467  
                                         
Non-cash items:                                        
Changes in accounts payable excluded from capital expenditures   $     $ 473     $     $     $ 473  

 

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CYPRESS ENERGY PARTNERS, L.P.

 Notes to the Unaudited Condensed Consolidated Financial Statements

 

Condensed Consolidating Statement of Cash Flows

For the Six Months Ended June 30, 2016

(in thousands)

 

                Non-              
    Parent     Guarantors     Guarantors     Eliminations     Consolidated  
                               
Operating activities:                                        
Net income (loss)   $ (7,851 )   $ (10,073 )   $ (10,311 )   $ 15,258     $ (12,977 )
Adjustments to reconcile net income (loss) to cash provided by (used in) operating activities:                                        
Depreciation, amortization and accretion           2,251       656             2,907  
Impairments           2,119       8,411             10,530  
Gain on asset disposal                 (2 )           (2 )
Interest expense from debt issuance cost amortization     282                         282  
Equity-based compensation expense     507                         507  
Equity in earnings of investee           (30 )                 (30 )
Distributions from investee           63                   63  
Equity earnings in subsidiaries     5,094       10,164             (15,258 )      
Deferred tax benefit, net           (38 )     26             (12 )
Non-cash allocated expenses     1,935                         1,935  
Changes in assets and liabilities:                                        
Trade accounts receivable           (1,304 )     540       2,510       1,746  
Receivables from affiliates           (1,524 )           1,524        
Prepaid expenses and other     (75 )     679       155       154       913  
Accounts payable and accrued payroll and other     (28 )     7,868       2,589       (4,223 )     6,206  
Income taxes payable           (268 )     (85 )     35       (318 )
Net cash provided by (used in) operating activities     (136 )     9,907       1,979             11,750  
                                         
Investing activities:                                        
Proceeds from fixed asset disposals                 4             4  
Purchases of property and equipment           (446 )     (198 )           (644 )
Net cash used in investing activities           (446 )     (194 )           (640 )
                                         
Financing activities:                                        
Repayments of long-term debt           (4,000 )                 (4,000 )
Taxes paid related to net share settlement of equity awards     (47 )                       (47 )
Contribution attributable to general partner     2,000                         2,000  
Distributions from subsidiaries     9,622       (9,239 )     (383 )            
Distributions to limited partners     (9,622 )                       (9,622 )
Distributions to non-controlling members                 (367 )           (367 )
Net cash provided by (used in) financing activities     1,953       (13,239 )     (750 )           (12,036 )
                                         
Effects of exchange rates on cash           191       201             392  
                                         
Net increase (decrease) in cash and cash equivalents     1,817       (3,587 )     1,236             (534 )
Cash and cash equivalents, beginning of period     378       19,570       4,202             24,150  
Cash and cash equivalents, end of period   $ 2,195     $ 15,983     $ 5,438     $     $ 23,616  
                                         
Non-cash items:                                        
Accrued capital expenditures   $     $ 140     $ 48     $     $ 188  

 

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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 “Item 1A. Risk Factors” of our Annual Report on Form 10-K for the year ended December 31, 2016 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, 2016 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 or may not occur. See “Cautionary Remarks 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 broken down into three segments: (1) our Pipeline Inspection Services (“PIS”) segment is comprised of our investment in the TIR Entities; (2) our Integrity Services (“IS”) segment, made up of our 51% ownership investment in Brown and; (3) our Water and Environmental Services (W&ES”) segment, comprised of our investments in various salt water disposal (“SWD”) facilities and activities related thereto. The financial information for PIS, IS and W&ES 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 in our Consolidated Financial Statements for the year ended December 31, 2016.

 

Overview

 

We are a growth-oriented master limited partnership formed in September 2013 to provide services to the oil and gas industry. We provide independent pipeline inspection and integrity services to energy exploration and production (“E&P”) companies, public utility companies, and midstream companies and their vendors in our PIS and IS segments throughout the United States and Canada. The PIS segment is comprised of the operations of the TIR Entities and the IS segment is comprised of the operations of Brown. We also provide SWD and other water and environmental services to U.S. onshore oil and natural gas producers and trucking companies through our W&ES segment. We operate ten SWD facilities, eight of which are located in the Bakken Shale region of the Williston Basin in North Dakota and two of which are located in the Permian Basin in west Texas. We also have a management agreement in place to provide staffing and management services to an SWD facility in the Bakken Shale region (a facility in which we own a 25% interest). W&ES customers are oil and natural gas E&P companies and trucking companies operating in the regions that we serve. In all of our 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, assisting in reducing their operating costs.

 

Ownership

 

As of June 30, 2017, Holdings owns approximately 58.6% of the Partnership, while affiliates of Holdings own approximately 5.8% of the Partnership, for a total ownership percentage of the Partnership of approximately 64.4% by Holdings and its affiliates. Holdings’ ownership group also owns 100% of the General Partner and the incentive distribution rights (“IDR’s”).

 

Omnibus Agreement

 

We are party to an omnibus agreement with Holdings and other related parties. The omnibus agreement 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 expense we incur as a result of being a publicly traded partnership. For the three and six months ended June 30, 2017 and 2016, Holdings provided sponsor support to us by waiving payment of the quarterly administrative fee;

 

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  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 affiliates of Holdings control our General Partner, the omnibus agreement will remain in effect, unless we and Holdings agree to terminate it sooner. If affiliates of Holdings cease 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.

 

Holdings incurred expenses of $0.8 million and $1.0 million on our behalf for the three months ended June 30, 2017 and 2016, respectively, and $1.8 million and $1.9 million on our behalf for the six months ended June 30, 2017 and 2016, respectively. These expenses are reported within general and administrative in the accompanying Unaudited Condensed Consolidated Statements of Operations and as contribution from general partner in the accompanying Unaudited Condensed Consolidated Statement of Owners’ Equity.  In addition to funding certain general and administrative expense on our behalf, during the second quarter of 2016, Holdings contributed $2.0 million in cash attributable to the General Partner as a reimbursement of certain expenditures previously incurred by the Partnership. This payment was recorded as an equity contribution and is reflected as a component of the net loss attributable to the general partner in the Unaudited Condensed Consolidated Statement of Operations for the three and six month periods ended June 30, 2016.

 

Pipeline Inspection Services

 

We generate revenue in the PIS segment primarily by providing 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 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 and distribution systems, and the legal and regulatory requirements relating to the inspection and maintenance of those assets. We charge our customers on a per-inspector basis, including per diem charges, mileage, and other reimbursement items.

 

Integrity Services

 

We generate revenue in our IS segment primarily by providing hydrostatic testing services to major natural gas and petroleum companies and pipeline construction companies of newly-constructed and existing natural gas and petroleum pipelines. We generally charge our customers in this segment on a fixed-bid basis, depending on the size and length of the pipeline being inspected, the complexity of services provided, and the utilization of our work force and equipment. Our results in this segment are driven primarily by the number of field personnel that perform services for our customers and the fees that we charge for those services, which depend on the type and number of field personnel used on a particular project, the type of equipment used and the fees charged for the utilization of that equipment, and the nature and duration of the project.

 

Water and Environmental Services

 

We generate revenue in the W&ES segment primarily by treating flowback and produced water and injecting the saltwater into our SWD facilities. Our 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 these 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 water. We also generate revenue managing an SWD facility for a fee.

 

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 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 current and projected prices of oil, natural gas, and natural gas liquids (“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 correlate with long-term trends in prices of oil, natural gas, and NGLs.

 

We also generate revenues from the sales of residual oil recovered during the saltwater treatment process. Our ability to recover 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 usually 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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Outlook

 

Overall

 

For each of our business segments, revenues, margins, and margin percentages were higher in the second quarter of 2017 than they were in the first quarter of 2017. This is consistent with the seasonality inherent in our business, in which the first quarter of each year is generally the slowest phase of the annual business cycle primarily due to weather conditions and the annual business cycles of our customers as they are developing and finalizing expenditure budgets.

 

For our PIS segment, headcount was higher in the second quarter of 2017 than it was in the first quarter of 2017 or in the second quarter of 2016. We believe market activity is beginning to increase, as we believe our inspection clients are starting new projects and increasing their spending on maintenance and integrity work that was deferred when possible during the recent industry downturn. We have continued to invest in our nondestructive examination business, as this business typically generates higher margins than our legacy inspection business. We expect revenues of our Canadian operations to be much lower in the near future than they have been in the recent past, due to the loss of our largest Canadian customer at the end of the second quarter.

 

Revenues of our IS segment were significantly higher in the second quarter of 2017 than they were in the first quarter of 2017, as we began to win bids for a number of projects. We continue to bid on numerous opportunities in an effort to increase our backlog. Earlier in 2017, we hired new business development personnel to assist in these efforts.

 

Revenues of our W&ES segment were modestly higher in second quarter 2017 than in first quarter 2017, although revenues in the second quarter of 2017 were lower than those of the same quarter in the prior year. Two of our facilities are located in the Permian basin, which has experienced an increase in production activity. The remainder of our facilities are in the Bakken region, where the recovery of production activity has been slower. In both regions, a significant number of wells have been drilled but not yet completed; once producers complete these wells, we expect to have the opportunity to generate additional volumes and revenues.

 

We continue to evaluate acquisition opportunities, some of which are exclusive and in the latter stages of negotiation, across our business segments, as well as other traditional midstream opportunities. Our general partner and its affiliates remain willing to deploy capital to assist us in acquiring assets that might be larger than what we can currently acquire on our own, with plans to offer those assets to us as “drop-down” opportunities.

 

Pipeline Inspection Services

 

We operate in a very large market with many customer prospects that we do not currently serve and provide federally-mandated essential services to protect our nation’s critical energy infrastructure. The majority of our existing and potential customers are once again investing in their businesses following a difficult two-year economic downturn. We continue to focus on new lines of business to serve our existing customers. The majority of our clients are public, investment-grade companies with long planning cycles that lead to healthy backlogs of new long-term projects and existing pipeline networks that also require inspection and integrity services. The public utility company (“PUC”) component of the industry, which brings natural gas to homes and businesses, remains an area with substantial growth potential. We believe that with increasing regulatory requirements, and the aging pipeline infrastructure, that the PIS business is more insulated from changes in commodity prices in the near term than has been the case in the past. However, a prolonged depression in oil and natural gas prices could lead to a downturn in demand for our services as was the case over the last two years.

  

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The downturn in energy prices required many of our customers that rely more heavily on commodity prices to focus on reducing their operating costs. Several clients have sought to reduce the rates paid to inspectors to reduce their inspection costs. We have recently renewed several sizable existing contracts and are bidding on several new contracts. However, we continue to see certain of our customers’ projects slipping past original start dates as a result of permitting or other delays and were informed in the second quarter that we were not a successful bidder on a proposal to perform inspection services for a customer that represented a majority of the revenues of our Canadian operations.

 

Integrity Services

 

Brown had a difficult year in 2016, which forced us to implement aggressive measures to manage and reduce its cost structure. We have recently hired some business development personnel who are focused on the potential synergies that may develop between IS and our other current customers, as well as the growth and nurture of its historical, ongoing business. Brown operated in 13 states during 2016, compared with almost 40 states that the TIR Entities (through our PIS segment) operated in throughout 2016. Although Brown’s revenues were low during the first quarter of 2017, the backlog began to improve in the second quarter of 2017. 

 

Water and Environmental Services

 

In our W&ES segment, the decline in the market price of crude oil which began in 2014 had an adverse impact on our revenues over the last two years. The resultant slowdown in exploration and production activity led to lower volumes, and lower commodity prices led to lower revenues from sales of crude oil we recovered from the water we processed. In addition, many of our E&P customers requested pricing concessions to help them cope with the lower commodity prices. In the majority of the basins in the country, new SWD facilities were developed to support previous rig counts and activity levels prior to the sharp contraction in activity and commodity prices. These events have led to excess SWD facility supply relative to current demand in many locations, including the Bakken and the Permian that, in turn, has led to aggressive pricing. Rig activity has increased significantly in the Permian Basin during 2017, but has increased at a slower rate in the Bakken since its low point in the first half of 2016. We have always focused on produced water rather than flowback water and therefore we believe we have been less impacted than many of our competitors. We are clearly being impacted by lower water volumes in the markets we serve, lower skim oil volumes as our flowback volumes decline, lower per-barrel water pricing and lower per-barrel oil pricing. In the second quarter of 2016, we took aggressive actions to reduce operating costs in an effort to offset the financial impact of continued depressed market volumes and prices and continue to see the positive results of those actions. Additionally, we continue to focus on piped water opportunities to secure additional long-term volumes of produced water for the life of the oil and gas wells’ production. Piped water continues to represent a growing percentage of our total volume. We also provide management services for an SWD facility in which we own a 25% interest.

 

We will continue to actively pursue the right acquisition opportunities with the same discipline that protected the Partnership during a heated market in 2014 and 2013 that drove up valuations to unsustainable levels. We also continue to evaluate and compete for some interesting opportunities for pipelines and SWDs directly with E&P companies seeking to monetize their midstream assets.

 

Despite the low oil and gas commodity prices of recent years, we have maintained positive operating cash flows throughout 2016 and the first six months of 2017 and expect to continue generating positive operating cash flows throughout the remainder of 2017. We continue to work collaboratively with our customers to help them address the volatility in commodity prices and their need to reduce operating expenses until prices stabilize. We also continue to carefully evaluate market pricing on a facility-by-facility basis. In January 2017, one of our facilities was struck by lightning. The downhole facilities were not damaged and we had insurance covering the surface facilities with a reasonable deductible. We do not carry business interruption insurance given its costs, waiting periods, and coverages. Within two weeks, the facility re-opened with temporary surface facilities. We have begun the process of designing and evaluating new surface facility configurations that will be implemented with insurance proceeds.

 

In July 2017, a lightning strike at our Grassy Butte SWD facility initiated a fire that effectively destroyed the surface equipment at the facility. We believe that the property damage associated with the lightning strike and fire is covered by insurance, although we do not yet know the extent or timing of any insurance reimbursement for the losses incurred at the facility.

  

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Results of Operations

 

Consolidated Results of Operations

 

The following table summarizes our Unaudited Condensed Consolidated Statements of Operations for the three and six month periods ended June 30, 2017 and 2016:

 

    Three Months Ended June 30,     Six Months Ended June 30,  
    2017     2016     2017     2016  
    (in thousands)  
                         
Revenues   $ 74,567     $ 72,311     $ 139,289     $ 145,785  
Costs of services     65,958       64,946       124,351       130,660  
Gross margin     8,609       7,365       14,938       15,125  
                                 
Operating costs and expense:                                
General and administrative - segment     4,157       4,445       8,075       9,432  
General and administrative - corporate     1,172       1,115       2,364       2,317  
Depreciation, amortization and accretion     1,206       1,246       2,377       2,471  
Impairments           10,530       3,598       10,530  
(Gains) losses on asset disposals and insurance recoveries, net     (113 )           (113 )      
Operating income (loss)     2,187       (9,971 )     (1,363 )     (9,625 )
                                 
Other income (expense):                                
Interest expense, net     (1,795 )     (1,619 )     (3,504 )     (3,237 )
Foreign currency gains     267             267        
Other, net     60       24       105       47  
Net income (loss) before income tax expense     719       (11,566 )     (4,495 )     (12,815 )
Income tax expense (benefit)     222       50       (71 )     162  
Net income (loss)     497       (11,616 )     (4,424 )     (12,977 )
                                 
Net loss attributable to non-controlling interests     (133 )     (4,612 )     (1,298 )     (4,979 )
Net income (loss) attributable to partners / controlling interests     630       (7,004 )     (3,126 )     (7,998 )
                                 
Net loss attributable to general partner     (829 )     (2,967 )     (1,750 )     (3,935 )
Net income (loss) attributable to limited partners   $ 1,459     $ (4,037 )   $ (1,376 )   $ (4,063 )

 

See the detailed discussion of revenues, costs of services, gross margin, general and administrative expense and depreciation, amortization and accretion by reportable segment below. The following is a discussion of significant changes in the non-segment related corporate other income and expenses during the respective periods.

 

General and administrative – corporate. General and administrative-corporate remained relatively consistent from period to period and primarily represents expenses incurred by Holdings on our behalf (and not charged to us).

 

Interest expense. Interest expense primarily consists of interest on borrowings under our Credit Agreement, as well as amortization of debt issuance costs and unused commitment fees. Interest expense increased from 2016 to 2017 primarily due to an increase in interest rates. Average debt outstanding during the six months ended June 30, 2017 and 2016 was $136.9 million and $137.7 million, respectively. The average interest rate on our borrowings has increased from 4.05% in the six months ended June 30, 2016 to 4.48% in the six months ended June 30, 2017.

 

Other, net. Other income includes income associated with our 25% interest in an SWD facility, which we account for under the equity method.

 

Foreign currency gains. During the three months ended June 30, 2017, we recorded $0.3 million of income associated with currency translation adjustments on intercompany balances among our consolidated subsidiaries that were previously recorded in other comprehensive loss on our Unaudited Condensed Consolidated Statement of Owners' Equity.

 

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Income tax expense. Income tax expense includes income taxes related to two of our taxable corporate subsidiaries in the United States and one taxable corporate subsidiary in Canada (two in our PIS segment and one in our IS segment), as well as business activity, gross margin, and franchise taxes incurred in certain states. We estimate an annual tax rate based on our projected income for the year and apply that annual tax rate to our year-to-date earnings. We incurred net losses related to our taxable entities (as described) during the first half of 2017, and as a result, we recorded a net tax benefit for the six months ended June 30, 2017.

 

Net loss attributable to noncontrolling interests. We own a 51% interest in Brown and a 49% interest in CF Inspection. The accounts of these subsidiaries are included within our consolidated financial statements. The portion of the net income (loss) of these entities that is attributable to outside owners is reported in net income (loss) attributable to noncontrolling interest in our Unaudited Condensed Consolidated Statements of Operations.

 

Net loss attributable to general partner. The net loss attributable to the general partner during the three and six months ended June 30, 2017 and 2016 consists of expenses that Holdings incurred on our behalf. Since Holdings did not charge us for these expenses, we recorded these expenses as an equity contribution from our general partner. The net loss attributable to the general partner in the three and six months ended June 30, 2016 also includes $2.0 million of cash support provided by the General Partner.

 

Segment Operating Results

 

Pipeline Inspection Services (PIS)

 

The following table summarizes the operating results of the PIS segment for the three months ended June 30, 2017 and 2016.

 

    Three Months Ended June 30,  
    2017     % of
Revenue
    2016     % of
Revenue
    Change     % Change  
    (in thousands, except average revenue and inspector data)   
                                     
Revenue   $ 70,154           $ 67,610           $ 2,544     3.8 %
Costs of services     63,384             61,365             2,019     3.3 %
Gross margin     6,770     9.7 %     6,245     9.2 %     525     8.4 %
                                           
General and administrative     3,065     4.4 %     3,079     4.6