ITEM 1. BUSINESS
Emerge Energy Services LP (“Emerge”) is a Delaware limited partnership that completed its initial public offering (“IPO”) on May 14, 2013 to become a publicly traded partnership. The combined entities of Superior Silica Sands LLC (“SSS”), a Texas limited liability company, and Allied Energy Company LLC (“AEC”), an Alabama limited liability company, represent the predecessor for accounting purposes (the “Predecessor”) of Emerge.
Immediately prior to the closing of the IPO, Insight Equity Management Company LLC and its affiliated investment funds and its controlling equity owners, Ted W. Beneski and Victor L. Vescovo (collectively “Insight Equity”) conveyed all of the interests in SSS and AEC to the Partnership as a capital contribution, and the Partnership conveyed its interests in SSS and AEC to the Partnership's subsidiary Emerge Energy Services Operating LLC (“Emerge Operating”), a Delaware limited liability company. In addition, the Partnership formed Emerge Energy Distributors Inc. (“Distributor”), a Delaware corporation, and purchased Direct Fuels LLC (“Direct Fuels”), a Delaware limited liability company, through a combination of cash, issuance of common units, and assumption of debt, and the Partnership conveyed all of the interest in Direct Fuels to Emerge Operating. Therefore, the historical financial statements contained in this Form 10-K reflect the combined assets, liabilities and operations of the Partnership, SSS and AEC for periods ending before May 14, 2013 and the assets, liabilities and operations of the Partnership and all of its subsidiaries for periods beginning on or after May 14, 2013.
On August 31, 2016, Emerge completed the sale of its Fuel business pursuant to an Amended and Restated Purchase and Sale Agreement, dated August 31, 2016 (the “Restated Purchase Agreement”), with Susser Petroleum Operating Company LLC and Sunoco LP (together, “Sunoco”). Sunoco paid Emerge a purchase price of approximately $167.7 million in cash (subject to certain working capital and other adjustments in accordance with the terms of the Restated Purchase Agreement), of which $14.25 million is placed into several escrow accounts to satisfy potential claims from Sunoco for indemnification under the Restated Purchase Agreement. Any escrowed funds remaining after certain periods of time set forth in the Restated Purchase Agreement will be released to Emerge, provided that no unsatisfied indemnity claims exist at such time.
References to the “Partnership,” “we,” “our” or “us” when used for dates or periods ended prior to the IPO, refer collectively to the Predecessor. References to the “Partnership,” “we,” “our” or “us” when used for dates or periods ended on or after the IPO, refer collectively to Emerge and all of its subsidiaries.
Overview
We are a publicly-traded limited partnership formed in 2012 by management and affiliates of Insight Equity to own, operate, acquire, and develop a diversified portfolio of energy service assets.
The results of operations of the Fuel business have been classified as discontinued operations for all periods presented. We now operate our continuing business in a single sand segment. We are engaged in the businesses of mining, processing, and distributing silica sand, a key input for the hydraulic fracturing of oil and natural gas wells.
The Fuel business operated transmix processing facilities located in the Dallas-Fort Worth area and in Birmingham, Alabama. The Fuel business also offered third-party bulk motor fuel storage and terminal services, biodiesel refining, sale and distribution of wholesale motor fuels, reclamation services (which consists primarily of cleaning bulk storage tanks used by other petroleum terminal and others) and blending of renewable fuels.
We conduct our Sand operations through our subsidiary SSS. We believe that our subsidiary brand has significant name recognition and a strong reputation with our customers.
Our principal offices are located at 6000 Western Place, Suite 465, Fort Worth, Texas 76107. Our telephone number is (817) 618-4020 and our website address is www.emergelp.com.
Business Strategies
During 2016, we took numerous steps to improve our financial position and lower our outstanding balance on the revolver. In order to improve our competitive positioning and retain upside for the eventual recovery in the oil and gas cycle, we divested our Fuel business which helped reduce our debt burden. We recorded a gain of
$31.7 million
on the sale of the Fuel business and paid down
$154.0 million
of our outstanding borrowings under our revolving credit facility. Concurrently, we restructured our amended and restated revolving credit and security agreement (as amended, the “Credit Agreement”) among Emerge Energy Services LP, as parent guarantor, each of its subsidiaries, as borrowers (the “Borrowers”), and PNC Bank, National Association, as administrative agent and collateral agent (the “agent”), and the lenders thereto to align our balance sheet and covenants to our needs.
On August 8, 2016, we entered into a Securities Purchase Agreement (the “Purchase Agreement”) with an institutional investor (the “Purchaser”) to issue and sell to the Purchaser in a private placement (the “Private Placement”) an aggregate principal amount of
$20 million
of our Series A Preferred Units (the “Preferred Units”) and a warrant (the “Warrant”) that may be exercised to purchase common units (the “Warrant Units”) representing limited partner interests in the Partnership. The net proceeds of
$18.4 million
were used to repay outstanding borrowings under our revolving credit agreement.
In November 2016, we completed a public offering of 3,400,000 of our common units at a price of $10.00 per unit and granted the underwriters an option to purchase up to an additional 510,000 common units, which the underwriter exercised in full. The offering closed on November 23, 2016. We received proceeds (net of underwriting discounts and offering expenses) from the offering of approximately
$36.9 million
. The net proceeds from this offering was used to repay outstanding borrowings under our revolving credit agreement.
During 2016, we completed negotiations with various railcar lessors pursuant to which we terminated a future order of railcars, deferred future railcar deliveries and reduced and deferred payments on existing leases. We have negotiated, and continue to negotiate, price concessions and purchase commitment concessions from our major vendors, such as railcar lessors, rail transportation providers, mine operators, transload facilities operators, and professional services providers.
The primary components of our business strategy are:
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Focus on profitability and improving financial condition.
We are applying financial discipline to all aspects of our business with the primary goals of reducing costs, minimizing capital expenditures, restructuring our long-term lease and purchase commitments, realigning our human resource capital, idling our higher costs plants when necessary, and accelerating the introduction of technology-based sand products that could improve our financial performance. These strategy efforts include, but are not limited to:
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minimizing the overall cost of sand sold by finding the lowest cost combinations of sand source, production location and transportation providers wherever possible;
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continuing to negotiate price concessions and purchase commitment concessions from our major vendors, such as railcar lessors, rail transportation providers, mine operators, transload facilities operators, and professional services providers (we completed several railcar lease and transload agreement restructurings during 2016);
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demonstrating, through field trials and sales, the value proposition of our Self-Suspending Sand, SandMaxX™, which we also believe will result in higher profit margins.
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Capitalize on the current market recovery.
After oil and gas prices stabilized in the second half of 2016, North American onshore oil and gas producers have publicly communicated plans to substantially increase drilling and completion activity in 2017. A corresponding rebound in frac sand consumption will be needed in the energy services supply chain, and we plan on growing our business in 2017 through the market’s recovery and by increasing our market share. We are strategically ramping up utilization of our mines and dry plants to meet the higher demand projected for 2017 while also recovering price concessions made during the downturn in 2015 and 2016.
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Optimize existing assets.
We intend to focus on efforts that complement our existing asset base or provide attractive returns in new geographic areas or business lines. We have three Northern White dry plant facilities located in Wisconsin and an additional dry plant facility located in Kosse, TX. To reduce costs in 2016, we temporarily idled some of our higher cost operations in Wisconsin, and these plants are back in operation in 2017. If demand for our products continues to improve as it did during the second half of 2016, we are currently ramping up utilization of our mining and production operations in 2017 to meet customers’ orders.
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Introduce new products serving our core end users.
We intend to increase our presence and market share in frac sand end markets that we believe are poised for growth. In September 2015, we introduced a unique, technically advanced proppant to the oil and gas industry and began selling the product in 2016. This dustless proppant, brand named SandGuard™, improves the handling, in-basin management, and job-site implementation of the hydraulic fracturing of oil and gas wells. Silica sands can potentially release dust particles into the air that are harmful to personnel when exposed in large quantities, so mechanical dust collection systems act to remove silica dust from the workplace. Our SandGuard™ dustless product eliminates the need for expensive dust collection systems at the wellsite or at a transload terminal. With a SandGuard™ treatment facility in Barron County, Wisconsin, we have the ability to enhance the already strong qualities of its Northern White silica sand with the protective coating to help create a safer work environment for our customers’ employees.
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In November 2015, we acquired 11 patents and other intellectual property assets from AquaSmart Enterprises LLC for their Self-Suspending Sand technology. The product brand is marketed as SandMaxX™. While subject to ongoing field testing that began in 2016 and data validation, this new technology offers the potential to increase productivity and completion efficiencies in oil and gas wells while improving pump time, and well site economics. At our Barron dry
plant, we have a pilot production circuit capable of producing in excess of 175,000 tons per year of SandMaxX™ product. This pilot production circuit uses proprietary and patented technology to coat all grades of standard frac sand. SandMaxX™ was pumped downhole in 26 different trial wells during 2016, and while the early results appear favorable, we are working closely with our customers to confirm and document actual well performance data in addition to comparing the results against wells completed with regular sand. Our plans for constructing a commercial scale coating plant depend upon the successful completion of the field trial testing and achieving market acceptance of the product.
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Focus on customer contracts.
We are constantly working to secure or renew long-term take-or-pay, fixed-volume, and efforts-based contracts with existing and new customers in order to cover the substantial majority of our production capacity. In 2016, total sales to customers under long-term contracts, including efforts-based, fixed-volume, and take-or-pay arrangements, accounted for 62% of our sand sales volumes. As of December 31, 2016, we had 6.4 million tons under long-term contract, primarily efforts-based arrangements, with a weighted average remaining of approximately four years.
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Capitalize on industry fundamentals.
The demand for frac sand decreased in 2015 and the first half of 2016 as North American drilling activity declined in response to falling oil and gas prices. Rig count reductions were partially offset by a higher number of wells drilled per operating rig and an increase in sand intensity per well drilled or completed. After nearly two years of declining oil and gas prices beginning in the middle of 2014, the prospects for the oil and gas industry improved in the second half of 2016 as production declines and planned production cuts from the Organization of the Petroleum Exporting Countries (“OPEC”) helped to stabilize energy prices. We believe that the frac sand industry is poised to grow in 2017, and we continue to believe the frac sand market offers attractive long-term growth fundamentals.
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Grow business through strategic and accretive business or asset acquisitions.
Financial performance and condition permitting, we plan to selectively pursue accretive acquisitions in our areas of operation that we believe will allow us to realize operational efficiencies by capitalizing on our existing infrastructure, personnel and commercial relationships in energy services, and we may also seek acquisitions in new geographic areas or complementary business lines. In December 2015, we acquired the rights to mine high quality northern white silica sand reserves in Jackson County, Wisconsin. We have not engaged an expert to assess the volume and quality of these sand reserve rights. This transaction not only provides us with future access to high quality sand reserves, but also strengthens our position in the marketplace with a leading pressure pumper across a number of shale plays in North America. We currently do not have plans to develop this property in the immediate future.
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Distributions.
While Amendment No. 11 to the Amended and Restated Revolving Credit and Security Agreement limits our ability to make distributions to our unitholders, our board of directors of our general partner remains committed to resuming distributions as our financial condition allows.
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Competitive Strengths
We believe that we are well positioned to successfully execute our business strategies because of the following competitive strengths:
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High quality, strategically located assets.
We currently operate several scalable frac sand production facilities in and around Barron County, Wisconsin and Kosse, Texas. Our facilities in Wisconsin are supported by approximately
76.9 million
tons of proven recoverable sand reserves and our facility in Texas is supported by approximately
27.1 million
tons of proven recoverable sand reserves. We believe that our Wisconsin and Texas reserves provide us access to a balanced amount of coarse sand (16/30, 20/40, and 30/50 mesh sands) and fine sand (40/70 and 100 mesh) compared to other frac sand producers. Our sample boring data and production data indicated that our Wisconsin reserves contain deposits of nearly 35% 40 mesh or coarser substrate, with our Barron reserves being comprised of more than 60% 50 mesh or coarser substrate. Our mine deposits in Wisconsin can be targeted to extract finer grades when the market dictates such demand is wanted, as is the current trend. Also, our Kosse, TX operation primarily consists of fine sand product, which affords us significant flexibility of serving our customers with their desired product type needs.
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Logistics.
The logistics capabilities of our Wisconsin facilities enable us to serve the major United States and Canadian oil and natural gas producing basins, as well as provide us with economical access to Mexico and South America. Our New Auburn facility is connected to a rail line owned by Union Pacific, and our Barron facility is connected to the Canadian National rail line. Between our two Wisconsin rail yards, we have storage space for approximately 1000 railcars. Our Baron and New Auburn dry plant facilities can accommodate unit trains. As of
December 31, 2016
, we had a total of
5,573
railcars in our fleet, including
287
dedicated customer cars and
5,286
railcars under lease with a weighted average remaining term of 5.2 years. As of
December 31, 2016
, we had
14
transload facilities in North America, each of which is positioned to serve a number of our target markets.
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Competitive operating cost structure.
We believe that our operations are characterized by an overall low cost structure which allows us to capture attractive margins in the industries in which we operate. Our low cost structure is a result of the following key attributes:
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close proximity of our silica sand reserves to our processing plants, which reduces operating costs;
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expertise in designing, building, maintaining and operating advanced frac sand processing, storage and loading facilities;
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a large proportion of the costs we incur in our production of sand are only incurred when we produce saleable frac sand;
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open dialogue with key vendors allowing for cost reduction in down markets;
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proximity to major sand and logistics infrastructure, minimizing transportation and fuel costs, and headcount needs;
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competitive mineral royalty expenses;
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enclosed dry plant operations which allow full run rates during winter months, thereby increasing plant utilization; and
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a diversified and growing customer base spread across nearly every major shale play in North America.
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In addition to these capabilities, we have taken a number of proactive steps to further lower our operating costs, including upgrading equipment at our Kosse, Texas facility, refining our mining techniques at our Barron county mines and wet plants. We began using new lower cost mining techniques at two of our Wisconsin mines in the third quarter of 2015, and introduced these techniques to our Kosse mine in July 2016. We also introduced new processing techniques at our Kosse plant in the third quarter of 2015 that allowed us to inexpensively extract significant amounts of saleable frac sand from previously mined and discarded waste streams.
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Strong reputation with our customers, suppliers and other constituencies.
Our management and operating teams have developed longstanding relationships with our customers, suppliers, and other constituencies. Based on our track record of dependability, timely delivery and high-quality products that consistently meet customer specifications, we believe that we are well positioned to secure additional contracted commitments in the future, and that our product mix and customer service will continue to benefit our reputation within the frac sand industry.
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Experienced management team with industry specific operating and technical expertise.
Our senior management team has extensive industry experience in managing and operating industrial mineral production facilities. They have managed numerous frac sand mining and processing plants, successfully led acquisitions in the industry and developed multiple greenfield industrial mineral processing facilities. We believe that our customers value our commitment to customer service, our reliable delivery, and our focus on high-quality product.
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Sand Business
Our Sand business mines, processes and distributes high quality silica sand, a key input for the hydraulic fracturing of oil and gas wells. Our Wisconsin facilities consist of three dry plants located in Arland, Barron and New Auburn, Wisconsin with a total permitted capacity of
6.3 million
finished tons per year, and five wet plants and mine complexes that supply the dry plants with Northern White silica sand, which we believe is the highest quality raw frac sand available. We also have a fourth dry plant in Kosse, Texas, with a capacity of
600,000
tons per year that is supplied by a separate mine and wet plant that processes local Texas sand. As of
December 31, 2016
, we also had
14
transload facilities located throughout North America in the key basins where we deliver our sand, as well as a fleet of
5,573
railcars.
Our Sand business experienced rapid growth from 2011 to 2014 due to technological advances in horizontal drilling and the hydraulic fracturing process that have made the extraction of large volumes of oil and natural gas from domestic unconventional hydrocarbon formations economically feasible. Demand for frac sand decreased during 2015 and 2016 as a result of the industry downturn, but we saw early signs of a recovery near the end of 2016. We believe that the premium geologic characteristics of our Wisconsin sand reserves, the strategic location of our sand mines, our location on multiple Class One rail lines, our extensive transload and logistics network, the industry experience of our senior management team, and the reputation that SSS has with our customers position us as a highly attractive source of frac sand to the oil and natural gas industry.
The production of our sand consists of three basic processes: mining, wet plant operations, and dry plant operations. All mining activities take place in an open pit environment, whereby we remove the topsoil, which is set aside, and then remove other non-economic minerals, or “overburden,” to expose the sand deposits. We then “bump” the sand using explosives on the mine face, which causes the sand to fall into the pit, where it is then carried by truck to the wet plant operations. We also utilize a process called hydraulic mining whereby we use high pressure water cannons to dislodge the sandstone, and transport the sand and water mixture via pipeline to the wet plant. Where the geology is suitable, this technique minimizes the use of heavy excavation machinery, thereby lowering operating costs. Once we have mined out a portion of the reserves, we then either return the land to its previous contours or to a more usable contour, and then replace the topsoil. At our wet plant, the mined sand goes through a series of
processes designed to separate the sand from unusable materials. The resulting wet sand is then conveyed to a wet sand stockpile where most of the water is allowed to drain into our on-site recycling facility, while the remaining fine grains and other materials, if any, are separated through a series of settlement ponds. We reuse all of the water that does not evaporate in our wet process. Wet sand from our stockpile is then conveyed or trucked to our dry plants where the sand is dried, screened into specific mesh categories, and stored in silos. From the silos, we load sand directly into railcars or trucks, which we then ship to one of our transload facilities or directly to one of our customers.
Our frac sand facilities are located in Barron County and Chippewa County, Wisconsin and Kosse, Texas. Based on the reports of third-party independent engineering firms, we have approximately
104.0 million
tons of proven recoverable reserves. We are currently capable of producing up to
8.8 million
tons and
6.9 million
tons of wet and dry sand per year, respectively, from our current facilities. We believe that the coarseness, conductivity, sphericity, acid-solubility, and crush-resistant properties of our Wisconsin reserves and our facilities' connectivity to rail and other transportation infrastructure afford us an advantage over our competitors and make us one of a select group of sand producers capable of delivering high volumes of frac sand that is optimal for oil and natural gas production to all major unconventional resource basins currently producing throughout North America and abroad.
Our Wisconsin sand reserves give us access to a range of high-quality sand that meets or exceeds all API specifications and includes a mix between concentrations of coarse grades (16/30, 20/40 and 30/50 mesh sands) and finer grades (40/70 and 100 mesh). While our Wisconsin reserves provide us access to a high amount of coarse sand compared to other Northern White deposits located in Wisconsin's Jordan, St. Peter, and Wonewoc formations, we have the ability to target certain locations in our deposits to obtain finer sands. Our sample boring data and our historical production data have indicated that our Wisconsin reserves contain deposits of nearly 35% 40 mesh or coarser substrate, with our FLS, Church Road, LP Mine and Thompson Hills reserves being comprised of more than 60% 50 mesh or coarser substrate. We are also one of a select number of mine operators that can offer commercial amounts of 16/30 mesh sand, the coarsest grade of widely-used frac sand on the market. Our Wisconsin dry plants are fully enclosed, which means that we are capable of running year-round, regardless of the weather. Under normal market conditions, we operate our Wisconsin plants with work crews of four to six employees. These crews work 40-hour weeks, with shifts between eight and twelve hours, depending on the employee's function. Because raw sand cannot be wet-processed during extremely cold temperatures, we typically mine and wet-process frac sand eight months out of the year at our Wisconsin locations.
Our mine, wet plant, and dry plant in Kosse, Texas operate year-round. The reserves primarily consist of finer mesh grades, which strategically complement the coarser grades from our Wisconsin deposits. We operate our Kosse facilities with crews of four to six employees who work twelve-hour shifts and average 40 hours per week. This allows us to optimize facility utilization.
Each of our facilities undergoes regular maintenance to minimize unscheduled downtime, and to ensure that the quality of our frac sand meets applicable ISO and API standards and our customers' specifications. In addition, we make capital investments in our facilities as required to support customer demand, and our internal performance goals.
The following table provides information regarding our frac sand production facilities as of
December 31, 2016
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Wet Plant
Location (1)
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Proven Recoverable Reserves
(Millions of Tons) (2)
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Lease Expiration Date (3)
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Annual Plant Capacity
(Thousands of Tons)
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2016 Production
(Thousands of Tons)
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Auburn
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15.5
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March 2036
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2,000
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Thompson Hills
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40.9
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December 2037
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1,600
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498
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FLS Mine
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10.3
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July 2037
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1,200
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358
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Church Road
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5.3
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N/A
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1,200
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LP Mine
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4.9
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March 2038
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1,200
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581
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Kosse, TX
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27.1
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N/A
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1,600
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228
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Dry Plant Location (1)
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On-site Railcar
Storage Capacity (4)
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Annual Plant Capacity
(Thousands of Tons)
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2016 Production Volumes
(Thousands of Tons)
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Arland
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N/A
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2,500
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186
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Barron
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650 cars
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2,400
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1,588
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New Auburn
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420 cars
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1,400
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352
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Kosse, TX
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N/A
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600
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140
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(1)
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All facilities are located in Wisconsin, except for our Kosse facility.
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(2)
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Reserves are estimated as of
December 31, 2016
by third-party independent engineering firms based on core drilling results and in accordance with the SEC’s definition of proven recoverable reserves and related rules for companies engaged in significant mining activities and represent marketable finished product.
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(3)
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We own the land and mineral rights at our Church Road mine and the mineral rights at our Kosse mine.
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(4)
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We transload sand produced at Arland to rail loadouts at New Auburn, Barron, and a third location in Minnesota.
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Mineral Reserves
We believe that our strategically located mines and facilities provide us with a large and high-quality mineral reserve base. The coarseness and conductivity of the Northern White frac sand that we mine in Wisconsin significantly enhances recovery of oil and liquids-rich gas by allowing hydrocarbons to flow more freely than would be possible with competing native sand. The low acid-solubility increases the integrity of the Northern White sand relative to other proppants with higher acid-solubility, especially in shales where hydrogen sulfide and other acidic chemicals are co-mingled with the targeted hydrocarbons. In addition, its crush resistant properties enable Northern White frac sand to be used in deeper drilling applications than the frac sand produced from mineral deposits located in Texas, Arkansas, or other southern United States locations.
We categorize our reserves as proven recoverable in accordance with SEC definitions and have further limited the definition to apply only to sand reserves that we believe could be extracted at an average cost that is economically feasible. According to such a definition, we estimate that we had a total of approximately
104 million
tons of proven recoverable mineral reserves as of
December 31, 2016
. The quantity and nature of the mineral reserves at each of our properties are estimated first by third-party geologists and mining engineers and we internally track the depletion rate on an interim basis. Cooper Engineering Company, Inc. prepared estimates of our proven mineral reserves at our Wisconsin mine locations, while Westward Environmental, Inc. prepared estimates of our proven mineral reserves at our Kosse facility, each as of
December 31, 2016
. Our external geologists and engineers update our reserve estimates annually, making necessary adjustments for operations at each location during the year and additions or surveying, drill core analysis and other tests to confirm the quantity and quality of the acquired reserves.
Our mineral reserve leases in Wisconsin with third-party landowners expire at various times between 2036 and 2038. We do not anticipate any issues in renewing these leases should we decide to do so. Consistent with industry practice, we conduct only limited investigations of title to our properties prior to leasing. Title to lands and reserves of the lessors or grantors and the boundaries of our leased properties are not completely verified until we prepare to mine those reserves.
Mines and Wet Plants
The deposits found in our open-pit Wisconsin-based mines are Cambrian quartz sandstone deposits that produce high-quality Northern White frac sand and have a minimum silica content of approximately 99%. Mining takes place in phases lasting from six months to one year in duration, after which the property is reclaimed in a manner that typically provides the landowners with additional cropland.
New Auburn
Our New Auburn wet plant can process up to
2 million
tons of wet sand per year. It is located in Chippewa County, Wisconsin, 12 miles from our New Auburn dry plant, to which we have year-round trucking access. The mine site consists of approximately 418 acres adjacent to our New Auburn wet plant. The site contains
15.5 million
tons of proven recoverable sand reserves.
In 2011, we awarded Fred Weber, Inc. (“Fred Weber”) a five-year contract for the entirety of our Auburn mining operations and for a portion of our wet processing needs at that facility. Under this contract, Fred Weber financed and built the wet plant at our Auburn facility. We amended and extended this contract on January 1, 2015, which now expires in December 31, 2021. Fred Weber now mines the sand reserves, creates stockpiles of washed sand, and maintains the plant and equipment at Auburn. We agreed, under a take-or-pay arrangement, to purchase 500,000 tons of washed sand from Fred Weber each year that the plant is in operation. We pay Fred Weber a set price per ton of washed sand, subject to adjustments each operational year for diesel prices, the quality of the sand mined, and the quantity of sand purchased. During the term of the agreement Fred Weber will own the wet plant along with the equipment and other temporary structures used for mining on the property. At the end of the term of the agreement or following a default under the contract by Fred Weber, we have the right to take ownership of the wet plant and other mining equipment without charge. Subject to certain conditions, ownership of the plant and equipment will transfer from Fred Weber to us at the expiration of the term. The contract was suspended for the year ended
December 31, 2016
. During the suspension period, we were responsible for mine upkeep and maintenance. The contract resumed on January 1, 2017.
Thompson Hills
Our Thompson Hills wet plant can process up to
1.6 million
tons of wet sand per year. It is located 15 miles from our New Auburn dry plant and 26 miles from our Barron dry plant. The mine site is situated on 580 acres and consists of a series of seven leases in Barron County, Wisconsin. The site contains
40.9 million
tons of proven recoverable sand reserves.
We completed construction of the mine and wet plant in September 2014. We incorporated two features into the wet plant that we believe provide the plant with higher quality sand within a more environmentally sound footprint. The first is that we wash our sand both before and after we run the wet sand through the hydrosizer. The resulting sand has turbidity that is the lowest of any wet plant with which we are familiar, which results in less fugitive dust both at our facilities and at the drilling site for our customers. The second is that we separate our fines and other unusable material without the use of settling ponds, which enables us to use less water in our wet plant. Hydraulic mining was implemented at this site during the third quarter of 2015, reducing our mining costs.
FLS mine
Our FLS wet plant can process up to
1.2 million
tons of wet sand per year. It is located 12 miles from our Barron dry plant. The mine site is situated on 364 acres and consists of a series of five adjacent mineral deposits in Barron County, Wisconsin. The site contains
10.3 million
tons of proven recoverable sand reserves.
Church Road
Our Church Road wet plant can process up to
1.2 million
tons of wet sand per year. It is located less than one mile from our Arland dry plant. The mine site is situated on 130 acres. The site contains
5.3 million
tons of proven recoverable sand reserves.
LP Mine
Our LP wet plant can process up to
1.2 million
tons of wet sand per year. It is located 2 miles from our Arland dry plant. The mine site is situated on 145 acres. The site contains
4.9 million
tons of proven recoverable sand reserves. Hydraulic mining was implemented at this site during the third quarter of 2015.
Kosse
We own the mineral rights to a 225 acre mineral deposit located in Kosse, Texas, adjacent to our Kosse dry plant. The deposit has a minimum silica content of approximately 99% and controlling attributes that include sand grain crush strength and size distribution. As of
December 31, 2016
, the Kosse mineral deposit contained
27.1 million
tons of proven recoverable reserves which we process into a high-quality, 100 mesh frac sand. The wet plant at our Kosse facility is capable of producing up to
1.6 million
tons of wet sand per year. We are not obligated to make royalty payments in connection with our mining operations at this location. We use heavy equipment to mine sand from the open-pit. We introduced hydraulic mining techniques to our Kosse mine in 2016.
Future Projects
In December 2015, we acquired the rights to mine high quality northern white silica sand reserves in Jackson County, Wisconsin from a subsidiary of Performance Technologies, L.L.C (“PTL”), which is wholly-owned by Seventy Seven Energy Inc. (NYSE: SSE). We have not engaged an expert to assess the volume and quality of these sand reserve rights. The assets acquired include certain owned and leased land, sand deposit leases and related prepaid royalties, and transferable mining and reclamation permits. This transaction strengthens our position in the marketplace with a leading pressure pumper across a number of shale plays in North America. In consideration for the assets, PTL and SSS amended and restated the existing supply agreement between the parties and entered into a new sand purchase option agreement that provides PTL with a market-based discount on sand purchased from SSS. Under the new agreements with PTL, SSS has the option to supply the contracted tons from its existing footprint of northern white sand operations or construct a new sand mine and dry plant in Jackson County, Wisconsin. We currently do not have plans to develop this property in the near future.
Dry Plant Facilities
Arland
Our Arland dry plant is located in the township of Arland in Barron County, Wisconsin on 22 acres that we own. The facility is located on a county road, which gives us year-round trucking access, and is situated 11 miles from our Barron facility, and 37 miles from our New Auburn facility. Our Arland dry plant is an enclosed facility that has a rated production capacity of 8,800 tons per day year-round and regardless of weather conditions. Our current air permit allows us to produce up to 3.5 million tons per year of finished product. The facility has a 300 ton per hour natural gas fired rotary dryer as well as twelve high capacity gyratory mineral separators, or (“screeners”), that are capable of producing up to
2.5 million
tons per year. Our finished product is transported via truck to one of our dry plant facilities with rail access or to a third-party rail loadout facility located in Minnesota.
For the year ended
December 31, 2016
, our Arland facility produced approximately
0.2 million
tons of Northern White frac sand. In January 2016, we temporarily idled the Arland plant due to the challenging market conditions and higher cost structure as compared to our other dry plants. However, we resumed consistent production in October 2016, and the plant was operating at a high level of utilization to start 2017.
Barron
Our Barron dry plant is located in the township of Clinton, Wisconsin in Barron County on 83 acres that we own. The facility is located on a US Highway, which gives us year-round trucking access, and is situated along a rail spur owned by the Canadian National (“CN”) railway that connects to the CN main line. Our Barron dry plant is an enclosed facility that has a rated production capacity of 8,800 tons per day year-round regardless of weather conditions, and has on-site railcar loading facilities. Our current air permit allows us to produce up to 2.4 million tons per year of finished product. The facility has a 300 ton per hour natural gas fired rotary dryer as well as twelve high capacity screeners. Our railyard at Barron consists of 18 spur tracks and is capable of storing up to 650 railcars.
Our location on the CN rail spur allows us to offer direct access to the rapidly growing oil and gas shale plays in northwestern Canada and the northeastern United States, including the Western Canadian Sedimentary Basin, the Marcellus Shale, and the Utica Shale plays. The CN also presents us with access to emerging plays in the southern United States as well as the port of New Orleans, which provides us access to emerging oil and gas markets in Latin America.
The Barron facility houses our technology-driven proppant (SandGuard™ and SandMaxX™) production circuits. In late 2015, we installed equipment that applies coating material for our SandGuard™ product. Our SSP pilot plant upgrade is currently under construction and will provide production of SandMaxX™ in limited quantities until the technology is tested in the field. If the technology proves successful and widely demanded by our customers, we will evaluate a larger-scale upgrade to an existing facility.
For the year ended
December 31, 2016
, our Barron facility produced
1.6 million
tons of Northern White sand.
New Auburn
Our New Auburn dry plant is located in Barron County, Wisconsin, approximately 12 miles from our New Auburn mine. The facility is on 37 acres that we own in the village of New Auburn, Wisconsin along a short line that connects with the mainline of the Union Pacific (“UP”) railway. Our New Auburn dry plant is an enclosed facility that has a rated production capacity of 4,400 tons per day year-round regardless of weather conditions, and has on-site railcar loading facilities capable of loading railcars. Our current air permit allows us to produce up to 1.4 million tons per year of finished product. The facility has a 175 ton per hour natural gas fired fluid bed dryer as well as six screeners.
We have access to a segment of on-site rail track that is tied into a rail line owned by UP, and we use this rail space to stage and store empty or recently loaded customer railcars. Because of the cost efficiencies of shipping frac sand by rail, our location adjacent to a UP short line provides our customers with the ability to transport Northern White frac sand from our New Auburn facility to major oil and natural gas basins currently producing in the United States and western Canada, including access to high-activity areas of oil production in Texas, Oklahoma, Colorado and the western United States.
For the year ended
December 31, 2016
, our New Auburn facility produced
0.4 million
tons of Northern White sand. We idled the facility periodically during 2016 but resumed consistent production in October 2016, and the plant was operating at high levels to start 2017.
Kosse
Our Kosse dry plant is located adjacent to our Kosse mine and wet plant on land we own in Kosse, Texas. The facility has a rated production capacity of 1,650 tons per day year-round. The dry plant utilizes a 200 ton per hour natural gas fired rotary dryer that is capable of producing up to 600,000 tons per year of dry native Texas frac sand, and has an air permit that allows us to produce up to 1.2 million tons per year of finished product. We introduced new processing techniques at our Kosse plant in 2015 that allowed us to inexpensively extract significant amounts of saleable frac sand from previously mined and discarded waste sand. The plant produces 100-mesh native Texas sand and is capable of producing a higher-cut 40/70 frac sand. We also sell sand to non-energy end users, including industrial applications, and sports sand for golf courses, stadiums and other sports-related venues. The Kosse facility has three on-site 1,000-ton storage silos designed for loading trucks for delivery to local and regional markets.
For the year ended
December 31, 2016
, our Kosse facility produced approximately
140,000
tons of frac sand.
Transportation Logistics and Infrastructure
We sell our sand both free-on-board (“FOB”) at our plants as well as at transload facilities that are closer to the wellhead. As the frac sand market has evolved, the point of sale between producers and purchasers of frac sand continues to move away from the FOB plant model and closer to the wellhead. For the year ended December 31, 2016, we sold approximately
43%
of our sand FOB plant and
57%
FOB transload. At our Kosse, Texas plant, orders are picked up by truck because most orders are transported
200 miles or less from our plant site. Because nearly all product from our Wisconsin plants is transported in excess of 200 miles and transportation costs typically represent more than 50% of our customers' overall cost for delivered Northern White sand, the majority of our Wisconsin shipments are transported by rail to a transload and storage location in close proximity to the customer's intended end use destination.
While many of our customers continue to purchase FOB plant, we offer our customers a total supply chain solution pursuant to which we manage every aspect of the supply chain from mining and manufacturing to delivery within close proximity to the wellhead. Currently, we have built a fleet of company-leased and customer-committed railcars, assembled a network of leased transload and terminal storage sites located near major shale plays, and designed a supply chain management system all of which allow us to flexibly and efficiently coordinate rail, truck, and storage assets with customer order information.
Transload Facilities
Due to limited storage capacity at or near the wellhead, our customers generally find it impractical to store frac sand in large quantities immediately near their job sites. We can service manifest rail deliveries or unit train shipments and minimize product fulfillment lead times through the simultaneous handling of multiple customers' railcars. In order to continue to service the customer closer to the wellhead, we have assembled a network of transload facilities within a number of the major basins that we serve. Below is a summary of the transload sites that we operate out of as of
December 31, 2016
.
|
|
|
|
|
|
|
|
|
|
|
Transload Location by Basin
|
|
Transload Sites as of December 31, 2016
|
|
Transload Sites Capable of Receiving Unit Trains
|
|
2016 Volume Sold
(Thousands of Tons)
|
Bakken Shale
|
|
1
|
|
|
1
|
|
|
181
|
|
Barnett Shale
|
|
1
|
|
|
—
|
|
|
1
|
|
Eagle Ford Shale
|
|
1
|
|
|
1
|
|
|
187
|
|
Haynesville Shale
|
|
1
|
|
|
1
|
|
|
3
|
|
Marcellus / Utica Shales
|
|
1
|
|
|
1
|
|
|
66
|
|
Mid-Continent Basin
|
|
1
|
|
|
1
|
|
|
118
|
|
Permian Basin
|
|
4
|
|
|
2
|
|
|
437
|
|
Western Canadian Sedimentary Basin
|
|
3
|
|
|
—
|
|
|
188
|
|
Export to South America
|
|
1
|
|
|
—
|
|
|
6
|
|
Total tons sold through transloads active at December 31, 2016
|
|
14
|
|
|
7
|
|
|
1,187
|
|
Tons sold through transloads not active at December 31, 2016
|
|
|
|
|
|
53
|
|
Tons sold through transloads in 2016
|
|
|
|
|
|
1,240
|
|
As of
December 31, 2016
, we had a total of
5,573
railcars in our fleet, including
287
railcars that are owned or leased by our customers but dedicated to us, and
5,286
railcars that we lease with a weighted average remaining term of 5.2 years.
Permits
In order to conduct our sand operations, we are required to obtain permits from various local, state and federal government agencies. The various permits we must obtain address such issues as mining, construction, air quality, water discharge, noise, dust, and reclamation. Prior to receiving these permits, we must comply with the regulatory requirements imposed by the issuing governmental authority. In some cases, we also must have certain plans pre-approved, such as site reclamation plans, prior to obtaining the required permits. A decision by a governmental agency to deny or delay issuing a new or renewed permit or approval, or to revoke or substantially modify an existing permit or approval, could have a material adverse effect on our ability to continue operations at the affected facility. Expansion of our existing operations also is predicated upon securing the necessary environmental and other permits and approvals. We have obtained all permits required for the operation of our existing facilities. We will also obtain permits necessary to process and distribute any new product, as might be required.
Intellectual Property
Our intellectual property consists primarily of patents, trade secrets, know-how and products such as “SandMaxX™” and “SandGuard™.” We hold 11 U.S. granted patents that are still in force, the majority of which have an expiration date after 2027. Typically, we utilize trade secrets to protect the formulations and processes we use to manufacture our products and to safeguard our proprietary formulations and methods. We believe we can effectively protect our trade secrets indefinitely through the use of confidentiality agreements and other security measures.
Fuel Business
The Fuel business consisted of our facilities located in the Dallas-Fort Worth metropolitan area and in Birmingham, Alabama, which were operated by Direct Fuels and AEC, respectively. Through this business, we acquired and processed transmix, which is a blend of different refined petroleum products that have become co-mingled in the pipeline transportation process, sold wholesale petroleum products; provided third-party terminaling services, and provided other complementary products and services. In these two markets, we were able to offer our customers gasoline and diesel at market rates, 24 hours a day, seven days a week. On August 31, 2016, we completed the sale of our Fuel business. Therefore, the results of operations of the Fuel business have been classified as discontinued operations for all periods presented. A selected summary of our volumes for the year ended
December 31, 2016
follows:
|
|
|
|
|
|
|
|
|
|
|
Plant Location
|
|
Fuel From Transmix Sold
|
|
Wholesale Fuel Volume Sold
|
|
Terminal Throughput Volume
|
|
|
|
|
|
|
|
|
|
(Volumes in thousands of gallons)
|
|
|
|
|
|
|
|
Dallas-Fort Worth, TX
|
|
37,213
|
|
|
11,869
|
|
|
45,532
|
|
Birmingham, AL
|
|
31,113
|
|
|
85,228
|
|
|
37,321
|
|
In our transmix business, we acquired transmix from terminal operators and others, which was delivered by pipeline or truck to our facilities. We then processed the transmix into refined products such as conventional gasoline and low sulfur diesel, which we sold over our truck loading rack to third party distributors as well as off-road customers such as railroad, and marine operators. We structured our transmix purchase agreements to capture a stable margin, as the price differential between the indices at which we purchased transmix supply and the sales price of the corresponding refined product. While our transmix purchase agreements were designed to capture a stable margin at the time of purchase, the final sales price was subject to daily fluctuations in fuel prices, and this holding period risk affected our profitability. We sought to partially mitigate the holding period risk by hedging a portion of our inventories.
In our wholesale fuel business, we purchased fuel that was delivered to our tanks via pipeline, which we then subsequently sold over our truck loading rack. At our Birmingham facility, we received refined fuels on pipelines operated by Plantation Pipeline, and Colonial Pipeline. We had shipper status on the Plantation line, but our space allocation was limited to one cycle per month. At our Dallas-Fort Worth facility, we received refined fuels and transmix on two lines operated by Explorer Pipeline Company, and we were connected to an independent refiner via a private pipeline. Our average holding period for transmix and wholesale gallons was 7-10 days, which served to minimize, but not eliminate, the effects of daily fluctuations in fuel price.
In our terminaling business, we leased our terminal space to third parties who used our facilities to store refined petroleum products. We were able to charge customers for the storage, intake, and/or outtake of refined products. We also had injection additive systems that allowed us to sell branded gasoline.
Other services included blending of renewable fuels into petroleum products, the manufacturing of biodiesel at our Birmingham facility and certain reclamation services, which consisted primarily of tank cleaning services. We were also are a net producer of Renewable Identification Numbers, or RINs, which we sold to reduce our cost of goods sold.
Customers
We sell substantially all of our sand to customers in the oil and gas proppants market. Our customers include major oilfield services companies as well as exploration and production companies that are engaged in hydraulic fracturing. Sales to the oil and gas proppants market comprised approximately 99% of our total Sand business sales in 2016. For the years ended
December 31, 2016
and
2015
, our top two customers, EP Energy Corporation and Performance Technologies, LLC, collectively accounted for approximately
51%
and
27%
, respectively, of our total revenues for continuing operations.
In 2016, total sales to customers under long-term contracts, including take-or-pay, fixed-volume, and efforts-based contracts, accounted for 62% of our total Sand business sales. As of
December 31, 2016
, we had 6.4 million tons under long-term contract with a weighted average remaining term of four years.
While we continue to actively pursue take-or-pay and fixed-volume contracts as part of our broader strategy, our customers increasingly favor efforts-based contracts over take-or-pay or fixed-volume contracts. As part of the overall value proposition, we also believe customers will be focused on the relative quality of sand, logistics capabilities, and service level offered by their frac sand providers.
Suppliers and Service Providers
We have engaged Fred Weber to mine and process wet sand at our New Auburn wet plant facility under a contract that expires at the end of 2021, at which time title and operations of the facility will revert to us. Fred Weber has mined and processed wet sand at New Auburn since we commenced operations in 2011. In 2015, the Weber contract was suspended until January 1, 2017. In July 2014, we closed on the acquisition of Midwest, which had been a supplier to us prior to the acquisition. During 2014, we purchased wet sand from other third parties in order to ensure sufficient wet sand for our dry plant operations. We did not purchase any third party wet sand outright in the fiscal year ended December 31, 2015. In 2016, we selectively purchased raw sand in order to supplement our supply during the winter months, or where there was demand for a particular grade that exceeded our capacity to produce. We will continue to consider such purchases in the future where it helps us better serve customers, and the economics make sense for us financially.
Competition
The frac sand market is a highly competitive market that is comprised of a small number of large, national producers, which we also refer to as “Tier 1” producers, and a larger number of small, regional, or local producers. Competition in the frac sand industry has increased from 2011 to 2014 due to favorable pricing and demand trends, and we expect competition to increase in the future. Suppliers compete based on price, consistency, quality of product, site location, distribution capability, customer service, reliability of supply, breadth of product offering and technical support.
Based on management's internal estimates, we believe we were one of the five largest producers of frac sand in 2016 by production capacity and sales volumes, together with FMSA Holdings, Inc., Hi-Crush Proppants LLC, U.S. Silica Holdings, Inc., and Unimin Corporation. In recent years there has also been an increase in the number of small producers servicing the frac sand market due to increased demand for hydraulic fracturing services and related proppant supplies. Demand trends up until the end of 2014 attracted new frac sand supply which softened pricing for most products in light of recent demand trends in the North American oil and natural gas industry. We believe, however, that the relative inexperience of many management teams operating in the frac sand industry coupled with the costs, length of time and operational challenges associated with identifying attractive frac sand reserves, obtaining necessary permits and regulatory approvals and constructing a sand processing facility will prevent these smaller competitors from prospering in the long-run. Further, the large capital outlay required to develop a national logistics network is a barrier to entry in a regular market environment. We believe that industry consolidation and the exit from the market by less successful competitors will occur in the near-term and should benefit the pricing environment for SSS and the remaining frac sand producers.
Seasonality
At our Sand operations, it is challenging to process raw sand during sub-zero temperatures; therefore, frac sand is typically water-washed only eight months of the year at our Wisconsin operations. This results in a seasonal build-up of inventory as we excavate excess sand to build a stockpile to feed the dry plant during the winter months, causing the average inventory balance to increase from a few weeks in early spring to more than 100 days in early winter. These seasonal variations in inventory balance affect our cash flow. We may also sell frac sand for use in oil and gas basins where severe winter weather conditions may curtail drilling activities, and, as a result, our sales volumes to those areas may be adversely affected. For example, we could experience a decline in both volumes sold and income for the second quarter relative to the first quarter each year due to seasonality of frac sand sales into western Canada because sales volumes are generally lower during April and May due to limited drilling activity resulting from that region's annual thaw.
Insurance
We believe that our insurance coverage is customary for the industries in which we operate and adequate for our business. We periodically review insurance plans to address most, but not all, of the risks against our business. Losses and liabilities not covered by insurance would increase our costs. To address the hazards inherent in our business, we maintain insurance coverage that includes physical damage coverage, third-party general liability insurance, employer's liability, environmental and pollution and other coverage, although coverage for environmental and pollution-related losses is subject to significant limitations.
Environmental and Occupational Health and Safety Regulations
We are subject to stringent and complex federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to protection of worker health, safety and the environment. Compliance with these environmental laws and regulations may expose us to significant costs and liabilities and cause us to incur significant capital expenditures in our operations. We are often obligated to obtain permits or approvals in our operations from various federal, state and local authorities. These permits and approvals can be denied or delayed, which may cause us to lose potential and current customers, interrupt our operations and limit our growth and revenue. Moreover, failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, imposition of remedial obligations, and the issuance of injunctions delaying or prohibiting operations. Private parties may also have the right to pursue legal actions to enforce compliance as well as to seek damages for non-compliance with environmental laws and regulations or for personal injury or property damage.
We do not believe that compliance with federal, state or local environmental laws and regulations will have a material adverse effect on our business, financial position or results of operations or cash flows. However, we cannot assure that future events, such as changes in existing laws or enforcement policies, the promulgation of new laws or regulations or the development or discovery of new facts or conditions adverse to our operations will not cause us to incur significant costs. The following is a discussion of material environmental and worker health and safety laws that relate to our operations.
Air emissions.
Our operations are subject to the Clean Air Act, as amended (the “CAA”), and comparable state and local laws restrict the emission of air pollutants from many sources and also impose various monitoring and reporting requirements. Compliance with these laws and regulations may require us to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce or significantly increase air emissions, obtain and strictly comply with stringent air emissions permit requirements or utilize specific equipment or technologies to control emissions. Obtaining air emissions permits has the potential to delay the development or continued performance of our operations. Over the next several years, we may be required to incur certain capital expenditures for air pollution control equipment or to address other air emissions-related issues such as, by way of example, the capture of increased amounts of fine sands matter emitted from produced sands. In addition, air permits are required for our frac sand mining operations that result in the emission of regulated air contaminants. These permits incorporate the various control technology requirements that apply to our operations and are subject to extensive review and periodic renewal. Any future changes to existing requirements, non-compliance, or failure to maintain necessary permits or other authorizations could require us to incur substantial costs or suspend or terminate our operations.
On August 16, 2012, the EPA published final rules that establish new air emission controls and practices for oil and natural gas production wells, including wells that are the subject of hydraulic fracturing operations and natural gas processing operations. The EPA later updated the storage tank standards on August 5, 2013 to phase in emission controls more gradually. In May 2016, the EPA finalized additional regulations to control emissions of methane and volatile organic compounds from the oil and natural gas sector. Compliance with these rules could result in significant costs to our customers, which may have an indirect adverse impact on our business.
There can be no assurance that future requirements compelling the installation of more sophisticated emission control equipment would not have a material adverse impact on our business, financial condition, or results of operations.
Our Fuel business, which we sold in 2016, was subject to additional regulations under the Clean Air Act and analogous state laws and regulations. For example, facilities that emit volatile organic compounds or nitrogen oxides face increasingly stringent regulations, including requirements to install various levels of control technology on sources of pollutants. The petroleum processing sector is subject to stringent and evolving EPA and state regulations that establish standards to reduce emissions of certain listed hazardous air pollutants. In October 2015, the EPA finalized a more stringent ozone National Ambient Air Quality Standard, which could result in the adoption of more stringent regulations by the Texas Commission on Environmental Quality. The CAA authorizes the EPA to require modifications in the formulation of the refined transportation fuel products that we manufactured in order to limit the emissions associated with the fuel product’s final use. Further, the CAA requires an increasing percentage of vehicle fuels to come from renewable sources, including biodiesel. Compliance with these and related laws and regulations did not have a material adverse effect on our operations or financial position.
Climate change.
In recent years, the U.S. Congress has considered legislation to reduce emissions of GHGs. It presently appears unlikely that comprehensive climate legislation will be passed by either house of Congress in the near future, although energy legislation and other regulatory initiatives are expected to be proposed that may be relevant to GHG emissions issues. In addition, almost half of the states have begun to address GHG emissions, primarily through the planned development of emission inventories or regional GHG cap and trade programs. Depending on the particular program, we could be required to control GHG emissions or to purchase and surrender allowances for GHG emissions resulting from our operations.
Independent of Congress, the EPA has adopted regulations controlling GHG emissions under its existing authority under the CAA. For example, the EPA has adopted rules requiring the reporting of GHG emissions in the United States for emissions from specified
large GHG emission sources. The EPA also has adopted rules establishing construction and operating permit requirements for certain large stationary sources of GHG emissions that are already potential major sources of criteria pollutants .
Although it is not currently possible to predict how any such proposed or future GHG legislation or regulation by Congress, the EPA, the states or multi-state regions will impact our business, any legislation or regulation of GHG emissions that may be imposed in areas in which we conduct business could result in increased compliance costs or additional operating restrictions or reduced demand for our services, and could have a material adverse effect on our business, financial condition and results of operations.
Further, in December 2015, over 190 countries, including the United States, reached an agreement to reduce global greenhouse gas emissions. The agreement entered into force in November 2016 after more than 70 countries, including the United States, ratified or otherwise consented to be bound by the agreement. To the extent the United States or any other country implement this agreement or impose other climate change regulations on the oil and gas industry, it could have an adverse direct or indirect effect on our business.
Water discharge.
The Clean Water Act, as amended (the “CWA”), and analogous state laws impose restrictions and strict controls with respect to the discharge of pollutants, including spills and leaks of oil and other substances, into regulated waters. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. The CWA and regulations implemented thereunder also prohibit the discharge of dredge and fill material into regulated waters, including jurisdictional wetlands, unless authorized by an appropriately issued permit. The CWA also requires the development and implementation of spill prevention, control and countermeasures, including the construction and maintenance of containment berms and similar structures, if required, to help prevent the contamination of regulated waters in the event of a petroleum hydrocarbon tank spill, rupture or leak at such facilities. In addition, the CWA and analogous state laws require individual permits or coverage under general permits for discharges of storm water runoff from certain types of facilities. Federal and state regulatory agencies can impose administrative, civil and criminal penalties as well as other enforcement mechanisms for non-compliance with discharge permits or other requirements of the CWA and analogous state laws and regulations.
Safe Drinking Water Act
. Although we do not directly engage in hydraulic fracturing activities, our customers purchase our frac sand for use in their hydraulic fracturing operations. Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into the formation to stimulate gas production. Legislation to amend the Safe Drinking Water Act (the “SDWA”) to repeal the exemption for hydraulic fracturing from the definition of “underground injection” and require federal permitting and regulatory control of hydraulic fracturing, as well as legislative proposals to require disclosure of the chemical constituents of the fluids used in the fracturing process have been proposed in recent sessions of Congress. We cannot predict whether any such legislation will ever be enacted and, if so, what its provisions would be. Scrutiny of hydraulic fracturing activities continues in other ways, with the EPA having released a final report regarding the impacts of hydraulic fracturing on drinking water resources in 2016. The report concluded that certain activities associated with hydraulic fracturing may impact drinking water resources under certain circumstances. In addition, the U.S. Department of Energy released a series of recommendations for improving the safety of the process in 2011. Further, the EPA and the U.S. Department of the Interior (the “DOI”) have adopted new regulations for certain aspects of the process. For example, the EPA finalized effluent limitations for the treatment and discharge of wastewater resulting from hydraulic fracturing. The DOI adopted rules that require disclosure of chemicals used in hydraulic fracturing activities upon federal and Indian lands and also would strengthen standards for well-bore integrity and the management of fluids that return to the surface during and after fracturing operations on federal and Indian lands (although implementation of this rule has been stayed pending the resolution of legal challenges). At the state level, some states, including Texas, have adopted, and other states are considering adopting, legal requirements that could impose more stringent permitting, public disclosure or well construction requirements on hydraulic fracturing activities. If additional levels of regulation and permits were required through the adoption of new laws and regulations at the federal or state level, that could lead to delays, increased operating costs and process prohibitions that could make it more difficult to complete natural gas wells in shale formations, increasing our customers' costs of compliance and doing business and otherwise adversely affect the hydraulic fracturing services they perform, which could negatively impact demand for our frac sand products. In addition, heightened political, regulatory and public scrutiny of hydraulic fracturing practices could potentially expose us or our customers to increased legal and regulatory proceedings, and any such proceedings could be time-consuming, costly or result in substantial legal liability or significant reputational harm. Any such developments could have a material adverse effect on our business, financial condition and results of operations, whether directly or indirectly. For example, we could be directly affected by adverse litigation involving us, or indirectly affected if the cost of compliance limits the ability of our customers to operate in the geographic areas we serve.
Solid waste.
The Resource Conservation and Recovery Act, as amended (the “RCRA”), and comparable state laws control the generation, storage, treatment, transfer and disposal of hazardous and non-hazardous waste. The EPA and various state agencies have limited the approved methods of disposal for these types of wastes. In the course of our operations, we generate waste that may be regulated as non-hazardous wastes or even hazardous wastes, obligating us to comply with applicable RCRA standards relating to the management and disposal of such wastes.
Site remediation.
The Comprehensive Environmental Response, Compensation and Liability Act, as amended (“CERCLA”), and comparable state laws impose strict, joint and several liability without regard to fault or the legality of the original conduct on certain classes of persons that contributed to the release of a hazardous substance into the environment. These persons include the owner and operator of a disposal site where a hazardous substance release occurred and any company that transported, disposed of, or arranged for the transport or disposal of hazardous substances released at the site. Under CERCLA, such persons may be liable for the costs of remediating the hazardous substances that have been released into the environment, for damages to natural resources, and for the costs of certain health studies. In addition, where contamination may be present, it is not uncommon for the neighboring landowners and other third parties to file claims for personal injury, property damage and recovery of response costs. On November 21, 2013, the EPA issued a General Notice Letter and Information Request (“Notice”) under Section 104(e) of CERCLA to one of our former subsidiaries. The Notice provides that the subsidiary may have incurred liability with respect to the Reef Environmental site in Alabama, and requested certain information in accordance with Section 107(a) of CERCLA. At this time, no specific claim for cost recovery has been made by the EPA (or any other potentially responsible party) against the Partnership. There is uncertainty relating to our share of environmental remediation liability, if any, because our allocable share of wastewater is unknown and the total remediation cost is also unknown. Consequently, management is unable to estimate the possible loss or range of loss, if any. We have not recorded a loss contingency accrual in our financial statements. In the opinion of management, the outcome of such matters will not have a material adverse effect on our financial position, liquidity, or results of operations.
The soil and groundwater associated with and adjacent to our former Dallas-Fort Worth terminal property have been affected by prior releases of petroleum products or other contaminants. A past owner and operator of the terminal property, ConocoPhillips, has been working with TCEQ to address this contamination. We, ConocoPhillips and owners and operators of adjacent industrial properties undertaking unrelated remediation obtained a Municipal Setting Designation (“MSD”) from the City of Fort Worth, which is an ordinance prohibiting the use of groundwater as drinking water in the area of our former terminal property. Following the certification of this MSD by the TCEQ, ConocoPhillips obtained approval of a remedial action plan for the property, which now only requires recordation of a restrictive covenant to comply with the TCEQ requirements. In connection with the sale of this facility, we have agreed to hold our successor harmless from any claims arising from this contamination, none of which has been asserted to our knowledge. We do not believe this former facility is likely to present any material liability to us.
Endangered Species.
The Endangered Species Act (“ESA”), restricts activities that may affect endangered or threatened species or their habitats. The designation of certain species has not caused us to incur material costs or become subject to operating restrictions or bans. However, the designation of previously unidentified endangered or threatened species could cause us to incur additional costs or become subject to operating restrictions or bans or limit future development activity in the affected areas. Moreover, as a result of a settlement approved by the U.S. District Court for the District of Columbia on September 9, 2011, the U.S. Fish and Wildlife Service is required to consider listing more than 250 species as endangered under the Endangered Species Act. Under the September 9, 2011 settlement, the U.S. Fish and Wildlife Service is required to review and address the needs of more than 250 species on the candidate list before the completion of the agency's 2017 fiscal year. The designation of previously unprotected species as threatened or endangered in areas where our exploration and production customers operate could cause us or our customers to incur increased costs arising from species protection measures and could result in delays or limitations in our customers' performance of operations, which could reduce demand for our services.
Mining and Workplace Safety.
Our sand mining operations are subject to mining safety regulation. The U.S. Mine Safety and Health Administration (“MSHA”) is the primary regulatory organization governing the frac sand industry. Accordingly, MSHA regulates quarries, surface mines, underground mines and the industrial mineral processing facilities associated with quarries and mines. The mission of MSHA is to administer the provisions of the Federal Mine Safety and Health Act of 1977 and to enforce compliance with mandatory worker safety and health standards. MSHA works closely with the Industrial Minerals Association, a trade association in which we have a significant leadership role, in pursuing this mission. As part of MSHA's oversight, representatives perform at least two unannounced inspections annually for each aboveground facility. To date these inspections have not resulted in any citations for material violations of MSHA standards.
We also are subject to the requirements of the U.S. Occupational Safety and Health Act (“OSHA”), and comparable state statutes that regulate the protection of the health and safety of workers. In addition, the OSHA Hazard Communication Standard requires that information be maintained about hazardous materials used or produced in operations and that this information be provided to employees, state and local government authorities and the public. OSHA regulates the customers and users of frac sand and provides detailed regulations requiring employers to protect employees from overexposure to silica through the enforcement of permissible exposure limits and the OSHA Hazard Communication Standard.
Local regulation
. As demand for frac sand in the oil and natural gas industry has driven a significant increase in current and expected future production of frac sand, some local communities have expressed concern regarding silica sand mining operations. These concerns have generally included exposure to ambient silica sand dust, truck traffic, water usage and blasting. In response, certain state and local communities have developed or are in the process of developing regulations or zoning restrictions intended to minimize dust from becoming airborne, control the flow of truck traffic, significantly curtail the amount of practicable area for
mining activities, provide compensation to local residents for potential impacts of mining activities and, in some cases, ban issuance of new permits for mining activities. To date, we have not experienced any material impact to our existing mining operations or planned capacity expansions as a result of these types of concerns. We are not aware of any proposals for significant increased scrutiny on the part of state or local regulators in the jurisdictions in which we operate or community concerns with respect to our operations that would reasonably be expected to have a material adverse effect on our business, financial condition or results of operations going forward.
Employees
We have no employees. All of our management, administrative and operating functions are performed by employees of Emerge Energy Services GP, LLC, which is our general partner. As of
December 31, 2016
, our general partner employed 149 full-time employees who provide these services for us. None of these employees are subject to collective bargaining agreements. We consider our employee relations to be good.
Available Information
We file annual, quarterly, and current reports and other documents with the SEC under the Securities and Exchange Act of 1934. We provide access free of charge to all of our SEC filings, as soon as practicable after they are filed or furnished, through our Internet website located at
www.emergelp.com.
References to our website addressed in this Annual Report on Form 10-K are provided as a convenience and do not constitute, and should not be viewed as, an incorporation by reference of the information contained on, or available through, the website.
You may also read and copy any of these materials at the SEC's Public Reference Room at 100 F. Street, NE, Room 1580, Washington, D.C. 20549. Information on the operation of the Public Reference Room is available by calling the SEC at 1-800-SEC-0330. Alternatively, the SEC maintains an Internet site (
www.sec.gov
) that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC.
Investors and others should note that we announce material financial information to investors using investor relations websites, press releases, SEC filings and public conference calls and webcasts. We also use Twitter (https://twitter.com/emergelp) as a means of disclosing information about our company, services and other matters. It is possible that the information we disclose could be deemed to be material information. Therefore, we encourage investors, the media and others interested in our company to review the information we post on Twitter.
ITEM 1A. RISK FACTORS
Limited partner interests are inherently different from capital stock of a corporation, although many of the business risks to which we are subject are similar to those that would be faced by a corporation engaged in the frac sand businesses. You should consider carefully the following risk factors together with all of the other information included in this report in evaluating an investment in our common units.
If any of the following risks were to occur, our business, financial condition or results of operations could be materially adversely affected. In that case, we may be unable to make distributions on our common units, the trading price of our common units could decline, and you could lose all or part of your investment.
Risks Related to Our Business
We may not have sufficient available cash to pay any quarterly distribution on our common units.
We may not have sufficient available cash each quarter to enable us to pay any distributions to our unitholders. For example, the board of directors of our general partner determined that we did not generate sufficient available cash to distribute to our unitholders for each quarter during the year ended December 31, 2016. Our partnership agreement does not require us to pay distributions on a quarterly basis or otherwise. Furthermore, our Credit Agreement currently prohibits us from making cash distributions to our unitholders and requires all cash receipts by us and our subsidiaries to be swept on a daily basis and used to reduce outstanding borrowings under the Credit Agreement.
In future periods when we are once again permitted to make cash distributions to our unitholders, the amount of cash we can distribute principally depends upon the amount of cash we generate from our operations, which fluctuates from quarter to quarter based on, among other things:
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the level of production of, demand for, and price of frac sand, particularly in the markets we serve;
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the fees we charge, and the margins we realize, from our frac sand sales and the other services we provide;
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changes in laws and regulations (or the interpretation thereof) related to the mining and oil and natural gas industries, silica dust exposure or the environment;
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the level of competition from other companies;
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the cost and time required to execute organic growth opportunities;
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difficulty collecting receivables; and
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prevailing global and regional economic and regulatory conditions, and their impact on our suppliers and customers.
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In addition, the actual amount of cash we have available for distribution depends on other factors, including:
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the levels of our maintenance capital expenditures and growth capital expenditures;
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the level of our operating costs and expenses;
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our debt service requirements and other liabilities;
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fluctuations in our working capital needs;
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restrictions contained in our revolving credit facility and other debt agreements to which we are a party;
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the cost of acquisitions, if any;
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fluctuations in interest rates;
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our ability to borrow funds and access capital markets; and
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the amount of cash reserves established by our general partner.
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Our partnership agreement does not require us to pay a minimum quarterly distribution. The amount of distributions that we pay, if any, and the decision to pay any distribution at all, are determined by the board of directors of our general partner. Our quarterly distributions, if any, are subject to significant fluctuations based on the above factors.
The amount of cash we have available for distribution to unitholders depends primarily on our cash flow and not solely on profitability.
You should be aware that the amount of cash we have available for distribution depends primarily upon our cash flow, including cash flow from financial reserves and working capital borrowings, and not solely on profitability, which is affected by non-cash items. As a result, we may not be able to make cash distributions during periods in which we record net income.
The amount of our quarterly cash distributions, if any, may vary significantly both quarterly and annually and will be directly dependent on the performance of our business. Unlike most publicly traded partnerships, we do not have a minimum quarterly distribution or employ structures intended to consistently maintain or increase distributions over time.
Investors who are looking for an investment that will pay regular and predictable quarterly distributions should not invest in our common units. We expect our business performance may be more volatile, and our cash flows may be less stable, than the business performance and cash flows of most publicly traded partnerships. As a result, our quarterly cash distributions may be volatile and may vary quarterly and annually. Unlike most publicly traded partnerships, we do not have a minimum quarterly distribution or employ structures intended to consistently maintain or increase distributions over time. The amount of our quarterly cash distributions is directly dependent on the performance of our business. Because our quarterly distributions will significantly correlate to the cash we generate each quarter after payment of our fixed and variable expenses, quarterly distributions paid to our unitholders may vary significantly from quarter to quarter and may be zero.
The board of directors of our general partner may modify or revoke our cash distribution policy at any time at its discretion. Our partnership agreement does not require us to make any distributions at all.
The board of directors of our general partner adopted a cash distribution policy pursuant to which we distribute all of the available cash we generate each quarter to unitholders of record on a pro rata basis. However, the board may change such policy at any time at its discretion and could elect not to make distributions for one or more quarters. For example, the board of directors of our General Partner determined not to make a cash distribution on our common units for each quarter during the year ended December 31, 2016. Our partnership agreement does not require us to make any distributions at all. Accordingly, investors are cautioned not to place undue reliance on the permanence of such a policy in making an investment decision. Any modification or revocation of our cash distribution policy could substantially reduce or eliminate the amounts of distributions to our unitholders.
We have a history of losses and expect to continue to incur losses in the future.
For the years ended December 31, 2016 and 2015, we have incurred aggregate losses of $
72.8 million
and $
9.4 million
, respectively. Our loss from continuing operations for the years ended December 31, 2016 and 2015 was $
113.2 million
and $
7.2 million
, respectively, and our income from discontinued operations was $
40.4 million
for the year ended December 31, 2016 and a loss of $
2.2 million
for the year ended December 31, 2015. There is no assurance that we will operate profitably or will generate positive cash flow in the future. In addition, our operating results in the future may be subject to significant fluctuations due to many factors not within our control, such as the demand for our frac sand products, and the level of competition and general economic conditions. As we transition our business after the close of the sale of our Fuel business to operating solely in the frac sand industry, we expect to continue to incur operating losses and negative cash flow until we generate significant revenue from the sale of our continuing products.
Our operations are subject to the cyclical nature of our customers' businesses and depend upon the continued demand for crude oil and natural gas.
Our frac sand sales are to customers in the oil and natural gas industry, a historically cyclical industry. This industry was adversely affected by the uncertain global economic climate in the second half of 2008 and in 2009. Natural gas, crude oil and NGL prices declined significantly in the second half of 2014 and have been negatively affected by a combination of factors, including weakening demand, increased production, the decision by the OPEC to keep production levels unchanged and a strengthening in the U.S. dollar relative to most other currencies. Further downward pressure on commodity prices continued throughout 2015 and the first nine months of 2016 and could continue for the foreseeable future. Natural gas prices have generally remained below $4.50 per mcf for the past six years and below $3.00 per mcf since early 2015. Worldwide economic, political and military events, including war, terrorist activity, events in the Middle East and initiatives by OPEC have contributed, and are likely to continue to contribute, to commodity price volatility. Additionally, warmer than normal winters in North America and other weather patterns may adversely impact the short-term demand for oil and natural gas and, therefore, demand for our products.
During periods of economic slowdown and long-term reductions in oil and natural gas prices, oil and natural gas exploration and production companies often reduce their oil and natural gas production rates and also reduce capital expenditures and defer or cancel pending projects, which results in decreased demand for our frac sand. Such developments occur even among companies that are not experiencing financial difficulties. A continued or renewed economic downturn in one or more of the industries or geographic regions that we serve, or in the worldwide economy, could adversely affect our results of operations. In addition, any future decreases in the rate at which oil and natural gas reserves are discovered or developed, whether due to increased governmental regulation, limitations on exploration and drilling activity, a sustained decline in oil and natural gas prices, or other factors, could have a material adverse effect on our business, even in a stronger natural gas and oil price environment.
Our operations are subject to operating risks that are often beyond our control and could adversely affect production levels and costs.
Our mining, processing and production facilities are subject to risks normally encountered in the frac sand industry. These risks include:
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changes in the price and availability of transportation;
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inability to obtain necessary production equipment or replacement parts;
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inclement or hazardous weather conditions, including flooding, and the physical impacts of climate change;
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unusual or unexpected geological formations or pressures;
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unanticipated ground, grade or water conditions;
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inability to acquire or maintain necessary permits or mining or water rights;
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labor disputes and disputes with our excavation contractors;
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late delivery of supplies;
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changes in the price and availability of natural gas or electricity that we use as fuel sources for our frac sand plants and equipment;
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technical difficulties or failures;
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cave-ins or similar pit wall failures;
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environmental hazards, such as unauthorized spills, releases and discharges of wastes, tank ruptures and emissions of unpermitted levels of pollutants;
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changes in laws and regulations (or the interpretation thereof) related to the mining and oil and natural gas industries, silica dust exposure or the environment;
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inability of our customers or distribution partners to take delivery;
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reduction in the amount of water available for processing;
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fires, explosions or other accidents; and
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facility shutdowns in response to environmental regulatory actions.
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Any of these risks could result in damage to, or destruction of, our mining properties or production facilities, personal injury, environmental damage, delays in mining or processing, losses or possible legal liability. Any prolonged downtime or shutdowns at our mining properties or production facilities could have a material adverse effect on us.
Not all of these risks are reasonably insurable, and our insurance coverage contains limits, deductibles, exclusions and endorsements. Our insurance coverage may not be sufficient to meet our needs in the event of loss, and any such loss may have a material adverse effect on us.
We may be adversely affected by decreased demand for frac sand or the development of either effective alternative proppants or new processes to replace hydraulic fracturing.
Frac sand is a proppant used in the completion and re-completion of natural gas and oil wells through hydraulic fracturing. Frac sand is the most commonly used proppant and is less expensive than ceramic proppant, which is also used in hydraulic fracturing to stimulate and maintain oil and natural gas production. A significant shift in demand from frac sand to other proppants, such as ceramic proppants, could have a material adverse effect on our financial condition and results of operations. The development and use of other effective alternative proppants, or the development of new processes to replace hydraulic fracturing altogether, could also cause a decline in demand for the frac sand we produce and could have a material adverse effect on our financial condition and results of operations.
We may be adversely affected by a reduction in horizontal drilling activity or the development of either effective alternative proppants or new processes to replace hydraulic fracturing.
Demand for frac sand is substantially higher in the case of horizontally drilled wells, which allow for multiple hydraulic fractures within the same well bore but are more expensive to develop than vertically drilled wells. The development and use of a cheaper, more effective alternative proppant, a reduction in horizontal drilling activity or the development of new processes to replace hydraulic fracturing altogether, could also cause a decline in demand for the frac sand we produce and could have a material
adverse effect on our business, financial condition and results of operations. A reduction in demand for the frac sand we produce may cause our contractual arrangements to become economically unattractive and could have a material adverse effect on our business, financial condition, and results of operations.
A large portion of our sales in our continuing sand operations is generated by a few large customers, and the loss of our largest customers or a significant reduction in purchases by those customers could adversely affect our operations.
During 2016, our top five sand customers represented 68.3% of sales from our continuing operations. Our customers who are not subject to firm contractual commitments may not continue to purchase the same levels of our products in the future due to a variety of reasons. For example, some of our top customers could go out of business or, alternatively, be acquired by other companies that purchase the same products and services provided by us from other third-party providers. Our customers could also seek to capture and develop their own sources of frac sand. In addition, some of our customers may be highly leveraged and subject to their own operating and regulatory risks. If any of our major customers substantially reduces or altogether ceases purchasing our products, we could suffer a material adverse effect on our business, financial condition, results of operations, cash flows, and prospects. In addition, upon the expiration or termination of our existing contracts, we may not be able to enter into new contracts at all or on terms as favorable as our existing contracts. We may also choose to renegotiate our existing contracts on less favorable terms (including with respect to price and volumes) in order to preserve relationships with our customers.
In addition, the long-term sales agreements we have for our frac sand may negatively impact our results of operations. Certain of our long-term agreements are for sales at fixed prices that are adjusted only for certain cost increases. As a result, in periods with increasing frac sand prices, our contract prices may be lower than prevailing industry spot prices. Our long-term sales agreements also contain provisions that allow prices to be adjusted downwards in the event of falling industry prices.
Any material nonpayment or nonperformance by any of our key customers could have a material adverse effect on our business and results of operations and our ability to make cash distributions to our unitholders.
Any material nonpayment or nonperformance by any of our key customers could have a material adverse effect on our revenue and cash flows and our ability to make cash distributions to our unitholders. Our long-term take-or-pay sales agreements with select customers contain provisions designed to compensate us, in part, for our lost margins on any unpurchased volumes; accordingly, in such circumstances, we would be paid less than the price per ton we would receive if our customers purchased the contractual tonnage amounts. Certain of our other long-term frac sand sales agreements provide for minimum tonnage orders by our customers but do not contain pre-determined liquidated damage penalties in the event the customers fail to purchase designated volumes. Instead, we would seek legal remedies against the non-performing customer or seek new customers to replace our lost sales volumes. Certain of our other long-term frac sand supply contracts are efforts-based and therefore do not require the customer to purchase minimum volumes of frac sand from us or contain take-or-pay provisions.
Our different types of contracts with our frac sand customers provide for different potential remedies to us in the event a customer fails to purchase the minimum contracted amount of frac sand in a given period. If we were to pursue legal remedies in the event a customer failed to purchase the minimum contracted amount of sand under a fixed-volume contract or failed to satisfy the take-or-pay commitment under a take-or-pay contract, we may receive significantly less in a judgment or settlement of any claimed breach than we would have received had the customer fully performed under the contract. In the event of any customer's breach, we may also choose to renegotiate any disputed contract on less favorable terms (including with respect to price and volumes) to us to preserve the relationship with that customer. Accordingly, any material nonpayment or performance by our customers could have a material adverse effect on our revenue and cash flows and our ability to make distributions to our unitholders.
Our long-term contracts may preclude us from taking advantage of increasing prices for frac sand or mitigating the effect of increased operational costs during the term of our long-term contracts, even though certain volumes under our long-term contracts are subject to annual fixed price escalators.
The long-term supply contracts we have may negatively impact our results of operations in future periods. Our long-term contracts require our customers to pay a specified price for a specified volume of frac sand each month. As a result, in periods with increasing prices, our sales may not keep pace with market prices. Additionally, if our operational costs increase during the terms of our long-term supply contracts, we may not be able to pass any of those increased costs to our customers. If we are unable to otherwise mitigate these increased operational costs, our net income and available cash for distributions could decline.
The credit risks of our concentrated customer base could result in losses.
Many of our customers are oil and gas companies that are facing liquidity constraints in light of the current commodity price environment. This concentration of our customers in the energy industry may impact our overall exposure to credit risk as customers may be similarly affected by prolonged changes in economic and industry conditions. If a significant number of our customers experience a prolonged business decline or disruption, we may incur increased exposure to credit risk and bad debts. If we fail to adequately assess the creditworthiness of existing or future customers or unanticipated deterioration in their creditworthiness, any resulting increase in nonpayment or nonperformance by them and our inability to re-market or otherwise use the production could
have a material adverse effect on our business, financial condition, results of operations and ability to pay distributions to our unitholders.
Certain of our contracts contain provisions requiring us to meet minimum obligations to our customers and suppliers. If we are unable to meet our minimum requirements under these contracts, we may be required to pay penalties or the contract counterparty may be able to terminate the agreement.
In certain instances, we commit to deliver products to our customers prior to production, under penalty of nonperformance. Depending on the contract, our inability to deliver the requisite tonnage of frac sand may permit our customers to terminate the agreement or require us to pay our customers a fee, the amount of which would be based on the difference between the amounts of tonnage contracted for and the amount delivered. We have significant long-term operating leases for railcars, both currently in service and yet to be delivered, under which we would still be obligated to pay despite any future decrease in the number of railcars needed to conduct our operations. Further, our agreement with Canadian National requires us to provide minimum volumes of frac sand for shipping on the Canadian National line. If we do not provide the minimum volume of frac sand for shipping, we will be required to pay a per-ton shortfall penalty, subject to certain exceptions. In addition, under our agreements with sand suppliers, we are obligated to order a minimum amount of wet sand per year or pay fees on the difference between the minimum and the amount we actually order. Similarly, we would be required to make minimum payments to mineral rights owners at certain of our mines in the event we purchase less than the minimum volumes of sand specified under the particular royalty agreement in place. If we are unable to meet our obligations under any of these agreements, we may have to pay substantial penalties or the agreements may become subject to termination, as applicable. In such events, our business, financial condition, and results of operations may be materially adversely affected.
We must effectively manage our production capacity.
To meet rapidly changing demand in the frac sand industry, we must effectively manage our resources and production capacity. During periods of decreasing demand for frac sand, we must be able to appropriately align our cost structure with prevailing market conditions and effectively manage our mining operations. Our ability to rapidly and effectively reduce our cost structure in response to such downturns is limited by the fixed nature of many of our expenses in the near term and by our need to continue our investment in maintaining reserves and production capabilities. Conversely, when upturns occur in the markets we serve, we may have difficulty rapidly and effectively increasing our production capacity or procuring sufficient reserves to meet any sudden increases in the demand for frac sand that could result in the loss of business to our competitors and harm our relationships with our customers. The inability to timely and appropriately adapt to changes in our business environment could have a material adverse effect on our our business, financial condition, results of operations or reputation.
Failure to maintain effective quality control systems at our mining, processing and production facilities could have a material adverse effect on our business and operations.
The performance, quality, and safety of our products are critical to the success of our business. For instance, our frac sand must meet stringent International Organization for Standardization, or ISO, and API technical specifications, including sphericity, grain size, crush resistance, acid solubility, purity, and turbidity, as well as customer specifications, in order to be suitable for hydraulic fracturing purposes. If our frac sand fails to meet such specifications or our customers' expectations, we could be subject to significant contractual damages or contract terminations and face serious harm to our reputation, and our sales could be negatively affected. The performance, quality, and safety of our products depend significantly on the effectiveness of our quality control systems, which, in turn, depends on a number of factors, including the design of our quality control systems, our quality-training program and our ability to ensure that our employees adhere to our quality control policies and guidelines. Any significant failure or deterioration of our quality control systems could have a material adverse effect on our business, financial condition, results of operations and reputation.
Increasing costs or a lack of dependability or availability of transportation services or infrastructure could have an adverse effect on our ability to deliver our frac sand products at competitive prices.
Because of the relatively low cost of producing frac sand, transportation and handling costs tend to be a significant component of the total delivered cost of sales. The bulk of our currently contracted sales involve our customers also contracting with truck and rail services to haul our frac sand to end users. If there are increased costs under those contracts, and our customers are not able to pass those increases along to end users, our customers may find alternative providers. We have provided fee-based transportation and logistics (including railcar procurement, freight management, and product storage) services for both our spot market and contract customers. Should we fail to properly manage the customer's logistics needs under those instances where we have agreed to provide them, we may face increased costs, and our customers may choose to purchase sand from other suppliers. Labor disputes, derailments, adverse weather conditions or other environmental events, tight railcar leasing markets and changes to rail freight systems could interrupt or limit available transportation services. A significant increase in transportation service rates, a reduction in the dependability or availability of transportation services or relocation of our customers' businesses to areas that are not served
by the rail systems accessible from our production facilities could impair our customers' ability to access our products and our ability to expand our markets.
We face significant competition that may cause us to lose market share and reduce our ability to make distributions to our unitholders.
The frac sand and refined products industries are highly competitive. The frac sand market is characterized by a small number of large, national producers and a larger number of small, regional, or local producers. Competition in this industry is based on price, consistency and quality of product, site location, distribution capability, customer service, reliability of supply, breadth of product offering and technical support.
Some of our competitors have greater financial and other resources than we do. In addition, our larger competitors may develop technology superior to ours or may have production facilities that offer lower-cost transportation to certain specific customer locations than we do. In recent years there has been an increase in the number of small, regional producers servicing the frac sand market due to an increased demand for hydraulic fracturing services and to the growing number of unconventional resource formations being developed in the United States. Should the demand for hydraulic fracturing services decrease or the supply of frac sand available in the market increase, prices in the frac sand market could materially decrease as less-efficient producers exit the market, selling frac sand at below market prices. Furthermore, oil and natural gas exploration and production companies and other providers of hydraulic fracturing services have acquired and in the future may acquire their own frac sand reserves to fulfill their proppant requirements, and these other market participants may expand their existing frac sand production capacity, all of which would negatively impact demand for our frac sand products. In addition, increased competition in the frac sand industry could have an adverse impact on our ability to enter into long-term contracts or to enter into contracts on favorable terms.
Our cash flows fluctuate on a seasonal basis and severe weather conditions could have a material adverse effect on our business.
Because raw sand cannot be wet-processed during extremely cold temperatures, frac sand is typically washed only eight months out of the year at our Wisconsin operations. Our inability to wash frac sand year round in Wisconsin results in a seasonal build-up of inventory as we excavate excess sand to build a stockpile that will feed the dry plant during the winter months. This seasonal build-up of inventory causes our average inventory balance to fluctuate from a few weeks in early spring to more than 100 days in early winter. As a result, the cash flows of our continuing sand operations fluctuate on a seasonal basis based on the length of time Wisconsin wet plant operations must remain shut down due to harsh winter weather conditions. We may also be selling frac sand for use in oil and gas-producing basins where severe weather conditions may curtail drilling activities and, as a result, our sales volumes to customers in those areas may be adversely affected. For example, we could experience a decline in volumes sold for the second quarter relative to the first quarter each year due to seasonality of frac sand sales to customers in western Canada as sales volumes are generally lower during the months of April and May due to limited drilling activity as a result of that region's annual thaw. Unexpected winter conditions (if winter comes earlier than expected or lasts longer than expected) may lead to us not having a sufficient sand stockpile to supply feedstock for our dry plant during winter months and result in us being unable to meet our contracted sand deliveries during such time, or may drive frac sand sales volumes down by affecting drilling activity among our customers, each of which could lead to a material adverse effect on our business, financial condition, results of operation and reputation. The inability of our logistics partners, including rail companies, to manage their own operations efficiently during inclement weather could have an effect on our ability to serve our customers where we are relying on our logistics partners to provide certain transportation services.
Diminished access to water may adversely affect our operations and the operations of our customers.
While much of our process water is recycled and recirculated, the mining and processing activities in which we engage at our wet plant facilities require significant amounts of water. During extreme drought conditions, some of our facilities are located in areas that can become water-constrained. We have obtained water rights and have installed high capacity wells on our properties that we currently use to service the activities on our properties, and we plan to obtain all required water rights to service other properties we may develop or acquire in the future. However, the amount of water that we are entitled to use pursuant to our water rights must be determined by the appropriate regulatory authorities in the jurisdictions in which we operate. Such regulatory authorities may amend the regulations regarding such water rights, increase the cost of maintaining such water rights or eliminate our current water rights, and we may be unable to retain all or a portion of such water rights. Such changes in laws, regulations or government policy and related interpretations pertaining to water rights may alter the environment in which we do business, which may negatively affect our financial condition and results of operations.
Similarly, our customers' performance of hydraulic fracturing activities may require the use of large amounts of water. The ability of our customers' to obtain the necessary amounts of water sufficient to perform hydraulic fracturing activities may well depend on those customers ability to acquire water by means of contract, permitting, or spot purchase. The ability of our customers to obtain and maintain sufficient levels of water for these fracturing activities are similarly subject to regulatory authority approvals, changes in applicable laws or regulations, potentially differing interpretations of contract terms, increases in costs to provide such water, and even changes in weather that could make such water resources more scarce.
Increases in the price of diesel fuel may adversely affect our results of operations.
Diesel fuel costs generally fluctuate with increasing and decreasing world crude oil prices, and accordingly are subject to political, economic and market factors that are outside of our control. Our continuing sand operations are dependent on earthmoving equipment, railcars, and trucks, and diesel fuel costs are a significant component of the operating expense of these vehicles. We contract with a third party industrial mining expert to excavate raw frac sand, deliver the raw frac sand to our processing facility, move the sand from our wet plant to our dry plant, and we pay a fixed price per ton of sand delivered to our wet plant, subject to a fuel surcharge based on the price of diesel fuel. Accordingly, increased diesel fuel costs at our continuing sand operations could have an adverse effect on our results of operations and cash flows.
Divestitures and discontinued operations could negatively impact our business, requires additional attention and resources that could divert our management’s focus from continuing operations, and retained liabilities from businesses that we sell could adversely affect our financial results.
In the third quarter of 2016, we completed the sale of our Fuel business and related product lines and transitioned our business to a primary focus on our frac sand operations. The divestiture of our discontinued operations poses risks and challenges that could negatively impact our business, including required separation or carve-out activities and costs and disputes with buyers or third parties, and also require additional management attention that distract from continuing operations even after closing. Dispositions also involve continued financial involvement, as we are required to retain responsibility for, or agree to indemnify buyers against, contingent liabilities related to our Fuel business, such as lawsuits, tax liabilities, working condition of assets and environmental matters. Under these types of arrangements, performance by the divested business or other conditions outside our control could affect our future financial results.
In addition, our primary focus on the sale of frac sand going forward and the divestiture of our Fuel business has resulted in a loss of historical revenue sources and a decrease in diversification of our operations. In the event of a business downturn in our frac sand operations due to increased competition, loss of clients, economic conditions, technology changes, or in the event of increased costs, disruption in services, a change in laws, or other events related to our frac sand operations, there could be a greater negative impact on our revenues than if we had retained our discontinued operations.
We may be unable to grow our cash flows if we are unable to expand our business, which could limit our ability to increase distributions to our unitholders.
A principal focus of our strategy is to continue to grow the per unit distribution on our units by expanding our businesses, particularly our frac sand business. Our future growth will depend upon a number of factors, some of which we cannot control. These factors include our ability to:
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develop new business and enter into contracts with new customers;
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retain our existing customers and maintain or expand the level of services we provide them;
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identify and obtain additional frac sand reserves;
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recruit and train qualified personnel and retain valued employees;
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expand our geographic presence;
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effectively manage our costs and expenses, including costs and expenses related to growth;
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consummate accretive acquisitions;
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obtain required debt or equity financing for our existing and new operations;
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meet customer-specific contract requirements or pre-qualifications;
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obtain permits from federal, state and local regulatory authorities; and
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make assumptions about mineral reserves, future production, sales, capital expenditures, operating expenses and costs, including synergies.
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If we do not achieve our expected growth, we may not be able to achieve our estimated results and, as a result, we would not be able to pay the estimated annual distribution, in which event the market price of our common units will likely decline materially.
We may be unable to grow successfully through future acquisitions, and we may not be able to integrate effectively the businesses we may acquire, which may impact our operations and limit our ability to increase distributions to our unitholders.
From time to time, we may choose to make business acquisitions to pursue market opportunities, increase our existing capabilities, and expand into new areas of operations. While we have reviewed acquisition opportunities in the past and will continue to do so in the future, we may not be able to identify attractive acquisition opportunities or successfully acquire identified targets. In
addition, we may not be successful in integrating any future acquisitions into our existing operations, which may result in unforeseen operational difficulties or diminished financial performance or require a disproportionate amount of our management's attention. Even if we are successful in integrating future acquisitions into our existing operations, we may not derive the benefits, such as operational or administrative synergies, that we expected from such acquisitions, which may result in the commitment of our capital resources without the expected returns on such capital. Furthermore, competition for acquisition opportunities may escalate, increasing our cost of making acquisitions or causing us to refrain from making acquisitions. Our inability to make acquisitions, or to integrate successfully future acquisitions into our existing operations, may adversely impact our operations and limit our ability to increase distributions to our unitholders.
Growing our business by constructing new plants and facilities subjects us to construction risks as well as market risks relating to insufficient demand for the services of such plants and facilities upon completion thereof.
One of the ways we intend to grow our business is through the construction of new dry plants, wet plants, and transload facilities in our continuing sand operations. The construction of such facilities requires the expenditure of significant amounts of capital, which may exceed our resources, and involves numerous regulatory, environmental, political, and legal uncertainties. If we undertake these projects, we may not be able to complete them on schedule or at all or at the budgeted cost. Moreover, our revenues may not increase upon the expenditure of funds on a particular project. For instance, if we build a new plant or facility, the construction will occur over an extended period of time, and we will not receive any material increases in revenues until at least after completion of the project, if at all. Moreover, we may construct new plants or facilities to capture anticipated future demand in a region in which anticipated market conditions do not materialize or for which we are unable to acquire new customers. As a result, new plants or facilities may not be able to attract enough demand to achieve our expected investment return, which could materially and adversely affect our results of operations and financial condition.
Our ability to grow in the future is dependent on our ability to access external growth capital.
We will distribute all of our available cash after expenses and prudent operating reserves to our unitholders. We expect that we will rely primarily upon external financing sources, including borrowings under our revolving credit facility and the issuance of debt and equity securities, to maintain our asset base and fund growth capital expenditures. However, we may not be able to obtain equity or debt financing on terms favorable to us, or at all. To the extent we are unable to efficiently finance growth externally, our cash distribution policy will significantly impair our ability to grow. In addition, because we distribute all of our available cash, we may not grow as quickly as businesses that reinvest their available cash to expand ongoing operations. To the extent we issue additional units in connection with other growth capital expenditures, such issuances may result in significant dilution to our existing unitholders and the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level. There are no limitations in our partnership agreement on our ability to issue additional units, including units ranking senior to the common units. The incurrence of borrowings or other debt by us to finance our growth strategy would result in interest expense, which in turn would affect the available cash that we have to distribute to our unitholders.
Our debt levels may limit our flexibility in obtaining additional financing, pursuing other business opportunities and paying distributions.
We have a $200 million revolving credit facility with outstanding borrowings of $
140.7 million
as of December 31, 2016. Our ability to incur additional debt is subject to limitations under our revolving credit facility. Our level of debt has important consequences to us, including the following:
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our ability to obtain additional financing, if necessary, for operating working capital, capital expenditures, acquisitions or other purposes may be impaired by our debt level, or such financing may not be available on favorable terms;
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we need a portion of our cash flow to make payments on our indebtedness, reducing the funds that would otherwise be available for operations, future business opportunities and distributions; and
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our debt level makes us more vulnerable than our competitors with less debt to competitive pressures or a downturn in our business or the economy generally.
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Our ability to service our debt depends upon, among other things, our future financial and operating performance, which is affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. In addition, our ability to service our debt under our revolving credit facility depends on market interest rates, since the interest rates applicable to our borrowings fluctuate with movements in interest rate markets. If our operating results are not sufficient to service our current or future indebtedness, we will be forced to take actions such as reducing distributions, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt, or seeking additional equity capital. We may be unable to effect any of these actions on satisfactory terms, or at all.
Restrictions in our revolving credit facility limit our ability to capitalize on acquisition and other business opportunities.
The operating and financial restrictions and covenants in our revolving credit facility and any future financing agreements could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. For example, our revolving credit facility restricts or limits our ability to:
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incur additional indebtedness;
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engage in a merger, consolidation or dissolution;
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enter into transactions with affiliates;
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sell or otherwise dispose of assets, businesses and operations;
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materially alter the character of our business as conducted at the closing of this offering;
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make acquisitions, investments and capital expenditures; and
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make distributions to our unitholders.
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Furthermore, our revolving credit facility contains certain operating and financial covenants. Our ability to comply with the covenants and restrictions contained in the revolving credit facility may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. If we violate any of the restrictions, covenants, ratios or tests a significant portion of our indebtedness may become immediately due and payable, our lenders' commitment to make further loans to us may terminate, and we will be prohibited from making distributions to our unitholders. We might not have, or be able to obtain, sufficient funds to make these accelerated payments. Any subsequent replacement of our revolving credit facility or any new indebtedness could have similar or greater restrictions.
We may have difficulty maintaining compliance with the covenants and ratios required under our Credit Agreement, which currently include covenants to maintain certain levels of excess available borrowings and generate minimum amounts of consolidated EBITDA on a quarterly basis. Failure to maintain compliance with these financial covenants could adversely affect our operations, financial condition, and our ability to pay distributions to our unitholders.
We depend on our Credit Agreement for future capital needs and to fund our operations and capital expenditures, as necessary. We are required to comply with certain financial covenants and ratios under the Credit Agreement. Our ability to comply with these restrictions and covenants in the future is uncertain and will be affected by the levels of cash flow from our operations and events or circumstances beyond our control, including events and circumstances that may stem from the condition of financial markets and commodity price levels. On August 31, 2016, we entered into the Eleventh Amendment to the Credit Agreement that, among other things, requires us to generate consolidated EBITDA in certain minimum amounts beginning with the quarter ending June 30, 2017 and to maintain an interest coverage ratio of not less than 2.00 to 1.00 beginning with the quarter ending March 31, 2018. In addition to our future compliance with these ratios, we are subject to additional covenants and restrictions including, among other things, a covenant to maintain $15 million of excess available borrowings under the Credit Agreement and a restriction from making cash distributions to our unitholders. At December 31, 2016, we were in compliance with our loan covenants.
Our failure to comply with any of the covenants of the Credit Agreement could result in a default, which could cause all of our existing indebtedness to become immediately due and payable. In the event that we are unable to access sufficient capital to fund our business and planned capital expenditures, we may be required to curtail our acquisitions, strategic growth projects, portions of our current operations and other activities. A lack of capital could result in a decrease in the operations of our sand business, subject us to claims of breach under customer and supplier contracts and may force us to sell some of our assets on an untimely or unfavorable basis, each of which could adversely affect our results of operations, financial condition and ability to pay distributions to our unitholders.
If we are unable to generate enough cash flow from operations to service our indebtedness or are unable to use future borrowings to refinance our indebtedness or fund other capital needs, we may have to undertake alternative financing plans, which may have onerous terms or may be unavailable.
We cannot assure you that our business will generate sufficient cash flow from operations to service our outstanding indebtedness, or that future borrowings will be available to us in an amount sufficient to enable us to pay our indebtedness or to fund our other capital needs. If we do not generate sufficient cash flow from operations to satisfy our debt obligations, we may have to undertake alternative financing plans, such as:
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refinancing or restructuring all or a portion of our debt;
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obtaining alternative financing;
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reducing or delaying capital investments;
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seeking to raise additional capital; or
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revising or delaying our strategic plans.
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However, we cannot assure you that we would be able to implement alternative financing plans, if necessary, on commercially reasonable terms or at all, or that undertaking alternative financing plans, if necessary, would allow us to meet our debt obligations and capital requirements or that these actions would be permitted under the terms of our various debt instruments.
Our inability to generate sufficient cash flow to satisfy our debt obligations or to obtain alternative financing could materially and adversely affect our business, financial condition, results of operations, cash flows, and prospects. Any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on acceptable terms. Further, if for any reason we are unable to meet our debt service and repayment obligations, we would be in default under the terms of the agreements governing our debt, which would allow our creditors at that time to declare all outstanding indebtedness to be due and payable (which would in turn trigger cross-acceleration or cross-default rights between the relevant agreements), the lenders under our Credit Agreement could terminate their commitments to loan money, and the lenders could foreclose against our assets securing their borrowings and we could be forced into bankruptcy or liquidation. If the amounts outstanding under our Credit Agreement or any of our other indebtedness were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full the money owed to the lenders or to our other debt holders.
Despite our current level of indebtedness, we may still be able to incur substantially more debt. This could further exacerbate the risks associated with our current indebtedness.
We and our subsidiaries may be able to incur substantial additional indebtedness in the future, subject to certain limitations, including under our Credit Agreement. If new debt is added to our current debt levels, the related risks that we now face could increase. Our level of indebtedness could, for instance, prevent us from engaging in transactions that might otherwise be beneficial to us or from making desirable capital expenditures. This could put us at a competitive disadvantage relative to other less leveraged competitors that have more cash flow to devote to their operations. In addition, the incurrence of additional indebtedness could make it more difficult to satisfy our existing financial obligations.
Our ability to manage and grow our business effectively may be adversely affected if we lose management or operational personnel.
We depend on the continuing efforts of our executive officers. The departure of any of our executive officers could have a significant negative effect on our business, operating results, financial condition and on our ability to compete effectively in the marketplace.
Additionally, our ability to hire, train and retain qualified personnel will continue to be important and will become more challenging as we grow and if energy industry market conditions continue to be positive. When general industry conditions are good, the competition for experienced operational personnel increases as other energy and manufacturing companies' personnel needs increase. Our ability to grow or even to continue our current level of service to our current customers will be adversely impacted if we are unable to successfully hire, train and retain these important personnel.
Inaccuracies in our estimates of mineral reserves could result in lower than expected sales and higher than expected costs.
We base our mineral reserve estimates on engineering, economic, and geological data assembled and analyzed by our engineers and geologists, which are reviewed by outside firms. However, sand reserve estimates are necessarily imprecise and depend to some extent on statistical inferences drawn from available drilling data, which may prove unreliable. There are numerous uncertainties inherent in estimating quantities and qualities of mineral reserves and in estimating costs to mine recoverable reserves, including many factors beyond our control. Estimates of recoverable mineral reserves necessarily depend on a number of factors and assumptions, all of which may vary considerably from actual results, such as:
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geological and mining conditions and/or effects from prior mining that may not be fully identified by available data or that may differ from experience;
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assumptions concerning future prices of frac sand products, operating costs, mining technology improvements, development costs and reclamation costs; and
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assumptions concerning future effects of regulation, including our ability to obtain required permits and the imposition of taxes by governmental agencies.
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Any inaccuracy in our estimates related to our mineral reserves could result in lower than expected sales and higher than expected costs and have an adverse effect on our cash available for distribution.
Our operations are dependent on our rights and ability to mine our properties and on our having renewed or received the required permits and approvals from governmental authorities and other third parties.
We hold numerous governmental, environmental, mining, and other permits, water rights and approvals authorizing operations at each of our sand facilities. A decision by a governmental agency or other third party to deny or delay issuing a new or renewed permit, water right or approval, or to revoke or substantially modify an existing permit, water right or approval, could have a material adverse effect on our ability to continue operations at the affected facility. Expansion of our existing operations is also predicated on securing the necessary environmental or other permits, water rights or approvals, which we may not receive in a timely manner or at all.
We are subject to compliance with stringent environmental laws and regulations that may expose us to substantial costs and liabilities.
Our sand and mining operations are subject to increasingly stringent and complex federal, state and local environmental laws, regulations and standards governing the discharge of materials into the environment or otherwise relating to environmental protection. These laws, regulations and standards impose numerous obligations that are applicable to our operations, including the acquisition of permits to conduct regulated activities; the incurrence of significant capital expenditures to limit or prevent releases of materials from our processors, terminals, and related facilities; and the imposition of remedial actions or other liabilities for pollution conditions caused by our operations or attributable to former operations. Numerous governmental authorities, such as the EPA, and similar state agencies, have the power to enforce compliance with these laws, regulations and standards and the permits issued under them, often requiring difficult and costly actions. Similar laws, regulations and standards apply to our Fuel business, which we sold in 2016.
Failure to comply with environmental laws, regulations, standards, permits, and orders may result in the assessment of administrative, civil and criminal penalties, the imposition of remedial obligations, and the issuance of injunctions limiting or preventing some or all of our operations. Certain environmental laws impose strict liability for the remediation of spills and releases of oil and hazardous substances that could subject us to liability without regard to whether we were negligent or at fault. In addition, changes in environmental laws and regulations occur frequently, and any such changes that result in more stringent and costly waste handling, storage, transport, disposal or remediation requirements with respect to our operations or more stringent or costly well drilling, construction, completion or water management activities with respect to our customers' operations could adversely affect our operations, financial results and cash available for distribution.
Increasingly stringent environmental laws and regulations, unanticipated remediation obligations or emissions control expenditures and claims for penalties or damages could result in substantial costs and liabilities, and our ability to make distributions to our unitholders could suffer as a result. Neither the owners of our general partner nor their affiliates will indemnify us for any environmental liabilities, including those arising from non-compliance or pollution, that may be discovered at, on or under, or arise from, our operations or assets. As such, we can expect no economic assistance from any of them in the event that we are required to make expenditures to investigate, correct or remediate any petroleum hydrocarbons, hazardous substances, wastes or other materials. Please see “Environmental and Occupational Health and Safety Regulations” for more detail regarding the environmental and occupational health and safety rules that impact our operations.
Government action on climate change could result in increased compliance costs for us and our customers.
Methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of natural gas, are examples of greenhouse gases (“GHGs”). In recent years, the U.S. Congress has considered legislation to reduce emissions of GHGs. It presently appears unlikely that comprehensive climate legislation will be passed by either house of Congress in the near future, although energy legislation and other regulatory initiatives are expected to be proposed that may be relevant to GHG emissions issues. In addition, almost half of the states have begun to address GHG emissions, primarily through the planned development of emission inventories or regional GHG cap and trade programs. Depending on the particular program, we could be required to control GHG emissions or to purchase and surrender allowances for GHG emissions resulting from our operations.
Independent of Congress, the EPA has adopted regulations controlling GHG emissions under its existing authority under the CAA. For example, the EPA has adopted rules requiring the reporting of GHG emissions in the United States from specified large GHG emission sources. The EPA also has adopted rules establishing construction and operating permit requirements for certain large stationary sources of GHG emissions that are already potential major sources of critical pollutants.
Although it is not currently possible to predict how any such proposed or future GHG legislation or regulation by Congress, the EPA, the states or multi-state regions will impact our business, any legislation or regulation of GHG emissions that may be imposed in areas in which we conduct business could result in increased compliance costs or additional operating restrictions or reduced demand for our services, and could have a material adverse effect on our business, financial condition and results of operations.
Further, in December 2015, over 190 countries, including the United States, reached an agreement to reduce global greenhouse gas emissions. The agreement entered into force in November 2016 after more than 70 countries, including the United States,
ratified or otherwise consented to be bound by the agreement. To the extent the United States or any other country implements this agreement or impose other climate change regulations on the oil and gas industry, it could have an adverse direct or indirect effect on our business.
Mine closures entail substantial costs, and if we close one or more of our mines sooner than anticipated, our results of operations may be adversely affected.
We base our assumptions regarding the life of our mines on detailed studies that we perform from time to time, but our studies and assumptions do not always prove to be accurate. If we close any of our mines sooner than expected, sales will decline unless we are able to increase production at any of our other mines, which may not be possible.
Applicable statutes and regulations require that mining property be reclaimed following a mine closure in accordance with specified standards and an approved reclamation plan. The plan addresses matters such as decommissioning and removal of facilities and equipment, re-grading, prevention of erosion and other forms of water pollution, re-vegetation and post-mining monitoring and land use. We may be required to post a surety bond or other form of financial assurance equal to the cost of reclamation as set forth in the approved reclamation plan. The establishment of the final mine closure reclamation liability is based on permit requirements and requires various estimates and assumptions, principally associated with reclamation costs and production levels. If our accruals for expected reclamation and other costs associated with mine closures for which we will be responsible were later determined to be insufficient, or if we were required to expedite the timing for performance of mine closure activities as compared to estimated timelines, our business, results of operations and financial condition could be adversely affected.
Federal, state and local legislative and regulatory initiatives relating to hydraulic fracturing and the potential for related regulatory action or litigation could result in increased costs and additional operating restrictions or delays for our customers, which could negatively impact our business, financial condition and results of operations and cash flows.
A significant portion of our business supplies frac sand to oil and natural gas industry customers performing hydraulic fracturing activities. Increased regulation of hydraulic fracturing may adversely impact our business, financial condition, and results of operations.
Hydraulic fracturing involves the injection of water, sand, and chemicals under pressure into the formation to stimulate gas production. Legislation to amend the Safe Drinking Water Act (the “SDWA”) to repeal the exemption for hydraulic fracturing from the definition of “underground injection” and require federal permitting and regulatory control of hydraulic fracturing, as well as legislative proposals to require disclosure of the chemical constituents of the fluids used in the fracturing process, were proposed in recent sessions of Congress. We cannot predict whether any such legislation will ever be enacted and, if so, what its provisions would be. Scrutiny of hydraulic fracturing activities continues in other ways, with the EPA having released a final report regarding the impacts of hydraulic fracturing on drinking water resources in 2016. The report concluded that certain activities associated with hydraulic fracturing may impact drinking water resources under certain circumstances. In addition, the U.S. Department of energy released a series of recommendations for improving the safety of the process in 2011. Further, the EPA and the U.S. Department of the Interior (the “DOI”) have proposed and adopted new regulations for certain aspects of the process. For example, the EPA finalized effluent limitations for the treatment and discharge of wastewater resulting from hydraulic fracturing. The DOI adopted rules that require disclosure of chemicals used in hydraulic fracturing activities upon federal and Indian lands and also would strengthen standards for well-bore integrity and the management of fluids that return to the surface during and after fracturing operations on federal and Indian lands (although implementation of this rule has been stayed pending the resolution of legal challenges).
In addition, various state, local and foreign governments have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permitting requirements, operational restrictions, disclosure requirements and temporary or permanent bans on hydraulic fracturing in certain areas, such as environmentally sensitive watersheds. For example, many states - including the major oil and gas producing states of North Dakota, Ohio, Oklahoma, Pennsylvania, Texas, and West Virginia - have imposed disclosure requirements on hydraulic fracturing well owners and operators. The availability of public information regarding the constituents of hydraulic fracturing fluids could make it easier for third parties opposing the hydraulic fracturing process to initiate individual or class action legal proceedings based on allegations that specific chemicals used in the hydraulic fracturing process could adversely affect groundwater and drinking water supplies or otherwise cause harm to human health or the environment. Moreover, disclosure to third parties or to the public, even if inadvertent, of our customers' proprietary chemical formulas could diminish the value of those formulas and result in competitive harm to our customers, which could indirectly impact our business, financial condition and results of operations. The adoption of new laws or regulations at the federal, state, local or foreign levels imposing reporting obligations on, or otherwise limiting or delaying, the hydraulic fracturing process could make it more difficult to complete natural gas wells in shale formations, increase our customers' costs of compliance and doing business and otherwise adversely affect the hydraulic fracturing services they perform, which could negatively impact demand for our frac sand products. In addition, heightened political, regulatory, and public scrutiny of hydraulic fracturing practices could potentially expose us or our customers to increased legal and regulatory proceedings, and any such proceedings could be time-consuming, costly or result in substantial legal liability or significant reputational harm. Any such developments could have a material adverse
effect on our business, financial condition, and results of operations, whether directly or indirectly. For example, we could be directly affected by adverse litigation involving us, or indirectly affected if the cost of compliance limits the ability of our customers to operate in the geographic areas we serve.
We are subject to the Federal Mine Safety and Health Act of 1977, which imposes stringent health and safety standards on numerous aspects of our operations.
Our operations are subject to the Federal Mine Safety and Health Act of 1977, as amended by the Mine Improvement and New Emergency Response Act of 2006, which imposes stringent health and safety standards on numerous aspects of mineral extraction and processing operations, including the training of personnel, operating procedures and operating equipment. We are also subject to standards imposed by MSHA and other federal and state agencies relating to workplace exposure to crystalline silica. Our failure to comply with such standards, or changes in such standards or the interpretation or enforcement thereof, could have a material adverse effect on our business and financial condition or otherwise impose significant restrictions on our ability to conduct mineral extraction and processing operations.
We and our customers are subject to other extensive regulations, including licensing, protection of plant and wildlife endangered and threatened species, and reclamation regulation, that impose, and will continue to impose, significant costs and liabilities. In addition, future regulations, or more stringent enforcement of existing regulations, could increase those costs and liabilities, which could adversely affect our results of operations.
In addition to the regulatory matters described above, we and our customers are subject to extensive governmental regulation on matters such as permitting and licensing requirements, plant and wildlife threatened and endangered species protection, jurisdictional wetlands protection, reclamation and restoration activities at mining properties after mining is completed, the discharge of materials into the environment and the effects that mining and hydraulic fracturing have on groundwater quality and availability. Our future success depends, among other things, on the quantity of our frac sand and other mineral deposits and our ability to extract these deposits profitably, and our customers being able to operate their businesses as they currently do.
In order to obtain permits and renewals of permits in the future, we may be required to prepare and present data to governmental authorities pertaining to the potential adverse impact that any proposed mining and processing activities may have on the environment, individually or in the aggregate, including on public lands. Certain approval procedures may require preparation of archaeological surveys, endangered species studies and other studies to assess the environmental impact of new sites or the expansion of existing sites. Compliance with these regulatory requirements is expensive and significantly lengthens the time needed to develop a site. Finally, obtaining or renewing required permits is sometimes delayed or prevented due to community opposition and other factors beyond our control. The denial of a permit essential to our operations or the imposition of conditions with which it is not practicable or feasible to comply could impair or prevent our ability to develop or expand a site. Significant opposition to a permit by neighboring property owners, members of the public or non-governmental organizations, or other third parties or delay in the environmental review and permitting process also could impair or delay our ability to develop or expand a site. New legal requirements, including those related to the protection of the environment, could be adopted that could materially adversely affect our mining operations (including our ability to extract or the pace of extraction of mineral deposits), our cost structure or our customers' ability to use our frac sand products. Such current or future regulations could have a material adverse effect on our business and we may not be able to obtain or renew permits in the future.
Terrorist attacks, the threat of terrorist attacks, hostilities in the Middle East, or other sustained military campaigns may adversely impact our results of operations.
The long-term impact of terrorist attacks, such as the attacks that occurred on September 11, 2001, and the magnitude of the threat of future terrorist attacks on the energy industry in general and on us in particular are not known at this time. Uncertainty surrounding hostilities in the Middle East or other sustained military campaigns may affect our operations in unpredictable ways, including disruptions of markets for frac sand and refined products and the possibility that infrastructure facilities and pipelines could be direct targets of, or indirect casualties of, an act of terror. Changes in the insurance markets attributable to terrorist attacks may make certain types of insurance more difficult for us to obtain. Moreover, the insurance that may be available to us may be significantly more expensive than our existing insurance coverage. Instability in the financial markets as a result of terrorism or war could also affect our ability to raise capital.
A failure in our operational and communications systems, loss of power, natural disasters, or cyber security attacks on any of our facilities, or those of third-parties, may adversely affect our financial results.
Our business is dependent upon our operational systems to process a large amount of data and a substantial number of transactions. If any of our financial, operational or other data processing systems fail or have other significant shortcomings, our financial results could be adversely affected. Our financial results could also be adversely affected if an employee causes our operational or financial systems to fail, either as a result of inadvertent error or by deliberately tampering with or manipulating our operational systems. In addition, dependence upon automated systems may further increase the risk that operational system flaws, employee tampering or manipulation of those systems will result in losses that are difficult to detect.
Due to technology advances, we have become more reliant on technology to help increase efficiency in our business. We use computer programs to help run our financial and operations processes, and this may subject our business to increased risks. Any future cyber security attacks that affect our facilities, communications systems, our customers or any of our financial data could have a material adverse effect on our business. In addition, cyber-attacks on our customer and employee data may result in a financial loss and may negatively impact our reputation. We do not maintain specialized insurance for possible liability resulting from a cyber-attack on our assets that may shut down all or part of our business. Third-party systems on which we rely could also suffer operational system failure. Any of these occurrences could disrupt our business, result in potential liability or reputational damage or otherwise have an adverse effect on our financial results.
Risks Inherent in an Investment in Us
Holders of our common units have limited voting rights and are not entitled to elect our general partner or its directors.
Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management's decisions regarding our business. Unitholders have no right on an annual or ongoing basis to elect our general partner or its board of directors. Insight Equity is the majority owner of our general partner and has the right to appoint our general partner's entire board of directors, including our independent directors. If the unitholders are dissatisfied with the performance of our general partner, they have little ability to remove our general partner. As a result of these limitations, the price at which the common units trade may be diminished because of the absence or reduction of a takeover premium in the trading price. Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions limiting the unitholders' ability to influence the manner or direction of management.
Insight Equity owns the majority of and controls our general partner, which has sole responsibility for conducting our business and managing our operations. Our general partner and its affiliates, including Insight Equity, have conflicts of interest with us and limited duties, and they may favor their own interests to the detriment of us and our common unitholders.
Insight Equity owns the majority of and controls our general partner and appoints all of the officers and directors of our general partner, some of whom are officers and directors of Insight Equity. Although our general partner has a duty to manage us in a manner that is beneficial to us and our unitholders, the directors and officers of our general partner have a fiduciary duty to manage our general partner in a manner that is beneficial to its owners. Conflicts of interest may arise between Insight Equity and our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts of interest, our general partner may favor its own interests and the interests of Insight Equity and the other owners of our general partner over our interests and the interests of our common unitholders. These conflicts include the following situations, among others:
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neither our partnership agreement nor any other agreement requires Insight Equity to pursue a business strategy that favors us or utilizes our assets or dictates what markets to pursue or grow;
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our general partner is allowed to take into account the interests of parties other than us, such as Insight Equity, in resolving conflicts of interest;
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our partnership agreement replaces the fiduciary duties that would otherwise be owed by our general partner with contractual standards governing its duties, limits our general partner's liabilities and restricts the remedies available to our unitholders for actions that, without these limitations, might constitute breaches of its fiduciary duty;
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our partnership agreement provides that whenever our general partner makes a determination or takes, or declines to take, any other action in its capacity as our general partner, our general partner is required to make such determination, or take or decline to take such other action, in good faith, meaning that it subjectively believed that the decision was in the best interests of our partnership, and, except as specifically provided by our partnership agreement, will not be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;
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except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval;
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our general partner determines the amount and timing of asset purchases and sales, capital expenditures, borrowings, issuances of additional partnership securities and the creation, reduction or increase of reserves, each of which can affect the amount of cash that is distributed to our unitholders;
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our general partner determines which of the costs it incurs on our behalf are reimbursable by us;
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our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or from entering into additional contractual arrangements with any of these entities on our behalf;
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our general partner intends to limit its liability regarding our obligations;
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our general partner may exercise its right to call and purchase all of the common units not owned by it and its affiliates if they own more than 80% of the common units;
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our general partner controls the enforcement of its and its affiliates' obligations to us; and
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our general partner decides whether to retain separate counsel, accountants or others to perform services for us.
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Our general partner limits its liability regarding our obligations.
Our general partner limits its liability under contractual arrangements so that the counterparties to such arrangements have recourse only against our assets, and not against our general partner or its assets. Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement provides that any action taken by our general partner to limit its liability is not a breach of our general partner's duties, even if we could have obtained more favorable terms without the limitation on liability. In addition, we are obligated to reimburse or indemnify our general partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would reduce the amount of cash otherwise available for distribution to our unitholders.
Our partnership agreement replaces our general partner's fiduciary duties to holders of our common units with contractual standards governing its duties.
Our partnership agreement contains provisions that eliminate the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law and replace those duties with several different contractual standards. For example, our partnership agreement permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner, free of any duties to us and our unitholders other than the implied contractual covenant of good faith and fair dealing, which means that a court will enforce the reasonable expectations of the partners where the language in the partnership agreement does not provide for a clear course of action. This provision entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. Examples of decisions that our general partner may make in its individual capacity include:
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how to allocate business opportunities among us and its affiliates;
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whether to exercise its limited call right;
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whether to seek approval of the resolution of a conflict of interest by the conflicts committee of the board of directors of our general partner;
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how to exercise its voting rights with respect to the units it owns; and
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whether or not to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.
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Our common unitholders have agreed to become bound by the provisions in the partnership agreement, including the provisions discussed above.
Our partnership agreement restricts the remedies available to holders of our common units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.
Our partnership agreement contains provisions that restrict the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law. For example, our partnership agreement:
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provides that whenever our general partner makes a determination or takes, or declines to take, any other action in its capacity as our general partner, our general partner is required to make such determination, or take or decline to take such other action, in good faith, meaning it subjectively believed that the decision was in the best interest of our partnership, and except as specifically provided by our partnership agreement, will not be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;
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provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as such decisions are made in good faith;
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provides that our general partner and its officers and directors will not be liable for monetary damages to us, our limited partners or their assignees resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was unlawful; and
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provides that our general partner will not be in breach of its obligations under our partnership agreement (including any duties to us or our unitholders) if a transaction with an affiliate or the resolution of a conflict of interest is:
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approved by the conflicts committee of the board of directors of our general partner, although our general partner is not obligated to seek such approval;
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approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner or any of its affiliates;
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determined by the board of directors of our general partner to be on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or
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determined by the board of directors of our general partner to be “fair and reasonable” to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.
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In connection with a situation involving a transaction with an affiliate or a conflict of interest, any determination by our general partner must be made in good faith. If an affiliate transaction or the resolution of a conflict of interest is not approved by our common unitholders or the conflicts committee and the board of directors of our general partner determines that the resolution or course of action taken with respect to the affiliate transaction or conflict of interest satisfies either of the standards set forth in bullets three and four above, then it will be presumed that, in making its decision, the board of directors acted in good faith, and in any proceeding brought by or on behalf of any limited partner or the partnership, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption. In this context, members of the board of directors of our general partner will be conclusively deemed to have acted in good faith if it subjectively believed that either of the standards set forth in bullets three and four above was satisfied.
Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units.
Unitholders' voting rights are further restricted by a provision of our partnership agreement providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, their direct transferees and their indirect transferees approved by our general partner (which approval may be granted in its sole discretion) and persons who acquired such units with the prior approval of our general partner, cannot vote on any matter.
Our general partner interest or the control of our general partner may be transferred to a third party without unitholder consent.
Our general partner may transfer its general partner interest to a third party in a merger or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, our partnership agreement does not restrict the ability of Insight Equity to transfer all or a portion of its ownership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with its own designees and thereby exert significant control over the decisions made by the board of directors and officers.
An increase in interest rates may cause the market price of our common units to decline.
Like all equity investments, an investment in our common units is subject to certain risks. In exchange for accepting these risks, investors may expect to receive a higher rate of return than would otherwise be obtainable from lower-risk investments. Accordingly, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government-backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield-based equity investments such as publicly traded partnership interests. Reduced demand for our common units resulting from investors seeking other more favorable investment opportunities may cause the trading price of our common units to decline.
We may issue additional units without your approval, which would dilute your existing ownership interests.
Our partnership agreement does not limit the number of additional limited partner interests that we may issue at any time without the approval of our unitholders. The issuance by us of additional common units or other equity securities of equal or senior rank will have the following effects:
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our existing unitholders' proportionate ownership interest in us will decrease;
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the amount of cash available for distribution on each unit may decrease;
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the ratio of taxable income to distributions may increase;
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the relative voting strength of each previously outstanding unit may be diminished; and
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the market price of the common units may decline.
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Our general partner has a call right that may require you to sell your units at an undesirable time or price.
If at any time our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price that is not less than their then-current market price, as calculated pursuant to the terms of our partnership agreement. As a result, you may be required to sell your common units at an undesirable time or price and may not receive any return or a negative return on your investment. You may also incur a tax liability upon a sale of your units.
Your liability may not be limited if a court finds that unitholder action constitutes control of our business.
A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership is organized under Delaware law, and we conduct business in a number of other states. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business. You could be liable for any and all of our obligations as if you were a general partner if a court or government agency were to determine that:
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we were conducting business in a state but had not complied with that particular state's partnership statute; or
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your right to act with other unitholders to remove or replace our general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitute “control” of our business.
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Unitholders may have liability to repay distributions that were wrongfully distributed to them.
Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to you if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of an impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Substituted limited partners are liable both for the obligations of the assignor to make contributions to the partnership that were known to the substituted limited partner at the time it became a limited partner and for those obligations that were unknown if the liabilities could have been determined from the partnership agreement. Neither liabilities to partners on account of their partnership interest nor liabilities that are non-recourse to the partnership are counted for purposes of determining whether a distribution is permitted.
The New York Stock Exchange, or NYSE, does not require a publicly traded partnership like us to comply with certain of its corporate governance requirements.
Because we are a publicly traded partnership, the NYSE does not require us to have a majority of independent directors on our general partner's board of directors or to establish a compensation committee or a nominating and corporate governance committee. Accordingly, unitholders do not have the same protections afforded to certain corporations that are subject to all of the NYSE corporate governance requirements.
If we cannot meet the New York Stock Exchange (“NYSE”) continued listing requirements, the NYSE may delist our common units which would have an adverse impact on the liquidity and market price of our common units.
Our common stock is currently listed on the NYSE. In the future, we may not be able to meet the continued listing requirements of the NYSE. As previously disclosed in our press release dated May 20, 2016 and our Notification of Late Filing on Form 12b-25 filed with the Securities and Exchange Commission on May 11, 2016, we were not able to file our Quarterly Report on Form 10-Q for the period ended March 31, 2016 in a timely manner. On May 17, 2016, we received a letter from the New York Stock Exchange Regulation, Inc. informing us that, as a result of our failure to timely file our Form 10-Q for the period ended March 31, 2016, we were subject to the procedures specified in Section 802.01E (SEC Annual Report Timely Filing Criteria) of the NYSE’s Listed Company Manual. We are in compliance with this NYSE requirement following the filing of our quarterly reports on Form 10-Q for the periods ended March 31, 2016 and June 30, 2016 on September 12, 2016. In addition, the continued listing requirements on the NYSE require, among other things; (i) that the average closing price of our common units be above $1.00 over 30 consecutive trading days and (ii) that our market capitalization be not less than $15 million over 30 consecutive trading days. If in the future we are unable to satisfy the NYSE criteria for continued listing, our common units would be subject to delisting. A delisting of our common units could negatively impact us by reducing the liquidity and market price of our common units, reducing the number of investors willing to hold or acquire our common units, which could negatively impact our ability to raise equity financing.
If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential unitholders could lose confidence in our financial reporting, which would harm our business and the trading price of our units.
Effective internal controls are necessary for us to provide reliable financial reports, prevent fraud, and operate successfully as a public company. If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed. We cannot be certain that we will be able to maintain adequate controls over our financial processes and reporting in the future or that we will be able to comply with our obligations under Section 404 of the Sarbanes Oxley Act of 2002. Any failure to maintain effective internal controls, or difficulties encountered in implementing or improving our internal controls, could harm our operating results or cause us to fail to meet our reporting obligations. Ineffective internal controls could also cause investors to lose confidence in our reported financial information, which would likely have a negative effect on the trading price of our units.
Tax Risks to Common Unitholders
Our tax treatment depends on our status as a partnership for federal income tax purposes. If the IRS were to treat us as a corporation for federal income tax purposes, which would subject us to entity-level taxation, then our cash available for distribution to our unitholders would be substantially reduced.
The anticipated after-tax economic benefit of an investment in the common units depends largely on our being treated as a partnership for federal income tax purposes. Despite the fact that we are a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. Although we do not believe based upon our current operations that we will be so treated, a change in our business or a change in current law could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.
If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35%, and would likely pay state and local income tax at varying rates. Distributions would generally be taxed again as corporate dividends (to the extent of our current and accumulated earnings and profits), and no income, gains, losses, deductions, or credits would flow through to you. Because a tax would be imposed upon us as a corporation, our cash available for distribution to you would be substantially reduced. Therefore, if we were treated as a corporation for federal income tax purposes, there would be a material reduction in the anticipated cash flow and after-tax return to our unitholders, likely causing a substantial reduction in the value of our common units.
If we were subjected to a material amount of additional entity-level taxation by individual states, it would reduce our cash available for distribution to our unitholders.
Changes in current state law may subject us to additional entity-level taxation by individual states. Because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Imposition of any such taxes may substantially reduce the cash available for distribution to you and, therefore, negatively impact the value of and investment in our common units.
The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.
The present federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units may be modified by administrative, legislative, or judicial interpretation at any time. For example, from time to time, the U.S. government considers substantive changes to the existing federal income tax laws that affect publicly traded partnerships, including the elimination of the qualifying income exception upon which we rely for our treatment as a partnership for federal income tax purposes.
Any modification to the federal income tax laws and interpretations thereof may or may not be retroactively applied and could make it more difficult or impossible to meet the exception for us to be treated as a partnership for federal income tax purposes. We are unable to predict whether any of these changes or other proposals will ultimately be enacted. However, it is possible that a change in law could affect us, and any such changes could negatively impact the value of an investment in our common units.
Our unitholders' share of our income is taxable to them for federal income tax purposes even if they do not receive any cash distributions from us.
Because a unitholder is treated as a partner to whom we allocate taxable income which could be different in amount than the cash we distribute, a unitholder's allocable share of our taxable income is taxable to it, which may require the payment of federal income taxes and, in some cases, state and local income taxes, on its share of our taxable income even if it receives no cash distributions from us. For example, a gain on the sale of any of our assets may result in a unitholder being allocated taxable income without receiving a corresponding cash distribution from us. Our unitholders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from that income.
If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our cash available for distribution to our unitholders.
The IRS has made no determination with respect to our treatment as a partnership for federal income tax purposes. The IRS may adopt positions that differ from the positions we take, and the IRS's positions may ultimately be sustained. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take and such positions may not ultimately be sustained. A court may not agree with some or all the positions we take. Any contest with the IRS, and the outcome of any IRS contest, may have a materially adverse impact on the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders because the costs will reduce our cash available for distribution.
If the IRS makes audit adjustments to our income tax returns for tax years beginning after December 31, 2017, it may assess and collect any taxes (including any applicable penalties and interest) resulting from such audit adjustment directly from us, in which case our cash available for distribution to our unitholders might be substantially reduced.
Pursuant to the Bipartisan Budget Act of 2015, for tax years beginning after December 31, 2017, if the IRS makes audit adjustments to our income tax returns, it may assess and collect any taxes (including any applicable penalties and interest) resulting from such audit adjustment directly from us. Generally, we expect to elect to have our general partner and our unitholders take such audit adjustment into account in accordance with their interests in us during the tax year under audit, but there can be no assurance that such election will be effective in all circumstances. If we are unable to have our general partner and our unitholders take such audit adjustment into account in accordance with their interests in us during the tax year under audit, our current unitholders may bear some or all of the tax liability resulting from such audit adjustment, even if such unitholders did not own units in us during the tax year under audit. If, as a result of any such audit adjustment, we are required to make payments of taxes, penalties and interest, our cash available for distribution to our unitholders might be substantially reduced. These rules are not applicable to us for tax years beginning on or prior to December 31, 2017.
Tax gain or loss on the disposition of our common units could be more or less than expected.
If you sell your common units, you will recognize a gain or loss for federal income tax purposes equal to the difference between the amount realized and your tax basis in those common units. Because distributions in excess of your allocable share of our net taxable income decrease your tax basis in your common units, the amount, if any, of such prior excess distributions with respect to the common units you sell will, in effect, become taxable income to you if you sell such common units at a price greater than your tax basis in those common units, even if the price you receive is less than your original cost. Furthermore, a substantial portion of the amount realized on any sale of your common units, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depreciation and depletion recapture. In addition, because the amount realized includes a unitholder's share of our nonrecourse liabilities, if you sell your common units, you may incur a tax liability in excess of the amount of cash you receive from the sale.
Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.
Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (known as IRAs), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, is unrelated business taxable income and is taxable to them.
Distributions to non-U.S. persons are reduced by withholding taxes at the highest applicable effective tax rate, and non-U.S. persons are required to file federal income tax returns and pay tax on their share of our taxable income. If you are a tax-exempt entity or a non-U.S. person, you should consult a tax advisor before investing in our common units.
We treat each purchaser of common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.
Because we cannot match transferors and transferees of common units and because of other reasons, we have adopted depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to you. It also could affect the timing of these tax benefits or the amount of gain or loss from your sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns.
We prorate our items of income, gain, loss and deduction between transferors and transferees of our common units each month based upon the ownership of our common units on the first business day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge aspects of our proration method, and, if successful, we would be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
We prorate our items of income, gain, loss and deduction between transferors and transferees of our common units each month based upon the ownership of our common units on the first business day of each month, instead of on the basis of the date a particular unit is transferred. The U.S. Department of Treasury and the IRS have issued Treasury Regulations that permit publicly traded partnerships to use a monthly simplifying convention that is similar to ours, but they do not specifically authorize all aspects of the proration method we have adopted. If the IRS were to successfully challenge this method, we could be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
A unitholder whose common units are loaned to a “short seller” to effect a short sale of common units may be considered as having disposed of those common units. If so, he would no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan and may recognize gain or loss from the disposition.
Because a unitholder whose common units are loaned to a “short seller” to effect a short sale of common units may be considered as having disposed of the loaned common units, he may no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan to the short seller, any of our income, gain, loss or deductions with respect to those common units may not be reportable by the unitholder, and any cash distributions received by the unitholder as to those common units could be fully taxable as ordinary income. Our unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a loan to a short seller are urged to consult a tax advisor to discuss whether it is advisable to modify any applicable brokerage account agreements to prohibit their brokers from loaning their common units.
The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.
We will be considered to have technically terminated our partnership for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. For purposes of determining whether the 50% threshold has been met, multiple sales of the same interest will be counted only once. Our technical termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns (and our unitholders could receive two Schedules K-1 if relief was not available, as described below) for one fiscal year and could result in a deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than a fiscal year ending December 31, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in his taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for federal income tax purposes, but instead we would be treated as a new partnership for tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred. The IRS has announced a publicly traded partnership technical termination relief program whereby, if a publicly traded partnership that technically terminated requests publicly traded partnership technical termination relief and such relief is granted by the IRS, among other things, the partnership will only have to provide one Schedule K-1 to unitholders for the year in which the termination occurs, notwithstanding two partnership tax years.
We may become a resident of Canada and be required to pay tax in Canada on our worldwide income, which could reduce our earnings, and unitholders could then become taxable in Canada in respect of their ownership of our common units.
Under the Income Tax Act (Canada), or the Canadian Tax Act, a company that is resident in Canada is subject to tax in Canada on its worldwide income, and unitholders of a company resident in Canada may be subject to Canadian capital gains tax on a disposition of its units and to Canadian withholding tax on dividends paid in respect of such units.
Under Canadian law, our place of residence would generally be determined based on the location where our central management and control is exercised. Although our central management and control is currently exercised in the United States and we intend to continue to conduct our affairs and operate in such a manner, if we were nonetheless to be considered a Canadian resident for purposes of the Canadian Tax Act, our worldwide income would become subject to Canadian income tax under the Canadian Tax Act. Further, unitholders who are non-residents of Canada may become subject under the Canadian Tax Act to tax in Canada on any gains realized on the disposition of our units and would become subject to Canadian withholding tax on dividends paid or deemed to be paid by us, subject to any relief that may be available under a tax treaty or convention.
As a result of investing in our common units, you may become subject to state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire properties.
In addition to federal income taxes, our unitholders could be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business
or control property now or in the future, even if they do not live in any of those jurisdictions. Our unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, our unitholders may be subject to penalties for failure to comply with those requirements. We currently own property or conduct business in many states, most of which impose an income tax on individuals, corporations and other entities. As we make acquisitions or expand our business, we may control assets or conduct business in additional states that impose a personal income tax. It is your responsibility to file all federal, state and local tax returns. Please consult your tax advisor.