Form 8-K/A AZURE MIDSTREAM PARTNERS For: Aug 06
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E-mailUNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 8-K/A
(Amendment No. 1)
CURRENT REPORT
PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
Date of Report (Date of earliest event reported): August 6, 2015
Azure Midstream Partners, LP
(Exact name of registrant as specified in its charter)
Delaware | 001-36018 | 46-2627595 | ||
(State or other jurisdiction of incorporation or organization) | (Commission File Number) | (IRS Employer Identification No.) | ||
12377 Merit Drive
Suite 300
Dallas, Texas 75251
(Address of principal executive office) (Zip Code)
(972) 674-5200
(Registrants’ telephone number, including area code)
Check the appropriate box below if the Form 8-K filing is intended to simultaneously satisfy the filing obligation of the registrant under any of the following provisions:
¨ | Written communications pursuant to Rule 425 under the Securities Act (17 CFR 230.425) |
¨ | Soliciting material pursuant to Rule 14a-12 under the Exchange Act (17 CFR 240.14a-12) |
¨ | Pre-commencement communications pursuant to Rule 14d-2(b) under the Exchange Act (17 CFR 240.14d-2(b)) |
¨ | Pre-commencement communications pursuant to Rule 13e-4(c) under the Exchange Act (17 CFR 240.13e-4(c)) |
Explanatory Note
As previously reported, on a Current Report on Form 8-K filed with the Securities and Exchange Commission on August 6, 2015 (the "Original Report"), Azure Midstream Partners, LP, a Delaware limited partnership (the “Partnership”), entered into a contribution agreement (the “Contribution Agreement”) with Azure Midstream Energy LLC, a Delaware limited liability company (“AME”), which is the sole member of Azure Midstream Partners GP, LLC, a Delaware limited liability company and the general partner of the Partnership (the “General Partner”). Pursuant to the Contribution Agreement, AME contributed 100% of the outstanding membership interests in Azure ETG, LLC, a Delaware limited liability company (“ETG”) that owns and operates the East Texas gathering system (the “ETG System”), to the Partnership in exchange for $80,000,000 in cash and the issuance of 255,319 common units representing limited partner interests in the Partnership. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of ETG was effective on July 1, 2015.
In the Original Report, the Partnership stated that it would provide the financial statements required by Item 9.01 by amendment to the Original Report within 71 days after the date of the Original Report.
Item 8.01 Other Events.
As described in the Original Report and above, on August 6, 2015, the Partnership entered into the Contribution Agreement related to the acquisition of the ETG System with AME. Because AME also controls the Partnership through its ownership of the General Partner, the contribution was considered a transfer of net assets between entities under common control. As a result, the Partnership is required to retrospectively update its financial statements to include the activities of the ETG System as of the date of common control. Exhibits 99.1, 99.2, and 99.3 included in this Current Report on Form 8-K give retroactive effect to the contribution of the ETG System as if the Partnership owned such business since the date of common control.
In connection with the closing of the transactions contemplated by the Contribution Agreement, the Partnership is providing: (i) historical carve-out financial statements of the Azure Legacy System entities and assets ( the "Legacy System") for the year ended December 31, 2014 and 2013, recast with respect to the historical financial statements of the ETG System (collectively, (the "Azure System"), which has been deemed to be the predecessor of the Partnership for accounting and financial reporting purposes ("Azure System Predecessor") ; (ii) selected sections of its Form 10-K for the year ended December 31, 2014, including Business and Properties, Risk Factors, Selected Historical Financial Data of the Azure System and the Azure System Predecessor and Management Discussion and Analysis of Financial Condition and Results of Operations of the Azure System and the Azure System Predecessor recast with respect to the historical information of the ETG System; (iii) selected sections of its Form 10-Q for the six months ended June 30, 2015, including Financial Statements and the notes thereto, Management Discussion and Analysis of Financial Condition and Results of Operations and Qualitative and Quantitative Disclosure about Market Risk recast with respect to the historical financial statements of the ETG System; (iv) certain audited historical financial statements of the ETG System; and (v) pro forma combined financial statements of the ETG System and the Partnership giving effect to the transactions contemplated by the Contribution Agreement, which are filed as Exhibits 99.1, 99.2, 99.3, 99.4 and 99.5 to this Current Report and are incorporated herein by reference.
Item 9.01 Financial Statements and Exhibits.
(a) Financial statements of businesses acquired. The audited financial statements of the ETG System as of December 31, 2014, 2013, 2012 and November 14, 2013 and for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, as well as, the unaudited interim periods as of and for the six months ended June 30, 2015 and 2014, are attached to this Form 8-K/A as Exhibit 99.4 and are incorporated herein by reference.
(b) Pro Forma financial information. The unaudited pro forma consolidated and combined financial statements and explanatory notes of the Partnership giving effect to the transactions contemplated by the Contribution Agreement and certain other transactions are attached as Exhibit 99.5 to this Form 8-K/A and are incorporated herein by reference.
(c) Exhibits.
Exhibit Number | Description | |
23.1 | Consent of KPMG LLP. | |
23.2 | Consent of KPMG LLP. | |
23.3 | Consent of KPMG LLP. | |
99.1 | Azure System carve‑out consolidated balance sheets as of December 31, 2014 and 2013, and the related statements of operations, parent company net investment and cash flows for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 and the The Azure System Predecessor carve‑out consolidated financial statements for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 and the related results of operations, change in parent company net investment and cash flows. | |
99.2 | Selected sections of Form 10-K for the year ended December 31, 2014, including Business and Properties, Risk Factors, Selected Historical Financial Data of the Azure System and the Azure System Predecessor and Management Discussion and Analysis of Financial Condition and Results of Operations of the Azure System and the Azure System Predecessor recast with respect to the historical financial statements of the ETG System. | |
99.3 | Selected sections of Form 10-Q for the six months ended June 30, 2015, including Financial Statements and the notes thereto, Management Discussion and Analysis of Financial Condition and Results of Operations and Qualitative and Quantitative Disclosure about Market Risk recast with respect to the historical financial statements of the ETG System. | |
99.4 | Azure ETG System audited balance sheets as of December 31, 2014, 2013, 2012 and November 14, 2013 and the related statements of operations, parent company net investment and cash flows for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, and the related notes to the financial statements, as well as the unaudited interim periods as of and for the six months ended June 30, 2015 and 2014. | |
99.5 | Unaudited Pro Forma Consolidated and Combined Financial Statements of the Partnership and explanatory notes as of and for the six months ended June 30, 2015 and the year ended December 31, 2014. | |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
Azure Midstream Partners, L P | ||||
By: | Azure Midstream Partners GP, LLC, its general partner | |||
Dated: October 5, 2015 | By: | /s/ Eric T. Kalamaras | ||
Name: Eric T. Kalamaras | ||||
Title: Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) | ||||
EXHIBIT INDEX
Exhibit Number | Description | |
23.1 | Consent of KPMG LLP. | |
23.2 | Consent of KPMG LLP. | |
23.3 | Consent of KPMG LLP. | |
99.1 | Azure System carve‑out consolidated balance sheets as of December 31, 2014 and 2013, and the related statements of operations, parent company net investment and cash flows for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 and the The Azure System Predecessor carve‑out consolidated financial statements for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 and the related results of operations, change in parent company net investment and cash flows. | |
99.2 | Selected sections of Form 10-K for the year ended December 31, 2014, including Business and Properties, Risk Factors, Selected Historical Financial Data of the Azure System and the Azure System Predecessor and Management Discussion and Analysis of Financial Condition and Results of Operations of the Azure System and the Azure System Predecessor recast with respect to the historical financial statements of the ETG System. | |
99.3 | Selected sections of Form 10-Q for the six months ended June 30, 2015, including Financial Statements and the notes thereto, Management Discussion and Analysis of Financial Condition and Results of Operations and Qualitative and Quantitative Disclosure about Market Risk recast with respect to the historical financial statements of the ETG System. | |
99.4 | Azure ETG System audited balance sheets as of December 31, 2014, 2013, 2012 and November 14, 2013 and the related statements of operations, parent company net investment and cash flows for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, and the related notes to the financial statements, as well as the unaudited interim periods as of and for the six months ended June 30, 2015 and 2014. | |
99.5 | Unaudited Pro Forma Consolidated and Combined Financial Statements of the Partnership and explanatory notes as of and for the six months ended June 30, 2015 and the year ended December 31, 2014. | |
Exhibit 23.1
Consent of Independent Registered Public Accounting Firm
The Board of Directors
Azure Midstream Holdings LLC:
We consent to the incorporation by reference in the registration statements on Form S-3 (No. 333-203451) and on Form S-8 (No. 333-190300) of Azure Midstream Partners, LP of our report dated October 5, 2015, with respect to the consolidated balance sheets of the Azure System and the Azure System Predecessor as of December 31, 2014 and 2013, and the related consolidated statements of operations, parent company net investment, and cash flows for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, which report appears in the Current Report on Form 8‑K/A of Azure Midstream Partners, LP dated October 5, 2015. Our report refers to the Azure System's change in controlling ownership on November 15, 2013, which resulted in a new cost basis for the Azure System.
/s/ KPMG LLP
Dallas, Texas
October 5, 2015
Exhibit 23.2
Consent of Independent Auditor
The Board of Directors
Azure Midstream Holdings LLC:
Azure Midstream Holdings LLC:
We consent to the incorporation by reference in the registration statements on Form S-3 (No. 333-203451) and on Form S-8 (No. 333-190300) of Azure Midstream Partners, LP of our report dated October 5, 2015, with respect to the balance sheets of the Azure ETG System as of December 31, 2014 and 2013, and the related statements of operations, parent company net investment and cash flows for the year ended December 31, 2014, and the period from November 15, 2013 to December 31, 2013, which report appears in the Current Report on Form 8‑K/A of Azure Midstream Partners, LP dated October 5, 2015.
/s/ KPMG LLP
Dallas, Texas
October 5, 2015
Exhibit 23.3
Consent of Independent Auditor
The Board of Directors
Azure Midstream Holdings LLC:
Azure Midstream Holdings LLC:
We consent to the incorporation by reference in the registration statements on Form S-3 (No. 333-203451) and on Form S-8 (No. 333-190300) of Azure Midstream Partners, LP of our report dated April 24, 2014, with respect to the balance sheets of TPF II East Texas Gathering, LLC as of November 14, 2013 and December 31, 2013, and the related statements of operations, member’s equity, and cash flows for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, which report appears in the Current Report on Form 8‑K/A of Azure Midstream Partners, LP dated October 5, 2015.
/s/ KPMG LLP
Omaha, Nebraska
October 5, 2015
Exhibit 99.1
EXPLANATORY NOTE
The consolidated financial statements included in this filing reflect the assets, liabilities and operations of the Legacy gathering system entities and assets (the "Legacy System"), updated to include the East Texas Gathering System entities and assets (the "ETG System"), as a result of the contribution of the entity owning the ETG System to the Partnership, (collectively the "Azure System").
On February 27, 2015, Azure Midstream Partners, LP formerly Marlin Midstream Partners, LP (the "Partnership") acquired the Legacy System, which has been deemed to be the predecessor of the Partnership for accounting and reporting purposes. As such, the term ("Azure System Predecessor") is sometimes used to refer to the Legacy System for periods prior to November 15, 2013, the date Azure Midstream Energy LLC, a Delaware limited liability company ("Azure Energy"), acquired 100% of the equity interest in the entities that own the Legacy System and ETG System.
On August 6, 2015, the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the consolidated financial statements and footnotes of the Legacy System to include the financial results of the ETG System for periods beginning November 15, 2013, the date Azure Energy acquired the ETG System.
The combined Legacy System and ETG System consolidated financial statements, (the “Azure System Carve‑Out Consolidated Financial Statements”) present the historical carve‑out financial position, results of operations, change in parent company net investment and cash flows of the Legacy System and ETG System as of December 31, 2014 and 2013, for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013.
The Azure System Carve‑Out Consolidated Financial Statements also present the historical carve‑out results of operations, change in parent company net investment and cash flows of the Azure System Predecessor for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012. The Azure System Carve‑Out Consolidated Financial Statements have been derived from the accounting records of Azure Midstream Holdings, LLC ("Azure Holdings" and collectively with Azure Energy, "Azure") and the Azure Midstream Predecessor (“Azure Predecessor”), defined further below, on a carve‑out basis.
1
AZURE SYSTEM and AZURE SYSTEM PREDECESSOR
Consolidated Financial Statements
December 31, 2014 and 2013 and the period from November 15, 2013 to
December 31, 2013, the period from January 1, 2013 to November 14, 2013
and the year ended December 31, 2012
2
Report of Independent Registered Public Accounting Firm
The Board of Directors
Azure Midstream Holdings LLC:
We have audited the accompanying consolidated balance sheets of the Azure System and the Azure System Predecessor as of December 31, 2014 and 2013, and the related consolidated statements of operations, parent company net investment, and cash flows for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Azure System as of December 31, 2014 and 2013, and the results of the operations and cash flows of the Azure System and the Azure System Predecessor for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
As discussed in note 1 to the consolidated financial statements, effective November 15, 2013, the Azure System had a change in controlling ownership. As a result of this change in control, the financial information after November 15, 2013 is presented on a different cost basis than that for the periods before the acquisition and, therefore, is not comparable.
/s/ KPMG LLP
Dallas, Texas
October 5, 2015
3
Azure System
Consolidated Balance Sheets
As of December 31, 2014 and 2013
(In Thousands)
December 31, 2014 | December 31, 2013 | |||||
Current Assets: | ||||||
Cash and cash equivalents | $ | — | $ | — | ||
Trade accounts receivable | 8,354 | 12,255 | ||||
Trade accounts receivable - affiliates | 76 | 922 | ||||
Other current assets | 435 | 1,025 | ||||
Total current assets | 8,865 | 14,202 | ||||
Property, plant and equipment, net | 304,175 | 302,163 | ||||
Other non-current assets | 6,163 | 8,198 | ||||
Total Assets | $ | 319,203 | $ | 324,563 | ||
Current Liabilities: | ||||||
Accounts payable and accrued liabilities | $ | 5,630 | $ | 13,084 | ||
Accounts payable and accrued liabilities - affiliates | 96 | 1,305 | ||||
Current portion of long-term debt associated with the Azure credit | ||||||
agreement | 10,104 | 10,104 | ||||
Total current liabilities | 15,830 | 24,493 | ||||
Long-term debt associated with the Azure credit agreement | 181,871 | 191,974 | ||||
Other long-term liabilities | 5,351 | 1,068 | ||||
Total liabilities | 203,052 | 217,535 | ||||
Parent company net investment | 116,151 | 107,028 | ||||
Total liabilities and parent company net investment | $ | 319,203 | $ | 324,563 | ||
See accompanying notes to the consolidated financial statements.
4
Azure System and Azure System Predecessor
Consolidated Statements of Operations
For the Year Ended December 31, 2014, the Period From November 15, 2013 to December 31, 2013,
the Period From January 1, 2013 to November 14, 2013 and the Year Ended December 31, 2012
(In Thousands)
Year ended December 31, 2014 | Period From November 15, 2013 to December 31, 2013 | Period From January 1, 2013 to November 14, 2013 | Year ended December 31, 2012 | ||||||||||||
Operating Revenues: | |||||||||||||||
Natural gas and NGL sales | $ | 47,484 | $ | 4,728 | $ | 31,749 | $ | 37,255 | |||||||
Natural gas and NGL sales - affiliates | 4,000 | 806 | — | — | |||||||||||
Gathering services and other fees | 22,251 | 3,096 | 7,887 | 1,502 | |||||||||||
Gathering services and other fees - affiliates | 986 | 229 | 1,627 | 12,737 | |||||||||||
Total operating revenues | 74,721 | 8,859 | 41,263 | 51,494 | |||||||||||
Operating expenses: | |||||||||||||||
Cost of purchased gas and NGL's sold | 30,654 | 3,050 | 11,735 | 8,820 | |||||||||||
Cost of purchased gas and NGL's sold - affiliates | 7,388 | 1,455 | 9,319 | 13,973 | |||||||||||
Operating expense | 13,714 | 2,643 | 11,330 | 11,183 | |||||||||||
General and administrative | 5,812 | 195 | 3,629 | 5,692 | |||||||||||
Depreciation and amortization | 7,961 | 958 | 9,999 | 11,229 | |||||||||||
Asset impairments | 228 | — | 659 | 5,720 | |||||||||||
Total expenses | 65,757 | 8,301 | 46,671 | 56,617 | |||||||||||
Income (loss) from operations | 8,964 | 558 | (5,408 | ) | (5,123 | ) | |||||||||
Interest expense | 15,149 | 1,855 | 3,167 | 4,951 | |||||||||||
Other (income) expense | 422 | — | (807 | ) | 304 | ||||||||||
Net loss before income taxes | (6,607 | ) | (1,297 | ) | (7,768 | ) | (10,378 | ) | |||||||
Income tax expense | 213 | 26 | 118 | 147 | |||||||||||
Net loss | $ | (6,820 | ) | $ | (1,323 | ) | $ | (7,886 | ) | $ | (10,525 | ) | |||
See accompanying notes to the consolidated financial statements.
5
Azure System and Azure System Predecessor
Consolidated Statements of Cash Flows
For the Year Ended December 31, 2014, the Period From November 15, 2013 to December 31, 2013,
the Period From January 1, 2013 to November 14, 2013 and the Year Ended December 31, 2012
(In Thousands)
Year ended December 31, 2014 | Period From November 15, 2013 to December 31, 2013 | Period From January 1, 2013 to November 14, 2013 | Year ended December 31, 2012 | |||||||||||||
Operating activities: | ||||||||||||||||
Net loss | $ | (6,820 | ) | $ | (1,323 | ) | $ | (7,886 | ) | $ | (10,525 | ) | ||||
Adjustments to reconcile net loss to net cash | ||||||||||||||||
provided by (used in) operating activities: | ||||||||||||||||
Depreciation and amortization | 7,961 | 958 | 9,999 | 11,229 | ||||||||||||
Amortization of deferred financing costs | 1,861 | 202 | 266 | 726 | ||||||||||||
Asset impairments | 228 | — | 659 | 5,720 | ||||||||||||
Other | 78 | — | — | — | ||||||||||||
Changes in operating assets and liabilities: | ||||||||||||||||
Accounts receivable, net | 6,980 | (2,691 | ) | (1,791 | ) | 5,181 | ||||||||||
Other current assets | (31 | ) | (47 | ) | 373 | (93 | ) | |||||||||
Accounts payable and other current liabilities | (6,360 | ) | 2,517 | 1,970 | (5,890 | ) | ||||||||||
Other long-term liabilities | 4,282 | — | — | — | ||||||||||||
Net cash provided by (used in) operating activities | 8,179 | (384 | ) | 3,590 | 6,348 | |||||||||||
Investing activities: | ||||||||||||||||
Acquisition of Legacy System | — | (212,515 | ) | — | — | |||||||||||
Cash received in ETG acquisition | — | 1,460 | — | — | ||||||||||||
Capital expenditures | (14,233 | ) | (1,068 | ) | (13,989 | ) | (9,887 | ) | ||||||||
Proceeds from sale of property and equipment | 394 | — | — | 7,500 | ||||||||||||
Net cash used in investing activities | (13,839 | ) | (212,123 | ) | (13,989 | ) | (2,387 | ) | ||||||||
Financing activities: | ||||||||||||||||
Allocated borrowings under Azure credit agreements | — | 202,078 | — | — | ||||||||||||
Allocated repayments under Azure credit agreements | (10,103 | ) | — | — | — | |||||||||||
Allocated repayments under Azure Predecessor credit | ||||||||||||||||
agreements | — | — | (26,471 | ) | — | |||||||||||
Allocated borrowings under Azure Predecessor credit | ||||||||||||||||
agreements | — | — | — | 9,013 | ||||||||||||
Allocated payment of deferred financing costs | (180 | ) | (7,922 | ) | — | (859 | ) | |||||||||
Parent company net investment | 15,943 | 18,351 | 36,870 | (12,115 | ) | |||||||||||
Net cash provided by (used in) financing activities | 5,660 | 212,507 | 10,399 | (3,961 | ) | |||||||||||
Increase (decrease) in cash and cash equivalents | — | — | — | — | ||||||||||||
Cash and cash equivalents - beginning of period | — | — | — | — | ||||||||||||
Cash and cash equivalents - end of period | $ | — | $ | — | $ | — | $ | — | ||||||||
See accompanying notes to the consolidated financial statements.
6
Azure System and Azure System Predecessor
Consolidated Statements of Parent Company Net Investment
For the Year Ended December 31, 2014, the Period From November 15, 2013 to December 31, 2013,
the Period From January 1, 2013 to November 14, 2013 and the Year Ended December 31, 2012
(In Thousands)
Azure System Predecessor parent company net investment - December 31, 2011 | $ | 212,187 | |
Azure System Predecessor net loss for the period | (10,525 | ) | |
Azure System Predecessor net distribution from parent for the period | (12,115 | ) | |
Azure System Predecessor parent company net investment - December 31, 2012 | 189,547 | ||
Azure System Predecessor net loss for the period | (7,886 | ) | |
Azure System Predecessor net contribution from parent for the period | 36,870 | ||
Ending Azure System Predecessor parent company net investment - November 14, 2013 | 218,531 | ||
Elimination of Azure System Predecessor parent company net investment | (218,531 | ) | |
Beginning Azure System parent company net investment - November 15, 2013 | 108,359 | ||
Azure System net loss for the period | (1,323 | ) | |
Azure System net distribution from parent for the period | (8 | ) | |
Ending Azure System parent company net investment - December 31, 2013 | 107,028 | ||
Azure System net loss for the period | (6,820 | ) | |
Azure System net contribution from parent for the period | 15,943 | ||
Ending Azure System parent company net investment - December 31, 2014 | $ | 116,151 | |
See accompanying notes to the consolidated financial statements.
7
Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
(1) Organization and Nature of the Business
Acquisition of the Legacy System
On February 27, 2015, the Partnership consummated a transaction agreement (the “Transaction Agreement”) by and among the Partnership, Azure , Marlin Midstream GP, LLC, a Delaware limited liability company and the sole general partner of the Partnership (the “GP”), NuDevco Midstream Development, LLC, a Texas limited liability-company and an affiliate of the partnership (“NuDevco”), and Marlin IDR Holdings, LLC a Delaware limited liability company and wholly owned subsidiary of NuDevco (“IDRH”).
The Transaction Agreement resulted in the contribution of the Legacy System to the Partnership and Azure receiving $92.5 million and acquiring 100% of the equity interests in the GP and 90% of the Partnership’s incentive distribution rights (as unitized, the “IDR Units”), as defined below. To effectuate the Transaction Agreement, the Partnership and Azure executed the following steps:
• | The Partnership (i) amended and restated its partnership agreement to reflect the unitization of all of the Partnership’s IDR Units and (ii) recapitalize the IDRs owned by IDRH into 100 IDR Units. |
• | The Partnership redeemed 90 IDR Units held by IDRH in exchange for a payment by the Partnership of $63.0 million to IDRH (the “Redemption”). |
• | Azure contributed the Legacy System to the Partnership through the contribution, indirectly or directly, of (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure (“Talco”) and (ii) certain assets (the “TGG Assets”) owned by TGG Pipeline, Ltd., a Texas limited liability company and subsidiary of Azure (“TGG”), in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of a cash payment of $99.5 million and in the form of the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”). |
• | Azure purchased from NuDevco (i) all of the outstanding membership interests in the GP for $7.0 million (the “GP Purchase,”) and (ii) an option to acquire up to 20% of each of the common units and subordinated units of the Partnership held by NuDevco as of the execution date of the Transaction Agreement (the “Option,” together with the Redemption, Contribution and GP Purchase, the “Transactions”) for aggregate cash consideration of $7.0 million. |
Contemporaneously with the Transactions, the Partnership entered into a new senior secured revolving credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC (collectively, the “Lenders”). The Credit Agreement has a maturity date of February 27, 2018 and up to $250.0 million in commitments.
The Partnership immediately borrowed $180.8 million under the Credit Agreement, of which $99.5 million was paid in connection with the Contribution, $63.0 million was paid in connection with the Redemption, $15.0 million was used to repay the outstanding balance as of February 27, 2015 under the Partnership’s existing senior secured revolving credit facility and $3.3 million was used to pay fees and expenses associated with the Credit Agreement. Associated Energy Services ("AES"), a wholly owned subsidiary of NuDevco and an affiliate of the Partnership, immediately pledged $15.0 million of the $63.0 million received as part of the Redemption as collateral for a letter of credit supporting the logistics segment transloading services agreements.
8
Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
Contribution of the ETG System
On August 6, 2015, the Partnership entered into a contribution agreement (the “Contribution Agreement”) with Azure which is the sole member of the general partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in Azure ETG, LLC ("Azure ETG"), to the Partnership in exchange for the consideration described below. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of the ETG System was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | As consideration for the membership interests of Azure ETG, the Partnership paid Azure $80.0 million in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure. |
• | The Partnership entered into a gas gathering agreement with TGG, an indirect subsidiary of Azure. |
The ETG System includes approximately 255 miles of gathering pipelines, two treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. A total of 336,000 gross acres in the Haynesville Shale and Bossier Shale formations are dedicated to the ETG System under 23 long-term producer contracts.
The Partnership financed the cash consideration paid for Azure ETG with an $80.0 million draw from its credit facility.
Azure Midstream Holdings LLC
On November 15, 2013, Azure Holdings acquired 100% of the equity interests in Talco and TGG (collectively “TGGT”) for an aggregate sales price of $910.0 million, plus customary working capital adjustments, from EXCO Resources, Inc. (“EXCO”) and BG Group plc (“BG”). As part of the acquisition of TGGT, members of Azure Holdings management, Energy Spectrum Partners VI LP, and its parallel and co‑investment funds (“Energy Spectrum Partners”), a group of co‑investors affiliated with Energy Spectrum Partners (the “Co‑Investors”) and an affiliate of Tenaska Capital Management, LLC (“Tenaska Capital Management” and collectively with the members of management, Energy Spectrum Partners and the Co‑Investors, the “Azure Members”) contributed a combined $410.0 million in cash for an ownership interest in Azure. In a related transaction, TPF II East Texas Gathering, LLC (“ETG”), a business managed by Tenaska Capital Management, was contributed to Azure Holdings in exchange for a $90.0 million additional ownership interest in Azure Holdings valued at $90.0 million (the “ETG Contribution”). The acquisition of TGGT and the ETG Contribution are collectively referred to as the ("Acquisition").
Subsequent to the Acquisition, TGGT and ETG are indirectly owned and operated by Azure Holdings through its wholly owned subsidiary, Azure Midstream Energy, LLC.
The Legacy System and ETG System are part of Azure Holdings, and have been carved‑out and derived from the accounting records of Azure Holdings for periods subsequent to the Acquisition.
Azure Predecessor
The Azure Predecessor was formed on August 14, 2009, arising from a transaction between EXCO and BG. EXCO contributed TGGT to the Azure Predecessor in exchange for membership interest. EXCO then sold 50% of its membership
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interest in the Azure Predecessor to BG for cash consideration. Upon formation, EXCO and BG each funded initial operations of the Azure Predecessor. The Azure Predecessor’s consolidated financial statements are comprised of the TGGT assets, liabilities and results of operations as of and for all periods prior to the Acquisition as TGGT is the predecessor of Azure Holdings for accounting purposes.
Azure System Predecessor
The Azure System Predecessor includes the Legacy System entities and assets, and has been carved‑out and derived from the accounting records of TGGT for the periods prior to the Acquisition.
Nature of Business
The Legacy System is comprised of midstream assets primarily located within Harrison, Panola and Rusk counties in Texas and Caddo parish in Louisiana. These midstream assets currently serve the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation. As of December 31, 2014, the Legacy System consisted of approximately 658 miles of high‑and low‑pressure gathering lines, ten 1,340 horsepower compressors and two additional compressors comprising 725 horsepower, for a total of 14,125 horsepower of compression. The Legacy System has access to four third‑party processing plants, including the Carthage Hub, which serve as a connection point for a number of intrastate and interstate pipelines.
The ETG System is primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby counties in East Texas and currently serves multiple formations including the Haynesville, Bossier and liquids –rich James Lime formation. The ETG system consists of approximately 255 miles of gathering lines and serves approximately 336,000 gross dedicated acres. The system has two owned treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. The new Fairway processing plant is designed to extract NGL content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Basis of Presentation
As a result of the Transactions, Azure acquired a controlling financial interest in the Partnership through the GP Purchase. Azure is considered the accounting acquirer of the GP, and therefore will record its acquisition of the GP as a business combination within Azure’s consolidated financial statements. The Legacy System is deemed to be the accounting acquirer of the Partnership because its parent company, Azure, obtained control of the Partnership through the indirect control of the GP. Consequently, the Legacy System is deemed to be the predecessor of the Partnership for financial reporting purposes, and the Legacy System's assets and liabilities will retain their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Legacy System in the business combination will be recorded at their fair values measured as of the acquisition date. The excess of the assumed purchase price of the Partnership, which has been determined using acceptable fair value methods and is partially based on the consideration Azure paid for the general partner interests and the IDR Units, over the estimated fair values of the Partnership's net assets acquired will be recorded as goodwill.
Additionally, because the Legacy System is reflected at Azure’s historical cost, the difference between the $162.5 million in consideration paid by the Partnership and Azure's historical carrying values (net book value) at February 27, 2015 was recorded as an adjustment to partners’ capital on a pro-rata basis.
The operating results and the majority of the assets and liabilities of the Azure System and the Azure System Predecessor have been specifically identified based on the existing divisional organization of Azure Holdings and the Azure
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Predecessor. Certain assets, liabilities and expenses presented in the carve‑out statements of financial position and statements of operations represent allocations and estimates of the costs of services incurred by either Azure Holdings or Azure Predecessor. These allocations and estimates were based on methodologies that management believes to be reasonable, and include items such as outstanding debt and related expenses associated with the Azure and Azure Predecessor credit agreements and general and administrative expenses incurred by Azure Holdings and the Azure Predecessor on behalf of the Azure System. See the accompanying notes for discussions of the specific allocation methodology applied to debt and related charges and others.
Revenues have been identified by contracts that are specifically identifiable to the Azure System and the Azure System Predecessor. Depreciation and amortization are based upon assets specifically identified to the Azure System and Azure System Predecessor. Salaries, benefits and other general and administrative costs have been allocated to the Azure System based on management’s use of a reasonable allocation methodology as such costs were historically not allocated to the Azure System and the Azure System Predecessor.
Azure Holdings and Azure Predecessor’s direct investment in the Azure System and the Azure System Predecessor is presented as parent company net investment in the Azure System Carve‑Out Consolidated Financial Statements and includes the accumulated net earnings and accumulated net contributions from Azure Holdings and Azure Predecessor, including allocated long‑term debt, interest expense and general and administrative expenses.
The acquisition of the ETG System is considered a transfer of net assets between entities under common control. The acquisition of the ETG System is recorded at amounts based on the historical carrying value of these assets at that date, and the Partnership is required to update its historical financial statements to include the activities of the ETG System as of the date of common control. The Partnership’s accompanying historical financial statements have been retrospectively updated to reflect the effects on financial position, cash flows and results of operations attributable to the activities of the ETG System as if the Partnership owned these assets for these periods.
The Azure System Carve‑Out Consolidated Financial Statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These principles are established by the Financial Accounting Standards Board. The preparation of the Azure System Carve‑Out Consolidated Financial Statements in accordance with GAAP requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities for the periods presented herein. The Azure System Carve‑Out Consolidated Financial Statements reflect the application of purchase accounting related to the acquisition of a controlling interest in TGGT and ETG, including the Legacy System and ETG System, effective as of November 15, 2013. The Azure System Predecessor consolidated financial statements are comprised of the Legacy System assets, liabilities and results of operations as of and for all periods prior to the Acquisition and relates to the period under Azure Predecessor ownership.
Operating Segments
The Azure System's chief operating decision-maker ("CODM") is the Azure president. The chief operating decision-maker reviews financial information presented in an aggregated manner in order to make decisions about the Azure System's resource allocations and to assess its performance. Accordingly, the Azure System has one reportable segment.
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(2) Summary of Significant Accounting Policies
Use of Estimates
The Azure System Carve‑out Consolidated Financial Statements have been prepared in conformity with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates, the reported amounts of revenue and expense, including fair value measurements, and disclosure of contingencies. Although management believes these estimates are reasonable, actual results could differ from its estimates.
Cash and Cash Equivalents
The Azure System utilizes Azure Holdings and the Azure Predecessor’s centralized processes and systems for cash management, payroll, purchasing and expenditures. As a result, cash generated by and cash received by the Azure System were deposited in and commingled with the general corporate funds of the respective period’s owner and is or was not specifically allocated to the Azure System. The net results of these cash transactions between the Azure System and the respective period’s owner are reflected in parent company’s net investment in the carved‑out balance sheets. Changes in long‑term debt associated with the Azure Credit Agreement (as defined in Note 6) is assumed as a cash borrowings or repayments in the statements of cash flows.
Trade Accounts Receivable
Trade accounts receivables are specifically identified based on contracts assigned by Azure Holdings to the Azure System and primarily represent receivables for gathering, compression, treating and other services provided to natural gas producers as well as natural gas and natural gas liquid ("NGL") sales receivable from third parties.
Allowance for Doubtful Accounts
In evaluating the collectability of accounts receivable, management performs ongoing credit evaluations of the Azure System’s customers and adjusts payment terms based upon payment history and each customer’s current creditworthiness, as determined by management’s review of such customer’s credit information, detailed analysis of the expected collectability of accounts receivable that are past due and the expected collectability of overall receivables. The allowance for doubtful accounts was not material to the Azure System Carve-Out Consolidated Financial Statements as of December 31, 2014 and 2013.
Concentration of Credit Risk
Financial instruments that potentially subject the Azure System to concentrations of credit risk are primarily trade accounts receivables. The Azure System performs ongoing credit evaluations of its customers’ financial condition. Declines in oil and gas prices have resulted in reductions in capital expenditure budgets of oil and gas exploration and development companies and could impact the financial condition of the Azure System’s customers.
Property, Plant and Equipment, Net
Property, plant and equipment is specifically identified based on authorization for expenditures for the Azure System and is recorded at its original cost of construction or, upon acquisition, at fair value of the assets acquired. Expenditures for maintenance and repairs that do not add capacity or extend the useful life of an asset are expensed as incurred. Expenditures to extend the useful lives of the assets or enhance their productivity or efficiency from their original design are capitalized over the expected remaining period of use. The carrying value of the assets is based on estimates, assumptions and judgments relative to
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useful lives and salvage values. Sales or retirements of assets, along with the related accumulated depreciation, are removed from the accounts and any gain or loss on disposition is included in the statement of operations. The Azure System gas gathering asset capital expenditures for the periods presented have been reduced by amounts reimbursed by producers for well connection costs.
Depreciation of property, plant, and equipment is recorded on a straight‑line basis over the estimated useful lives of the assets. These estimates are based on various factors including age (in the case of acquired assets), manufacturing specifications, technological advances and historical data concerning the useful lives of similar assets. In connection with the Acquisition, purchase accounting was applied to the Azure System assets acquired and liabilities assumed and an appropriate estimate for the useful lives of the assets acquired was determined. The Azure Holdings estimate of useful lives was different than the useful lives assigned to these assets by the Azure Predecessor.
Impairment of Long‑Lived Assets
Relevant accounting guidance requires long lived assets to be reviewed whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In order to determine whether an impairment has occurred, we compare the net book value of the asset to the estimated undiscounted future net cash flows related to the asset. Our estimate of undiscounted cash flows is based on assumptions regarding the purchase and resale margins on natural gas, volume of gas available to the asset, markets available to the asset, operating expenses, and prices of NGLs. The amount of availability of natural gas to an asset is sometimes based on assumptions regarding a producer’s future drilling activity, which may be dependent in part on natural gas prices. Projections of gas volumes and future commodity prices are inherently subjective and contingent upon a number of variable factors. Any significant variance in any of the above assumptions or factors could materially affect our cash flows, which could require us to record an impairment of an asset.
If an impairment has occurred, the amount of the impairment is determined based on the expected future net cash flows discounted using a rate management believes a market participant would assume is reflective of the risk associated with achieving the underlying cash flows.
Deferred Financing Costs
Deferred financing costs are capitalized and amortized as interest expense under the effective interest method over the term of the related debt. The unamortized balance of deferred financing costs is included in other assets on the balance sheets. All deferred financing costs have been allocated from Azure and are associated with the Azure Credit Agreement (see Note 6).
Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities primarily represent open invoices as of period end that are specifically identified for the Azure System and the Azure System Predecessor based on authorization for expenditures using the same information as for property, plant and equipment. Accrued liabilities are allocated to the Azure System and Azure System Predecessor based on historical analysis of invoices by authorization for expenditures in the period of services rendered.
Fair Value of Financial Instruments
Accounting guidance requires the disclosure of the fair value of all financial instruments that are not otherwise recorded at fair value in the consolidated financial statements. At December 31, 2014 and 2013, financial instruments recorded at contractual amounts that approximate fair value include accounts receivable, accounts payable and accrued expenses. The fair values of such items are not materially sensitive to shifts in market interest rates because of the short term to maturity of
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these instruments. The fair value of the debt funded through the Azure Credit Agreement or the Azure Predecessor Credit Agreement and allocated to the Azure System approximates its carrying amount as of December 31, 2014 and 2013 primarily due to the variable nature of the interest rate of the instrument. The fair value of the debt is considered a Level 2 fair value measurement.
Asset Retirement Obligations
Accounting standards related to asset retirement obligations require us to evaluate whether any future asset retirement obligations exist as of December 31, 2014 and 2013, and whether the expected retirement date of the related costs of retirement can be estimated. We have concluded that Azure System and Azure System Predecessor natural gas gathering assets, which include pipelines, compression facilities and treating facilities, have an indeterminate life because they are owned and will operate for an indeterminate future period when properly maintained. A liability for these asset retirement obligations will be recorded only if and when a future retirement obligation with a determinable life is identified. The Azure System Carve‑Out Consolidated Financial Statements did not provide any asset retirement obligations as of December 31, 2014 or 2013 because management of the Azure System did not have sufficient information to reasonably estimate such obligations, and had no intention of discontinuing use of any significant assets.
Gas Imbalances
Quantities of natural gas over delivered or under delivered related to imbalance agreements are recorded monthly as accounts receivable or accounts payable using an estimated price based on current market prices, an index to current market prices or the weighted average prices of natural gas at the plant or system pursuant to imbalance agreements for which settlement prices have yet to be finalized. Dependent on imbalance contract terms within certain volumetric limits, imbalances may be settled by deliveries of natural gas.
Revenue Recognition
Primary revenue producing activities are the sales of natural gas and NGLs purchased from third parties, for which the Azure System and the Azure System Predecessor takes title, and the sale of condensate liquids. Natural gas revenues arise from transactions that are completed under contracts with limited commodity price exposure, and we elect the normal purchases and normal sales exemption on all such transactions for accounting purposes. The Azure System and the Azure System Predecessor receives a market price per barrel on our revenue from natural gas condensate liquids. We report the natural gas and condensate revenues and the associated purchases and expenses on a gross basis within our statement of operations. The cost of natural gas purchased from third parties is reported as a component of operating costs and expenses.
Secondarily, the Azure System and the Azure System Predecessor earns gathering services and other fee revenues from the transportation, gathering, compression and treating of natural gas. These gathering services and other fees are generally provided on a fixed fee basis per unit based on the volumes (Mcf) or heating content (MMBtu) of natural gas.
Revenue from all services and activities are recognized when all of the following criteria are met: (i) persuasive evidence of an exchange arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) collectability is reasonably assured.
The ETG System has a natural gas gathering agreement with a customer that provides for a minimum revenue commitment (“MRC”). Under the MRC, our customer agrees to pay a minimum monetary amount over certain periods during the term of the MRC. The customer must make a deficiency payment to us at the end of the contract year if its actual revenues are less than its MRC for that year. The customer is entitled to utilize the deficiency payments to offset gathering fees in the
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following periods to the extent that such customer’s revenues in the following periods exceed its MRC for that period. This contract provision ranges for the entire duration of the gas gathering agreement, which is ten years. We record customer billings for obligations under the MRC (solely with respect to this natural gas gathering agreement) as deferred revenue when the customer has the right to utilize deficiency payments to offset gathering fees in subsequent periods. We recognize deferred revenue under this arrangement as revenue once all contingencies or potential performance obligations associated with the related revenues have either (i) been satisfied through the gathering of future excess volumes of natural gas, or (ii) expired (or lapsed) through the passage of time pursuant to the terms of the natural gas gathering agreement. We classify deferred revenue as noncurrent where the expiration of the customer’s right to utilize deficiency payments is greater than one year. As of December 31, 2014 and 2013, deferred revenue under the MRC agreement was $5.4 million and $1.1 million, respectively, and is included within other long term liabilities. No deferred revenue amounts under these arrangements were recognized as revenue during the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013.
Income Taxes
No provision for federal or state income taxes is included in the Azure System Carve‑out Consolidated Financial Statements as such income is taxable directly to the partners owning the Azure System and the Azure System Predecessor. Each partner is responsible for its share of federal and state income tax. Net earnings for financial statement purposes may differ significantly from taxable income reportable to each partner as a result of differences between the tax basis and financial reporting basis of assets and liabilities.
The Azure System and the Azure System Predecessor are subject to the Texas gross margin tax. The taxes owed in respect of the Azure System and Azure System Predecessor are reflected in the Azure System’s parent’s consolidated Texas franchise tax return. The current tax liability is assessed based on the gross revenue apportioned to Texas. Differences in amounts included in the determination of taxable gross margin for book and tax purposes result in deferred tax assets and liabilities. There were no deferred tax amounts incurred or recorded as of December 31, 2014 or 2013.
Uncertain Tax Positions
The tax positions taken or expected to be taken in the course of preparing the consolidated financial statements are evaluated to determine whether the tax positions are more likely than not of being sustained by the applicable tax authority. Tax positions deemed not to meet the more likely than not threshold would be recorded as a tax benefit or expense in the current year. Management believes that there are no uncertain tax positions for the Azure System Carve‑out Consolidated Financial Statements.
Environmental Liabilities
The operations of Azure System and the Azure System Predecessor are subject to various federal, state, and local laws and regulations relating to the protection of the environment. Although management of the Azure System believes that it is in compliance with applicable environmental regulations, the risk of costs and liabilities are inherent in pipeline ownership and operation, and there can be no assurances that significant costs and liabilities will not be incurred by the Azure System. Management is not aware of any contingent liabilities that currently exist with respect to environmental matters.
The Azure System’s policy is to accrue for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. Accruals for estimated losses from environmental remediation obligations generally are recognized no later than completion of the remedial feasibility study. Such accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not
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discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable.
Commitments and Contingencies
The carve‑out financial results of the Azure System and the Azure System Predecessor may be affected by judgments and estimates related to loss contingencies. Accruals for loss contingencies are recorded when management determines that it is probable that an asset has been impaired or a liability has been incurred and that such economic loss can be reasonably estimated. Such determinations are subject to interpretations of current facts and circumstances, forecasts of future events, and estimates of the financial impacts of such events. There are no material commitments and contingencies as of December 31, 2014 and 2013 associated with the Azure System.
Parent Company Net Investment
Azure Holdings and Azure Predecessor’s net investment in the operations of the Azure System is presented as parent company net investment in the Azure System Carve‑Out Consolidated Financial Statements. Parent company net investment represents the accumulated net earnings of the operations and the accumulated net contributions from Azure Holdings and the Azure Predecessor. Net contributions from Azure Holdings and Azure Predecessor at December 31, 2014 and 2013 were primarily comprised of intercompany operations and maintenance expense, cash clearing and other financing activities, and debt and general and administrative costs allocations to the Azure System.
Earnings Per Unit
Earnings per unit has not been presented because the Azure System and Azure System Predecessor's respective owners hold interests and not units.
Recent Accounting Pronouncements
Accounting standard‑setting organizations frequently issue new or revised accounting rules and pronouncements. We regularly review new accounting rules and pronouncements to determine their impact, if any, on our consolidated financial statements.
In May 2014, the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards (IFRS). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In July 2015, the FASB voted to approve a one-year deferral of the effective date for the new revenue standard, making the requirements of the standard effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The adoption could have a significant impact on the Azure System consolidated financial statements, however management of the Azure System is currently unable to quantify the impact.
There are currently no other recent pronouncements that have been issued that the Azure System believes will materially affect its consolidated financial statements.
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(3) Acquisitions
Legacy System
On November 15, 2013, Azure Holdings purchased TGGT from EXCO and BG, and was contributed ETG from Tenaska Capital Management, for a total purchase price of $1.0 billion, plus customary working capital adjustments. Both TGGT and ETG are engaged in natural gas gathering, processing, compression, treating, transportation and related services in North Louisiana and East Texas. The Legacy System assets and operations were a part of the TGGT legal entities and have been carved‑out from the assets and operations of Azure Holdings.
For purposes of the Azure System Carve‑Out Consolidated Financial Statements, we have allocated a portion of the total purchase price to the Legacy System assets acquired based on their estimated fair values at the acquisition date. The fair values of the assets and liabilities are based on assumptions related to expected future cash flows, discount rates and asset lives using currently available information. We utilized a mix of the cost, income and market approaches to determine the estimated fair values of such assets and liabilities. The fair value measurements and models have been classified as nonrecurring Level 3 measurements. There was no goodwill allocated to the Legacy System because it was determined that the purchase price allocated to the Legacy System was equal to the fair value of the Legacy System net assets acquired.
The following table summarizes the amount of consideration paid for in the acquisition and the amounts of estimated fair value of the assets acquired and liabilities assumed at the acquisition date that have been allocated to the Legacy System for purposes of the Azure System Carve‑Out Consolidated Financial Statements.
Purchase Price Allocation to Legacy System (In Thousands) | |||
Cash paid by Azure Midstream Holdings LLC for Legacy System | $ | 212,515 | |
Assets Acquired: | |||
Total tangible assets | $ | 213,426 | |
Net working capital assumed | (911 | ) | |
Total Purchase Price | $ | 212,515 | |
ETG System
On August 6, 2015, the Partnership announced it has acquired 100% of the equity interests of the entity that owns the ETG System for total cash consideration of $83.0 million, subject to customary purchase price adjustments. This acquisition was financed with an $80.0 million draw from the Partnership’s Credit Agreement and the issuance of 255,319 common units representing limited partner interests in the Partnership to the GP of the Partnership, on behalf of Azure.
On November 15, 2013, Tenaska Capital Management contributed ETG to Azure Holdings for a total purchase price of $90.0 million, plus customary working capital adjustments. Tenaska Capital Management was issued a $90.0 million equity interest in Azure Holdings in exchange for ETG . The fair value of the equity interest issued was determined based upon the cash amount paid for the remaining interest in Azure Holdings. The ETG System is engaged in natural gas gathering, processing, compression, treating, transportation and related services in North Louisiana and East Texas. The ETG System assets and operations have been carved out from the assets and operations of Azure Holdings.
For purposes of the Azure System Carve-Out Consolidated Financial Statements, we have allocated the total purchase price to the ETG System assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The
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Notes to the Consolidated Financial Statements
fair values of the assets and liabilities are based on assumptions related to expected future cash flows, discount rates and asset lives using currently available information. We utilized a mix of the cost, income and market approaches to determine the estimated fair values of such assets and liabilities. The fair value measurements and models have been classified as nonrecurring Level 3 measurements. There was no goodwill allocated to the ETG System because it was determined that the purchase price allocated to the ETG System was equal to the fair value of the ETG System net assets acquired.
The following table summarizes the amount of consideration paid for in the acquisition and the amounts of estimated fair value of the assets acquired and liabilities assumed at the acquisition date that have been allocated to the ETG System for purposes of the Azure System Carve-Out Consolidated Financial Statements.
Purchase Price Allocation to ETG System (In Thousands): | |||
Cash paid by Tenaska Capital | $ | (1,460 | ) |
Equity issued to Tenaska Capital | 90,000 | ||
Total purchase price | $ | 88,540 | |
Assets acquired: | |||
Current assets | $ | 3,392 | |
Property, plant and equipment | 90,000 | ||
Liabilities assumed: | |||
Current liabilities | (3,784 | ) | |
Other long-term liabilities | (1,068 | ) | |
Total purchase price | $ | 88,540 | |
Azure Holdings recognized $6.1 million of transaction costs during the period from November 15, 2013 to December 31, 2013 as a result of the Acquisition. These transaction costs have not been allocated to the Azure System Carve-Out Consolidated Financial Statements.
Azure System Predecessor
The Azure System Predecessor received an offer to purchase the Danville Gathering System during the fiscal year 2012, and in December 2012 the Danville Gathering System was sold for $7.5 million. The net book value of the Danville gathering system was $13.0 million, resulting in an impairment charge of $5.5 million.
(4) Accounts Receivable and Concentration of Credit Risk
The Azure System and Azure System Predecessor’s primary markets are in the North Louisiana and East Texas natural gas supply basins, and it delivers natural gas to major intrastate and interstate pipelines in these regions. The Azure System has a concentration of revenues and trade accounts receivable due from customers engaged in the production, trading, distribution and marketing of natural gas and condensate. These concentrations may affect overall credit risk in that these customers may be affected similarly by changes in the economic, regulatory, environmental or other factors. The Azure System analyzes its customers’ historical financial and operational information before extending credit. The Azure System Predecessor’s concentration of credit risk was not materially different than that of the Azure System.
The Azure System had four customers that individually represented greater than 10% of total operating revenues during the year ended December 31, 2014 totaling 59%. BP plc ("BP") and Conoco Phillips ("Conoco") represented 37% of total operating revenues while Texla Energy Management, Inc. ("Texla") and Waskom Gas Processing Company represented 22%. The Azure System had three customers that individually represented greater than 10% of total operating revenues during the period from November 15, 2013 to December 31, 2013, with Tenaska, BP and Texla representing 49%; and the Azure
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System Predecessor had four customers that individually represented greater than 10% of total operating revenues during the period from January 1, 2013 to November 14, 2013 with BP and Texla representing 33% and Tenaska and MarkWest Energy Partners representing 25%. The Azure System Predecessor had three customers that individually represented greater than 10% of total operating revenues for the year ended December 31, 2012, specifically Exco, Houston Pipeline Company, and Tenaska represented 47%, during the period.
As of December 31, 2014, BP represented 47% of the Azure System accounts receivable. As of December 31, 2013, BP represented 27% of the Azure System accounts receivable.
(5) Property, Plant and Equipment, Net
Property, plant and equipment, net consisted of the following as of each respective period:
Azure System | ||||||||||||
Estimated Useful | December 31, | |||||||||||
Life (years) | 2014 | 2013 | ||||||||||
Pipelines | 45 | $ | 278,548 | $ | 279,871 | |||||||
Buildings | 30 | 2,058 | 2,058 | |||||||||
Gas processing and compression facilities | 20 | 28,357 | 17,867 | |||||||||
Other depreciable assets | 5 - 15 | 2,405 | 2,370 | |||||||||
Total property, plant and equipment | 311,368 | 302,166 | ||||||||||
Accumulated depreciation | (8,915) | (958) | ||||||||||
Total | 302,453 | 301,208 | ||||||||||
Construction in progress | 895 | 747 | ||||||||||
Land and other | 827 | 208 | ||||||||||
Property, plant and equipment, net | $ | 304,175 | $ | 302,163 | ||||||||
Depreciation is provided using the straight‑line method based on the estimated useful life of each asset. The Azure System estimated useful lives were different than the estimated useful lives assigned by the Azure System Predecessor. Depreciation expense recognized by the Azure System for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 was $8.0 million and $1.0 million, respectively. Depreciation expense recognized by the Azure System Predecessor for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 was $9.9 million and $11.2 million, respectively.
Long Lived Asset Impairments
Azure System
The Azure System recognized an asset impairment of $0.2 million during the year ended December 31, 2014 as a result of adjusting the carrying value of the assets held for sale to their net realizable fair value. The Azure System had no impairments during the period from November 15, 2013 to December 31, 2013.
Azure System Predecessor
The Azure System Predecessor recognized asset impairments of $0.7 million during the period from January 1, 2013 to November 14, 2013. The asset impairments were a result of adjusting the carrying value of assets held for sale to their net realizable fair value. The Azure System Predecessor recognized asset impairments of $5.7 million during the year ended
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December 31, 2012. The asset impairments were associated with the Danville Gathering System, discussed within Note 3, and the result of adjusting the carrying value of assets held for sale to their net realizable fair value.
(6) Long Term Debt
Azure Credit Agreement
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (“TLB”) maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (Revolver and collectively with the TLB, the “Azure Credit Agreement”) with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement are unconditionally guaranteed, jointly and severally, by all of the Azure subsidiaries, including the Legacy System, and are collateralized by first priority liens on substantially all of existing and subsequently acquired assets and equity.
Under the TLB, borrowings bear interest at Azure’s option of either the (i) monthly Eurodollar Rate, which is the British Bankers Association London Inter Bank Offered Rate and cannot be less than 1% per year or (ii) the Alternative Base Rate (ABR), which is the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Rate; plus 0.50% or (c) the 30‑day Eurodollar Rate; plus 1.0%; plus the applicable Eurodollar margin or the ABR margin which is 5.5% and 4.5%, respectively. Azure elected the Eurodollar Rate and Eurodollar margin for the TLB for the year ending December 31, 2014 and the period from November 15, 2013 to December 31, 2013. For the Revolver, borrowings bear interest under the same terms as the TLB and the applicable Eurodollar margin and ABR margin vary quarterly based on Azure Holdings consolidated leverage ratio. The weighted average interest rate for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 was 6.50%. Total outstanding borrowings associated with the Azure Credit Agreement were $522.5 million and $550.0 million as of December 31, 2014 and December 31, 2013, respectively, of which $27.5 million is due within one year. As of December 31, 2014 and 2013, all outstanding borrowings were associated with the TLB and there were no outstanding borrowings under the Revolver during either period.
In September 2014, Azure Holdings and Azure entered into the first amendment to the Azure Credit Agreement (the "First Amendment"). Among other things, the First Amendment reduced borrowing capacity under the Revolver from $50.0 million to $40.0 million and provided for more favorable financial condition covenants. A loss on the extinguishment of debt in the amount of $0.3 million was recognized by Azure Holdings as a result of the First Amendment, and a portion, $0.1 million, of the loss on the extinguishment of debt has been allocated to the Legacy System and is included within interest expense.
Azure Predecessor Credit Agreement
The Azure Predecessor had a $600.0 million senior secured credit facility (the "Predecessor Credit Agreement"). Borrowings under the Predecessor Credit Agreement were unconditionally guaranteed, jointly and severally, by all of the Azure Predecessor’s subsidiaries, including the Legacy System Predecessor, and were collateralized by first priority liens on substantially all of the existing and subsequently acquired assets and equity.
The weighted average interest rate associated with the Predecessor Credit Agreement for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 was 2.42% and 2.72%, respectively. Outstanding borrowings associated with the Predecessor Credit Agreement averaged $446.6 million and $512.1 million for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, respectively.
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Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
Azure System and Azure System Predecessor Long‑Term Debt and Related Expenses Allocation
The Azure Credit Agreement and the Predecessor Credit Agreement served as the sole borrowing agreement applicable for the Azure System and the Azure System Predecessor during the periods presented. In addition, substantially all of Azure Holdings and the Azure Predecessor’s subsidiaries, including the Azure System and the Azure System Predecessor, served as guarantors and pledges with respect to the Azure Credit Agreement and the Predecessor Credit Agreement.
The Azure System and the Azure System Predecessor’s long‑term debt and related expense balances represent an allocation of its proportionate share of the Azure and Azure Predecessor’s consolidated long‑term debt as of and for all periods presented. Substantially all of the Azure System and Azure System Predecessor’s capital expenditures, including $550 million used to fund a portion of the Acquisition, were financed by the Azure Credit Agreement or the Predecessor Credit Agreement during these respective periods. As a result, the long‑term debt and related expense balances presented within the Azure System Carve‑Out Consolidated Financial Statements represent the Azure System and the Azure System Predecessor’s proportionate share using proportional book value of the Azure System and the Azure System Predecessor’s assets as a percentage of total assets financed by the Azure Credit Agreement and the Predecessor Credit Agreement, respectively. The long-term debt allocated to the Azure System as of December 31, 2014 and 2013 was $192.0 million and $202.1 million, respectively.
In connection with entering into the Azure Credit Agreement and the Predecessor Credit Agreement, Azure and the Azure Predecessor incurred financing costs. These deferred financing costs were being amortized to interest expense over the term of the loan. Applying the same allocation methodology as the long‑term debt balances, the Azure System’s deferred finance costs at December 31, 2014 and 2013 were $6.0 million and $7.7 million, respectively. Amortization expense associated with these deferred finance costs was $1.8 million, $0.2 million, $0.3 million and $0.7 million for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, respectively.
The estimated remaining principal payments associated with the Azure Credit Agreement that will be allocated to the Azure System are $10.1 million for the fiscal years 2015, 2016 and 2017, and the remaining principal balance is due upon maturity in 2018.
The Azure System and Azure System Predecessor’s interest expense has also been calculated in a similar allocation methodology as long‑term debt.
(7) Lease Obligations
The Azure System leases compression and treating equipment and these leases are accounted for as operating leases. Total rent expense for operating leases, including those with terms of less than one year, was $3.2 million and $0.6 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, respectively.
The following table is a schedule of future minimum lease payments for leases that had initial or noncancelable lease terms in excess of one year as of December 31, 2014.
Amount | |||
Year | (In Thousands) | ||
2015 | $ | 2,584 | |
2016 | 1,204 | ||
2017 | 156 | ||
2018 | 153 | ||
Thereafter | 763 | ||
$ | 4,860 | ||
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Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
The Azure System Predecessor also leased compression and treating equipment and these leases were accounted for as operating leases. Total rent expense for operating leases, including those with terms of less than one year, was $1.2 million and $2.3 million for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, respectively.
(8) Commitments and Contingencies
Legal Matters
Azure System
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties, or from other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. Legal costs related to any such contingencies are expensed as incurred. Accruals for estimated losses are adjusted as further information develops or as circumstances change. At December 31, 2014 and December 31, 2013, the Azure System did not have an accrual related to contractual disputes.
During the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, Azure Holdings and its subsidiaries has been a party to litigation arising from events occurring during the normal course of business. While we are unable to estimate the range of exposure, we believe that there is no significant exposure to the Azure System arising out of these matters. At December 31, 2014 and 2013, the Azure System had no active litigation matters that management believes will have a material adverse impact on its results of operations, financial condition or cash flows.
Azure System Predecessor
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties, or from other sources were recorded by the Azure Predecessor when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. Legal costs related to any such contingencies were expensed as incurred. Accruals for estimated losses are adjusted as further information develops or as circumstances change. The Azure System Predecessor had no such loss contingencies during the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012.
Regulatory Compliance
In the ordinary course of business, the Azure System and Azure System Predecessor are subject to various laws and regulations. In the opinion of management, compliance with current laws and regulations will not have a material effect on our results of operations, cash flows or financial condition.
Commitments
The Azure System and certain related parties were co‑guarantors of the Credit Agreement as of December 31, 2014 and 2013. The amounts outstanding under the Credit Agreement were $522.5 million and $550.0 million as of December 31, 2014 and 2013, respectively.
(9) Related Party Transactions
EXCO and BG are considered related parties of the Azure System for financial reporting purposes as a result of their combined 7% ownership interest in Azure Holdings. The Azure System also provides services to an affiliate of Tenaska Capital Management, which is also considered a related party. For the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, the Azure System recorded revenues from these affiliates in the amount of $5.0
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Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
million and $1.0 million, respectively. As of December 31, 2014 and 2013, accounts receivable from these affiliates were $0.1 million and $0.9 million, respectively.
EXCO and BG were also considered related parties of the Azure System Predecessor as a result of their combined 100% ownership interest in the Azure Predecessor. For the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, the Azure System Predecessor recorded revenues from these affiliates in the amount of $1.6 million and $12.7 million.
Allocated Expenses
Substantially all of the Azure System’s senior management is employed by Azure Holdings, and certain functions critical to the Azure System’s operations are centralized and managed by Azure Holdings. Additionally, the Azure System resides in office space provided by Azure Holdings. As a result, 42.5% of the total consolidated Azure Holdings’ general and administrative expenses have been allocated to the Azure System for the periods presented. The Azure System allocated general and administrative expenses from Azure were $5.8 million and $0.3 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, respectively. The ETG System allocated operating expense labor from Azure was $1.3 million and $0.1 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013.
This allocation represents management’s best estimate of the general and administrative expenses incurred on behalf of the Azure System and was determined after consideration of multiple operating metrics, including dedicated operating personnel, pipeline mileage and system throughput as a percentage of each total consolidated Azure’s operating metric. Management of the Azure System and Azure believe these allocations reasonably reflect the utilization of services provided and benefits received. The allocated costs are included within general and administrative expense and operating expense in the statements of operations.
The Azure System Predecessor allocated general and administrative expenses from the Azure Predecessor has been calculated under the same methodology as the Azure System, and for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 the amount of allocated general and administrative expense was $3.6 million and $5.7 million, respectively, which is included within general and administrative expenses.
See notes 2 and 6 for a discussion of long‑term debt and interest allocated from Azure and the Azure Predecessor to the Azure System and Azure System Predecessor.
(10) | Supplemental Footnote Information |
Supplemental Cash Flow Information | ||||||
Year Ended December 31, 2014 | Period from November 15, 2013 to December 31, 2013 | |||||
Supplemental schedule of noncash investing and financing activities: | ||||||
Noncash capital expenditures included in accounts payable and | ||||||
accrued liabilities | $ | — | $ | 1,655 | ||
Members' equity issued for property and equipment in the Acquisition | $ | — | $ | (90,000 | ) | |
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Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
(11) Subsequent Events
On February 27, 2015, in connection with the consummation of the Transactions discussed in Note 1, the Partnership entered into the Credit Agreement and immediately borrowed $180.8 million. The Partnership used the initial borrowings to fund (i) the $99.5 million paid in connection with the Contribution, (ii) the $63.0 million paid in connection with the Redemption, (iii) the $15.0 million payment to repay the outstanding balance under the Partnership’s existing senior secured credit facility as of February 27, 2015 and (iv) the $3.3 million in fees associated with the Credit Agreement. AES immediately pledged $15.0 million of the $63.0 million received as part of the Redemption as collateral for a letter of credit supporting the Partnership's transloading services agreements associated with its logistics segment. Substantially all of the Partnership’s assets, including the Legacy System, are pledged as collateral under the Credit Agreement.
The Transactions resulted in the Legacy System being acquired by the Partnership for consideration, in the form of the IDR Units and cash, of $162.5 million. The consideration received was less than the carrying value of the Legacy System as of the consummation of the transaction, and, as a result, management considered this to be a long lived asset impairment triggering event. Management has performed an impairment analysis on the Legacy System in accordance with the applicable long lived asset impairment accounting guidance, and management has concluded that no asset impairment exists for the Legacy System as of the close of the Transactions.
The Legacy System is deemed to be the accounting acquirer of the Partnership, and the historical consolidated financial statements of the Partnership for the three years ended December 31, 2014 have been recast and now reflect those of the Legacy System, as accounting acquirer. Therefore, the business combination will be accounted for under the acquisition method of accounting, and the assets and liabilities of the Partnership will be reflected at their estimated fair values when combined with the historical financial statements of the Legacy System. The excess of the assumed purchase price of the Partnership over the preliminary estimated fair values of the Partnership's net assets acquired is recorded as goodwill.
The preliminary assumed purchase price and fair value of the Partnership has been determined by using a combination of an income, market and cost valuation methodology, and considered the evaluation of comparable company transactions, the Partnership's discounted future cash flows, the fair value of the Partnership's common units as of the closing of the Transactions and the consideration paid by Azure for the general partner interests and IDR Units. The preliminary assumed purchase price, fair values and asset useful lives are based on management's preliminary estimate and are subject to adjustment based upon final analysis and review by our valuation advisor's.
The following tables summarizes the preliminary estimate of the assumed purchase price and fair value and its allocation to the assets acquired and liabilities assumed (in thousands):
Total assumed purchase price and fair value of Marlin Midstream Partners, LP | $ | 393,171 | |
The preliminary allocation of the purchase price is as follows (in thousands):
Purchase price allocation to Marlin Midstream Partners, LP | |||||
Marlin Midstream Partners, LP fair values: | |||||
Current assets | $ | 123,022 | |||
Property, plant and equipment, net | 193,316 | ||||
Identifiable intangible assets | 65,000 | ||||
Goodwill | 215,758 | ||||
Other assets | 3,418 | ||||
Current liabilities | (11,161 | ||||
Long-term debt | (195,771) | ||||
Deferred income tax liability | (411) | ||||
Total assumed consideration and fair value of Marlin Midstream Partners, LP | $ | 393,171 | |||
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Azure System and Azure System Predecessor
Notes to the Consolidated Financial Statements
Unaudited Pro Forma Financial Information
The following unaudited pro forma financial information for the periods presented assumes the Transactions occurred on January 1, 2012. The pro forma adjustments for the periods presented consist of (i) adjustments to combine the Partnership's historical results of operations with those of the Azure System, (ii) adjustments to interest expense to remove the previously recognized interest expense and include the interest expense associated with the new Credit Agreement and (iii) adjustments to depreciation and amortization expense attributable to adjustments recorded as a result of purchase accounting.
The following table presents the unaudited pro forma revenues and net income of the Azure System and the Partnership as if the Transactions had occurred on January 1, 2012:
Year Ended December 31, | ||||||||||||||||||
2014 | 2013 | 2012 | ||||||||||||||||
(in thousands) | ||||||||||||||||||
Revenues | $ | 149,949 | $ | 117,535 | $ | 133,764 | ||||||||||||
Net income (loss) | $ | 6,702 | $ | (270,989 | ) | $ | (30,191 | ) | ||||||||||
On June 17, 2015, we and the General Partner entered into an underwriting agreement with Merrill Lynch, Pierce, Finner & Smith Incorporated, Wells Fargo Securities, LLC, J.P. Morgan Securities LLC and RBC Capital Markets, LLC, as representatives of the several underwriters named therein (the “Underwriting Agreement”) related to the public offering of 3,500,000 common units representing limited partner interests in the Partnership at a price to the public of $14.17 per common unit (the “Offering”). Pursuant to the Underwriting Agreement, we also granted the underwriters a 30-day option to purchase up to an additional 525,000 common units at the same price.
The Offering closed on June 22, 2015. We received net proceeds from the sale of the common units sold in the Offering of approximately $48.3 million, including the proportionate capital contribution by the General Partner to maintain its 1.97% general partner interest and after deducting the underwriting discount and estimated offering expenses payable by the Partnership.
On July 17, 2015, the underwriters of the Partnership’s Offering, exercised their option to purchase an additional 90,000 common units at a price to the public of $14.17 per common unit. Total net proceeds from the sale of these additional common units, after deducting underwriting discounts and commissions, and estimated offering expenses, was approximately $1.2 million.
On August 6, 2015, the Partnership announced it has acquired 100% of the equity interests of Azure ETG for total cash consideration of $83.0 million, subject to customary purchase price adjustments. This acquisition was financed with an $80.0 million draw from the Partnership’s Credit Agreement and the issuance of 255,319 common units representing limited partner interests in the Partnership to the GP of the Partnership, on behalf of Azure. The assets of the ETG System include certain natural gas gathering pipelines located in Nacogdoches and Shelby Counties in Texas. This acquisition was effective as of July 1, 2015, and the Partnership's financial results will retrospectively include the financial results attributable to the acquired gas gathering pipelines for all periods beginning July 1, 2015.
In accordance with applicable accounting guidance, management has reviewed and updated its subsequent events related to the Azure System through the date these consolidated financial statements were available to be issued. There were no other material subsequent events that required recognition or additional disclosure in the consolidated financial statements.
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Exhibit 99.2
PART I
Items 1 and 2. Business and Properties
GENERAL OVERVIEW
In this report, the terms "Partnership," as well as the terms "our," "we," "us" and "its" refer to Azure Midstream Partners, LP itself or Azure Midstream Partners, LP together with its consolidated subsidiaries, including the Azure System Predecessor, as the context requires. The term "Azure System Predecessor" is sometimes used to refer to the Legacy gathering system entities and assets (the "Legacy System"), which has been deemed to be the predecessor of the Partnership for accounting and financial reporting purposes. On May 19, 2015, the Partnership changed its name from Marlin Midstream Partners, LP to Azure Midstream Partners, LP.
In this report the term "Azure System" refers to the operations of the Legacy System together with the contribution of Azure ETG, LLC a Delaware limited liability company, that owns and operates the East Texas gathering system (the "ETG System") for periods beginning November 15, 2013, representing the period Azure Midstream Energy LLC, a Delaware limited liability company "Azure" acquired 100% of the equity interest, in the entities that own the Legacy System and the ETG System. Azure contributed the ETG System to the Partnership on August 6, 2015. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for periods beginning November 15, 2013, the date Azure acquired the ETG System.
Organization and Description of Business
Azure Midstream Partners, LP is a Delaware limited partnership formed in April 2013 by NuDevco Partners, LLC and its affiliates (“NuDevco”) to develop, own, operate and acquire midstream energy assets. Through our wholly owned subsidiaries, Marlin Logistics, LLC (“Marlin Logistics”) and Marlin Midstream, LLC (“Marlin Midstream”), we generate revenues by charging fees for gathering, transporting, treating and processing natural gas, transloading crude oil and selling or delivering NGLs to third parties.
As of December 31, 2014, NuDevco owned and controlled our general partner, Azure Midstream Partners GP, LLC, formerly Marlin Midstream GP, LLC (our “general partner”). NuDevco is wholly owned by W. Keith Maxwell III. In July 2013, we completed our initial public offering (the “IPO”) of 6,875,000 common units to the public for $20.00 per common unit. In exchange for NuDevco contributing Marlin Logistics and Marlin Midstream to us, we issued 1,849,545 common units and all of the Partnership’s subordinated units and incentive distribution rights to wholly owned subsidiaries of NuDevco. At December 31, 2014, common units held by public security holders represent 39.8% of our outstanding limited partner interests, and NuDevco held 60.2% of our outstanding limited partner interests.
The information in this report contains information occurring prior to the completion of the Transactions (as defined below) on February 27, 2015 discussed herein. Consequently, the combined financial statements and related discussion of financial condition and results of operations contained in this report for those periods prior to such date pertain to businesses and assets of the Azure System Predecessor.
Acquisition of the Legacy System
On February 27, 2015, we completed transactions (the “Transactions”), described in detail below, pursuant to a transaction agreement, dated January 14, 2015 (the “Transaction Agreement”), by and among us, Azure, the general partner, NuDevco and Marlin IDR Holdings, LLC, a Delaware limited liability company and wholly-owned subsidiary of NuDevco (“IDRH”). Pursuant to the Transaction Agreement, we acquired the Legacy System from Azure and Azure acquired all of the equity interests in our general partner and 90% of our IDR Units (as defined below) from NuDevco.
The following transactions were consummated on February 27, 2015, in connection with the closing of the Transactions (the “Closing”):
• | we amended and restated our partnership agreement to reflect the unitization of all of our incentive distribution rights (as unitized, the “IDR Units”) and recapitalized the incentive distribution rights owned by IDRH into 100 IDR Units; |
• | we redeemed 90 IDR Units held by IDRH in exchange for a payment by us of $63.0 million to IDRH (the “Redemption”); |
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• | we acquired the Legacy System from Azure through the contribution, indirectly or directly, of (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure, and (ii) certain assets owned by TGG Pipeline, Ltd. ("TGG"), a Texas limited liability company and subsidiary of Azure, in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of $99.5 million in cash and by the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”); and |
• | Azure purchased from NuDevco (i) all of the outstanding membership interests in our general partner and (ii) an option to acquire up to 20% of each of the common units and subordinated units held by NuDevco as of the execution date of the Transaction Agreement. |
Following the consummation of the Transactions, Azure controls us through its ownership of all of the equity interests in our general partner. Our general partner controls us through its ownership of our outstanding general partner units, which represents an approximate 2% economic general partner interest in us. Azure also owns 90 IDR Units, which represent 90% of our IDR Units. NuDevco owns approximately 60.2% of our outstanding limited partner interest and 10 IDR Units, which represent 10% of our IDR Units.
Contribution of the ETG System
On August 6, 2015, we entered into a contribution agreement (the “Contribution Agreement”) with Azure, which is the sole member of the general partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in the ETG System to the Partnership in exchange for the consideration described below (the "Contribution"). The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of the ETG System was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | as consideration for the membership interests of the ETG System, we paid Azure $80.0 million in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure; and |
• | we entered into a gas gathering agreement with TGG , an indirect subsidiary of Azure. |
Azure
Azure is a midstream company with a focus on owning, operating, developing and acquiring midstream energy infrastructure in core producing areas in the United States. Azure currently provides natural gas gathering, compression, treating and processing services in Northern Louisiana and East Texas in the prolific Haynesville and Bossier Shale formations.
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OUR ASSETS AND AREAS OF OPERATION
Overview
We are a fee-based, growth-oriented Delaware limited partnership formed to develop, own, operate and acquire midstream energy assets. We currently provide natural gas gathering, compression, dehydration, treating, processing and hydrocarbon dew-point control and transportation services, which we refer to as our midstream natural gas business, and crude oil transloading services, which we refer to as our crude oil logistics business. Our assets and operations are organized into the Midstream Natural Gas Segment and the Logistics Segment.
For additional information relating to revenues, profits and total assets by operating segment, please see Note 9 “Segment Information” to our Consolidated Financial Statements included in our Annual Report on Form 10-K.
Midstream Natural Gas Segment. As of December 31, 2014, our midstream natural gas segment primarily consisted of the following assets: (i) two related natural gas processing plants located in Panola County, Texas; (ii) a natural gas processing plant located in Tyler County, Texas; (iii) two natural gas gathering systems connected to our Panola County processing plants; and (iv) two NGL transportation pipelines that connect our Panola County and Tyler County processing plants to third party NGL pipelines. Our primary midstream natural gas assets are located in long-lived oil and natural gas producing regions in East Texas and gather and process NGL-rich natural gas streams associated with production primarily from the Cotton Valley Sands, Haynesville Shale, Austin Chalk and Eaglebine formations.
Subsequent to December 31, 2014, we have completed the following transactions:
• | acquisition of the Legacy System, the results of operations of which, will be included within our midstream natural gas segment. The addition of the Legacy System provides us with access to producing acreage that is currently not directly accessible within Harrison, Panola and Rusk counties in Texas. For a more detailed description of the Legacy System, see “Legacy Gathering System” below. |
• | acquisition of the ETG System, the results of operations of which will be included within our midstream natural gas segment. The addition of ETG System provides us with four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets and a total of 336,000 gross acres in the Haynesville Shale and Bossier Shale formations. For a more detailed description of the ETG System, see “East Texas Gathering System” below. |
The following table sets forth information about our primary midstream natural gas assets as of the year ended December 31, 2014 (including the Legacy System, which was acquired in February 2015 and the ETG System contributed in August 2015):
Midstream Natural Gas | System Type | County, State | Miles | Gas Compression (bhp) | Approximate Design Capacity (MMcf/d except as otherwise noted) | |||||||||
Panola 1 | Processing | Panola, Texas | N/A | 8,220 | 100 | |||||||||
Panola 2 | Processing | Panola, Texas | N/A | 10,400 | 120 | |||||||||
Total Panola | N/A | 18,620 | 220 | |||||||||||
Tyler (1) | Processing | Tyler, Texas | N/A | 4,640 | 80 | |||||||||
Lake Murvaul | Natural Gas Gathering | Panola and Harrison Counties, Texas | 54 | 6,300 | 100 | |||||||||
Oak Hill Lateral | Natural Gas Gathering | Panola and Harrison Counties, Texas | 11 | N/A | 100 | |||||||||
Turkey Creek (Bbls/d) | NGL Pipelines | Panola and Tyler Counties, Texas | 13 | N/A | 20,000 | |||||||||
Legacy Gathering System (2) | Natural Gas Gathering | Panola, Harrison and Rusk Counties, Texas and Caddo Parish Louisiana | 658 | 14,125 | 500 | |||||||||
East Texas Gathering System (3) | Natural Gas Gathering/Processing | Shelby, Nacogdoches, San Augustine and Sabine Counties, Texas | 255 | N/A | 1,750 | |||||||||
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(1) The Tyler processing facility includes one 40 MMcf/d cryogenic trains that are currently operational and two 20 MMcf/d cryogenic trains are currently idle.
(2) The Legacy Gathering System was acquired on February 27, 2015 in connection with the closing of the Transactions, and is currently operational.
(3) The East Texas Gathering System was acquired on August 6, 2015 in connection with the closing of the Contribution Agreement and is currently operational.
Panola County Processing Plants
Our Panola County processing plants are situated northeast of the town of Carthage in East Texas on approximately 35 acres. These plants process NGL-rich natural gas from the Haynesville Shale and Cotton Valley natural gas production areas, which are areas known for their long-lived reserves. These plants are natural gas treating and cryogenic processing plants that include residue gas compression, amine treating and dehydration equipment with current design capacity to process up to 220 MMcf/d of natural gas.
Our processing plants in Panola County, which we refer to as our Panola 1 and Panola 2 processing plants, are operational as a single integrated facility, with common inlet and outlet points. Our Panola County plants have the following characteristics:
• | Our Panola 1 processing plant consists of a cryogenic gas processing plant with a nameplate capacity of 100 MMcf/d, one 225 GPM amine treating unit and five dedicated compressor units with an aggregate of 8,220 bhp of residue gas compression; and |
• | Our Panola 2 processing plant consists of a cryogenic gas processing plant with a nameplate capacity of 120 MMcf/d, one 320 GPM amine treating unit and six dedicated compressor units with an aggregate of 10,400 bhp of residue gas compression. |
Inlet volumes at our Panola County plants are obtained from numerous sources with various natural gas compositions. Supply interconnects to the facility include nine pipelines extending from our Lake Murvaul gathering system, our Oak Hill Lateral, Atmos Energy Corporation’s (“Atmos Energy”) S2 pipeline, Kinder Morgan’s McCormick pipeline, Texas Gas Gathering’s Harrison and Panola County gathering systems and MarkWest Energy Partners, L.P.’s (“MarkWest”) pipeline. Residue gas from our Panola County plants is delivered to several pipelines, including the Texas Gas, CenterPoint CP, Tennessee Gas and Gulf South Pipeline, LP (“Gulf South”) pipelines, and the DCP Carthage trading hub through the Atmos Energy and Enterprise pipelines. NGL production from our Panola County plants is delivered into one of our Turkey Creek pipelines, which extends to TEPPCO Partners, L.P.’s Panola Pipeline for redelivery to the Enterprise fractionation facilities at the Mont Belvieu, Texas trading hub.
Tyler County Gas Processing Plant
Our Tyler County processing facility is situated northeast of the town of Woodville in East Texas on approximately ten acres. This facility processes NGL-rich natural gas from the Austin Chalk and Eaglebine natural gas production formations, which are areas known for their long- lived reserves. This facility consists of natural gas treating and cryogenic processing plants that include residue gas compression, amine treating, and glycol dehydration equipment with a design capacity to process up to 80 MMcf/d of natural gas.
Our Tyler County processing plant includes one cryogenic processing train with nameplate capacity of 40 MMcf/d, two 20 MMcf/d cryogenic processing trains with aggregate nameplate capacity of 40 MMcf/d, both of which are currently idle, two 40 MMcf/d glycol dehydration units and two 200 GPM amine units. Our Tyler County processing facility currently utilizes three compressor units with an aggregate of 4,640 bhp of residue gas compression.
We do not own or operate any natural gas gathering systems associated with our Tyler County processing plant. The facility receives all of its natural gas from a gathering system owned and operated by Anadarko and delivers residue gas through an interconnect with the Tennessee Gas Pipeline Company pipeline. To the extent we are not using the full capacity of our Tyler County processing plant to process Anadarko’s gas, we believe we would be able to access volumes from other producers to the extent we are able to construct new, or tie into existing third- party gathering systems. NGLs produced by our Tyler County processing plant are stored in two 30,000 gallon surge tanks and one 12,000 gallon surge tank and transported through one of our Turkey Creek NGL pipelines to an NGL pipeline owned by West Texas LPG Pipeline Limited Partnership for delivery to the Enterprise fractionator at the Mont Belvieu trading hub.
Lake Murvaul Gathering System
Our Lake Murvaul natural gas gathering system is connected to our Panola County processing plants and gathers natural gas primarily from delivery points on our gathering systems and interconnecting pipelines in the area. NuDevco and its affiliates purchased the original Lake Murvaul gathering system, consisting solely of a 12-inch trunk line extending approximately 10 miles southwest from the site of our Panola County processing plants, from CenterPoint Energy. The gathering system currently consists of approximately 31 miles of 12-inch trunk line, approximately 23 miles of 4-inch, 6-inch
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and 8-inch gathering lines and seven compressor stations with total compression of approximately 6,300 bhp. The gathering system has an aggregate capacity of approximately 100 MMcf/d.
Our Lake Murvaul gathering system has pipeline interconnects with Gulf South, Texas Eastern Transmission, LP, ETC Gas Company Ltd., Natural Gas Pipeline Company of America LLC and DCP Midstream Partners, LP (“DCP Midstream”). Producers generally bear the cost of connecting their wells to our system at delivery points on our gathering systems.
Oak Hill Lateral
Our Oak Hill Lateral, which was placed into service in March 2013, is connected to our Panola County processing plant and gathers natural gas through a connection to a gathering system owned by Anadarko. Our Oak Hill Lateral consists of approximately 11 miles of 12-inch trunk line with a current capacity of approximately 100 MMcf/d.
Turkey Creek NGL Pipelines
Our wholly owned subsidiary, Turkey Creek Pipeline, LLC, owns and operates the following two NGL pipelines, which we refer to as our Turkey Creek pipelines:
• | a 4-inch diameter y-grade NGL pipeline with a total capacity of 10,000 Bbls/d (expandable to 15,000 Bbls/d) extending approximately two miles from our Panola County processing plants to a pipeline owned by TEPPCO Partners, L.P. for redelivery to the Enterprise fractionator in Mont Belvieu; and |
• | a 6-inch diameter y-grade NGL pipeline with a total capacity of 10,000 Bbls/d extending approximately 11 miles from our Tyler County processing plants to an NGL pipeline owned by West Texas LPG Pipeline Limited Partnership for redelivery to the Enterprise fractionator in Mont Belvieu. |
Legacy Gathering System
The Legacy System was contributed to us as part of the Transactions on February 27, 2015. The Legacy System is primarily located within Harrison, Panola and Rusk Counties in Texas and Caddo Parish in Louisiana and currently serves the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation. The Legacy System consists of approximately 658 miles of high- and low-pressure gathering lines and served approximately 100,000 dedicated acres with access to seven major downstream markets, three third-party processing plants and the Panola County processing plants. The Legacy System has ten 1,340 bhp compressors and two additional compressors comprising 725 bhp, for a total of 14,125 bhp of compression. The Legacy System has an aggregate capacity of approximately 500 MMcf/d. Our Legacy System gathers high-Btu natural gas with an NGL content between 2.0 and 5.2 GPM.
East Texas Gathering System
The ETG System was contributed to us as part of the Contribution on August 6, 2015. The ETG System is primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby Counties in East Texas and currently serves multiple formations including the Haynesville, Bossier and the liquids-rich James Lime formation. The ETG System consists of approximately 255 miles of gathering lines and serves approximately 336,000 gross dedicated acres. The ETG System has two owned treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. The new Fairway processing plant is designed to extract NGL content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Other Midstream Natural Gas Assets
We own and operate approximately six miles of 6-inch natural gas pipeline, which we refer to as our Bethany Lateral, and a natural gas treating facility, which we refer to as our Stateline Treating facility. Our Stateline Treating facility is adjacent to our Bethany Lateral and is located southeast of the town of Bethany in Caddo Parish, Louisiana. Our Stateline Treating facility has an aggregate capacity of approximately 30 MMcf/d and provides CO2 removal services on behalf of Associated Energy Services, LP ("AES").
Logistics Segment
Our logistics segment consists of three crude oil transloading facilities: (i) our Wildcat facility located in Carbon County, Utah, where we currently operate two skid transloaders and four ladder transloaders; (ii) our Big Horn facility located in Big Horn County, Wyoming, where we currently operate two skid transloaders and two ladder transloaders; and (iii) our East New Mexico facility located in Sandoval County, New Mexico, where we currently operate two skid transloaders and two ladder transloaders. Our transloaders are used to unload crude oil from tanker trucks and load crude oil into railcars. Our facilities provide transloading services for production originating from well-established crude oil producing basins, such as the
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Uinta, San Juan and Powder River Basins, which we believe are currently underserved by our competitors. Our combined transloading capacity is 31,200 Bbls/d in normal operating conditions.
Wildcat Facility
At our Wildcat facility, crude oil is delivered to our site by third-party tanker trucks. Currently, AES contacts Wild West Equipment & Hauling, LLC, who currently provides the labor in connection with our transloading operations at our Wildcat facility, when they have crude oil that they wish to have transferred from truck to railcar. The crude oil is then transferred from the truck to a railcar or to a third-party tank leased by AES using either a skid transloader or a ladder transloader. On July 31, 2013, we entered into fee-based transloading services agreements with AES at our Wildcat facility that provides for a fixed fee per barrel for transloading services, subject to a minimum volume commitment of 7,600 Bbls/d with respect to our skid transloader and 1,260 Bbls/d with respect to each of our ladder transloaders.
Big Horn Facility
At our Big Horn facility, crude oil is delivered to our site by third-party tanker trucks at AES's request. We transfer crude oil from truck to railcar or to a third-party tank leased by AES using either a skid transloader or a ladder transloader. On July 31, 2013, we entered into fee-based transloading services agreements with AES at our Big Horn facility that provides for a fixed fee per barrel, subject to a minimum volume commitment of 7,600 Bbls/d with respect to our skid transloader and 1,260 Bbls/d with respect to our ladder transloader.
East New Mexico Facility
On July 30, 2014, we entered into a Contribution Agreement with NuDevco Midstream Development and our general partner for the purchase of the East New Mexico Transloading Facility, located in Sandoval County, New Mexico. The purchase closed on August 1, 2014. At our East New Mexico facility, crude oil is delivered to our site by third-party tanker trucks. AES requests we transfer crude oil from truck to railcar or to a third-party tank leased by AES using a skid transloader. On August 1, 2014, we entered into fee-based transloading services agreements with AES at our East New Mexico facility that provides for a fixed fee per barrel, subject to a minimum volume commitment of 5,000 Bbls per weekday with respect to our skid transloader.
Amendment to Transloading Service Agreements
On February 27, 2015, we entered into amendments to our (i) Wildcat facility transloading services agreement, (ii) Big Horn transloading services agreement and (iii) Ladder transloading services agreement, all of which are transloading services agreements with AES, an affiliated party. The amendments extend the terms, including the minimum volume commitments, associated with these transloading services agreements until February 27, 2020, or five years from the date of the amendment.
Our Fee-Based Commercial Agreements
Prior to July 31, 2013, we generated revenues primarily under keep-whole and other commodity-based gathering and processing agreements with third parties and their affiliates. On July 31, 2013, we terminated the existing commodity-based gas gathering and processing agreement with AES, assigned to AES all of the remaining keep-whole and other commodity-based gathering and processing agreements with third party customers and entered into a new three-year fee-based gathering and processing agreement with AES with a minimum volume commitment and annual inflation adjustments and new three-year fee-based transloading services agreements with AES at our Wildcat and Big Horn facilities.
Under our new gathering and processing agreement, AES pays us a fixed fee per Mcf (subject to an annual inflation adjustment) for gathering, treating, compression and processing services and a per gallon fixed fee for NGL transportation services. The agreement provides for a minimum volume commitment of 80 MMcf/d, which can be periodically increased. Under our transloading services agreements, AES pays us a fixed fee per barrel. The Wildcat and Big Horn agreements provide for a minimum volume commitment of 7,600 Bbls/d at each facility with respect to our skid transloaders and 1,260 Bbls/d with respect to each of our ladder transloaders. The East New Mexico agreement provides for a minimum volume commitment of 5,000 Bbls per weekday for the skid transloader at the facility.
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The following table summarizes certain information regarding our fee-based commercial agreements with Anadarko and AES:
Agreement | Current Term Expiration | Renewal | Minimum Volume Commitment | |||
Anadarko Panola County Agreement I | July 31, 2015 | Year-to-year | Yes | |||
Anadarko Panola County Agreement II | March 31, 2019 | Month-to-month | Yes | |||
AES Panola County Agreement (1) | Three years | Year-to-year | 100 MMcf/d | |||
Anadarko Tyler County Agreement | October 31, 2015 | Year-to-year | No | |||
AES Wildcat Skid Transloading Agreement (1) | Five years | Year-to-year | 7,600 Bbls/d | |||
AES Big Horn Skid Transloading Agreement (1) | Five years | Year-to-year | 7,600 Bbls/d | |||
AES Master Ladder Transloading Agreement (1) | Five years | Year-to-year | 3,780 Bbls/d | |||
AES East New Mexico Agreement (2) | Three years | Year-to-year | 5,000 Bbls per weekday | |||
(1) The AES agreements were entered into between us and AES in conjunction with the closing of the IPO on July 31, 2013. In connection with the Closing, the Transloading Agreements were extended until February 27, 2020, or five years from the date of the amendment. For additional information relating to our current sponsor relationship, please see Items 1 and 2 - "Business and Properties - Sponsor Relationship” included in this Form 10-K.
(2) The AES East New Mexico agreement was entered into between us and AES in conjunction with the dropdown from NuDevco on August 1, 2014. The initial term of this agreement is three years. AES is an affiliate under common control of NuDevco. For additional information relating to our current sponsor relationships, please see Items 1 and 2 - "Business and Properties - Sponsor Relationship” included in this Form 10-K.
As part of the Transactions, we also acquired certain contracts associated with the Legacy System. Major customers with long-term contracts on the Legacy System include BG, BP plc and Devon Energy Corporation, Endeavor Energy Resources, L.P., EXCO, Sabine Oil & Gas LLC and Samson Resources Corporation, among others. The Legacy System cash flows are primarily fee-based and the contracts have a remaining life varying from one year to life of lease.
CUSTOMERS
The primary suppliers of natural gas to us are a broad cross-section of the natural gas producing community. These suppliers include small and large exploration and production companies, large pipeline companies and natural gas marketers. Among those customers currently supplying natural gas to us for treating and processing are Anadarko, Kinder Morgan, Energy Transfer and AES. Customers on our Legacy System include BG Group, plc, BP plc, Devon Energy Corporation, Endeavor Energy Resources, L.P., EXCO Resources, Inc., Sabine Oil & Gas LLC and Samson Resources Corporation, among others. Customers on our ETG System include EOG Resources, Inc., SM Energy Company, Devon Energy Corporation, Crimson Exploration, Inc. and Goodrich Petroleum Corp. We actively seek new natural gas producing customers for all of our facilities to increase throughput volume and to offset natural declines in the production from connected wells. We obtain new natural gas supplies in our operating areas by contracting for production from new wells, by connecting new wells drilled on dedicated acreage and by obtaining natural gas that has been directly received or released from other gathering systems.
For the year ended December 31, 2014, Anadarko and AES each accounted for more than 10% of our revenues. Although we have gathering, processing or transportation agreements with these customers, these agreements have remaining terms ranging from one to five years. As these agreements expire, we will have to renegotiate extensions or renewals with these customers or replace the existing contracts with new arrangements with other customers. If either of these customers were to default on its contracts or if we were unable to renew our contracts with them on favorable terms, we may not be able to replace such customers in a timely manner, on favorable terms or at all. In any of these situations, our revenues and cash flows and our ability to make cash distributions to our unitholders would be materially and adversely affected.
In addition, AES is our sole customer with respect to our crude oil logistics business, and we expect to continue to derive the substantial majority of our transloading revenues from AES. AES is contracted for 100% of the capacity at our Wildcat, Big Horn, and East New Mexico facilities. Such concentration subjects us to increased risk in the case of nonpayment, nonperformance or non-renewal by AES under the transloading services agreements that we entered into with AES at the closing of our IPO, three of which were subsequently extended in connection with the Transactions until February 27, 2020. Any adverse developments concerning AES could materially and adversely affect our crude oil logistics business.
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Item 1A. Risk Factors
RISK FACTORS
Risks Related to our Business
Security holders and potential investors in our securities should carefully consider the risk factors set forth under Part I. Item 1A, Risk Factors, of our Annual Report on Form 10-K for the year ended December 31, 2014, which are incorporated by reference herein. The following risk factor updates the risks described in our Annual Report on Form 10-K. There has been no material change in our risk factors from those described in the Annual Report on Form 10-K other than those set forth below. These risks are not the sole risks for investors. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or results of operations.
Any decrease in the volumes of natural gas that the Partnership gathers, compresses, treats or processes would adversely affect our financial condition, results of operations and cash flows to the extent not mitigated by minimum volume or revenue commitments.
Our financial performance depends to a large extent on the volumes of natural gas gathered, compressed, treated and processed on the Partnership's assets. To the extent not protected by minimum volume or revenue commitments, decreases in the volumes of natural gas gathered, compressed, treated and processed would directly and adversely affect our revenues and results of operations. These volumes can be influenced by factors beyond our control, including:
• | compliance with environmental or other governmental requirements; |
• | adverse weather conditions and natural disasters; |
• | increases in storage levels of natural gas; |
• | increased use of alternative energy sources; |
• | decreased demand for natural gas; |
• | fluctuations in commodity prices, including the prices of natural gas; |
• | economic conditions; |
• | environmental hazards, such as natural gas leaks, oil spills, pipeline and tank ruptures, and unauthorized |
discharges of pollutants into the surface and subsurface environment;
• | supply disruptions; |
• | availability of supply connected to the Partnership's systems; and |
• | availability and adequacy of infrastructure to gather, compress, treat and process supply into and out of |
the Partnership's systems.
The volumes of natural gas gathered, compressed, treated and processed on the Partnership's assets also depend on the production of natural gas from the Haynesville, Bossier and Cotton Valley formations that these systems serve. Supply of natural gas can be affected by many of the factors listed above, including commodity prices and weather. In order to maintain or increase throughput levels on the Partnership's systems, it must obtain new sources of natural gas. The primary factors affecting the Partnership's ability to obtain non-dedicated sources of natural gas include (i) the level of successful leasing, permitting and drilling activity in its areas of operation, (ii) its ability to compete successfully for volumes from new wells and (iii) its ability to compete successfully for volumes from sources connected to other pipelines. The Partnership has no control over the level of drilling activity in its areas of operation, the amount of reserves associated with wells connected to its systems or the rate at which production from a well declines. In addition, it has no control over producers or their drilling or production decisions, which are affected by, among other things, the availability and cost of capital, levels of reserves, availability of drilling rigs and other costs of production and equipment.
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We may be unable to renew or replace expiring contracts at favorable rates or on a long-term basis.
Our primary exposure to market risk occurs at the time our existing contracts expire and are subject to
renegotiation and renewal. Our minimum revenue commitment has original terms of ten years and, as of December 31, 2014, had a weighted average remaining term of 6 years. The extension or replacement of existing contracts depends on a number of factors beyond our control, including:
• | the level of existing and new competition to provide services to our markets; |
• | the macroeconomic factors affecting natural gas economics for our current and potential customers; |
• | the balance of supply and demand, on a short-term, seasonal and long-term basis, in our markets; |
• | the extent to which the customers in our markets are willing to contract on a long-term basis; and |
• | the effects of federal, state or local regulations on the contracting practices of our customers. |
Any failure to extend or replace a significant portion of our existing contracts, or extending or replacing them at unfavorable or lower rates, could have a material adverse effect on our business, results of operations, financial condition and ability to make quarterly cash distributions to our unitholders.
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SELECTED HISTORICAL FINANCIAL DATA OF
THE AZURE SYSTEM AND THE AZURE SYSTEM PREDECESSOR
The following table presents the selected historical financial and operating data of the Azure System and the Azure System Predecessor for the periods presented. The selected historical financial data of the Azure System and Azure System Predecessor are derived from the historical financial statements of the Azure System and the Azure System Predecessor and should be read together with "Management's Discussion and Analysis of Financial Condition and Results of Operations" below and the audited financial statements attached as Exhibit 99.1 to this Current Report on Form 8-K/A. The following information is only a summary and is not necessarily indicative of the results of future operations of the Azure System and the Azure System Predecessor.
Azure System (1) | Azure System Predecessor | ||||||||||||||||||||
Year Ended | Period from November 15, 2013 to | Period from January 1, 2013 to | Year Ended December 31, | ||||||||||||||||||
December 31, 2014 | December 31, 2013 | November 14, 2013 | 2012 | 2011 | |||||||||||||||||
(Unaudited) | |||||||||||||||||||||
Statement of Operations Data: | |||||||||||||||||||||
Total operating revenues | $ | 74,721 | $ | 8,859 | $ | 41,263 | $ | 51,494 | $ | 68,393 | |||||||||||
Operating expenses: | |||||||||||||||||||||
Cost of purchased gas and NGLs sold | 38,042 | 4,505 | 21,054 | 22,793 | 37,447 | ||||||||||||||||
Operating expense | 13,714 | 2,643 | 11,330 | 11,183 | 17,787 | ||||||||||||||||
General and administrative | 5,812 | 195 | 3,629 | 5,692 | 5,845 | ||||||||||||||||
Asset impairments | 228 | — | 659 | 5,720 | 510 | ||||||||||||||||
Depreciation and amortization | 7,961 | 958 | 9,999 | 11,229 | 17,093 | ||||||||||||||||
Total expenses | 65,757 | 8,301 | 46,671 | 56,617 | 78,682 | ||||||||||||||||
Income (loss) from operations | 8,964 | 558 | (5,408 | ) | (5,123 | ) | (10,289 | ) | |||||||||||||
Interest expense (2) | 15,149 | 1,855 | 3,167 | 4,951 | 2,852 | ||||||||||||||||
Other (income) expense | 422 | — | (807 | ) | 304 | 4,001 | |||||||||||||||
Net loss before income taxes | (6,607 | ) | (1,297 | ) | (7,768 | ) | (10,378 | ) | (17,142 | ) | |||||||||||
Income tax expense | 213 | 26 | 118 | 147 | 195 | ||||||||||||||||
Net loss | $ | (6,820 | ) | $ | (1,323 | ) | $ | (7,886 | ) | $ | (10,525 | ) | $ | (17,337 | ) | ||||||
Balance Sheet Data (as of the period end): | |||||||||||||||||||||
Property, plant and equipment, net | $ | 304,175 | $ | 302,163 | $ | 341,848 | $ | 336,620 | $ | 353,461 | |||||||||||
Total assets | 319,203 | 324,563 | 351,102 | 345,381 | 365,913 | ||||||||||||||||
Parent company net investment | 116,151 | 107,028 | 218,531 | 189,547 | 212,187 | ||||||||||||||||
Key Performance Measures: | |||||||||||||||||||||
Adjusted EBITDA (3) | $ | 25,805 | $ | 2,702 | $ | 5,155 | $ | 11,826 | $ | 7,314 | |||||||||||
Capital expenditures | 14,233 | 1,068 | 13,989 | 9,887 | |||||||||||||||||
Operating Data: | |||||||||||||||||||||
Average throughput volumes of natural gas (MMcf/d) | 261 | 209 | 189 | 254 | 324 | ||||||||||||||||
(1) Beginning November 15, 2013, Azure acquired 100% equity interest in Azure System. On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. As such, we have recast the financial results of the Azure System to include the financial results of the ETG System from the period November 15, 2013 to December 31, 2013 and the year ended December 31, 2014.
(2) The interest expense reflected within the Azure System and Azure System Predecessor's statement of operations data represents an allocation of its proportionate share of the Azure and Azure Predecessor's consolidated interest expense in accordance with applicable accounting guidance.
(3) For a definition of Adjusted EBITDA and a reconciliation to net income, its most directly comparable financial measure calculated in accordance with GAAP, please read "Non-GAAP Financial Measures" below.
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Non-GAAP Financial Measures
The selected historical financial data includes the non-GAAP financial measure Adjusted EBITDA. We provide a reconciliation of EBITDA and Adjusted EBITDA, both non-GAAP financial measures, to net income, its most directly comparable financial measure as calculated and presented in accordance with GAAP.
EBITDA and Adjusted EBITDA
We define EBITDA as net income (loss), plus (1) interest expense, (2) income tax expense, and (3) depreciation and amortization expense. We define Adjusted EBITDA as EBITDA, plus adjustments associated with certain non-cash and other items.
EBITDA and Adjusted EBITDA are used as supplemental financial measures by management and external users of our financial statements, such as investors, commercial banks and research analysts, to assess the financial performance of our assets without regard to financing methods, capital structure or historical cost basis; our operating performance and return on capital as compared to those of other companies in the midstream energy sector, without regard to financing or capital structure; and the attractiveness of capital projects and acquisitions and the overall rates of return on alternative investment opportunities. Additionally, Adjusted EBITDA is used to assess the financial performance of our assets without the impact of certain non-cash and other item, including non-cash expenses, adjustments associated with cash received under the minimum revenue commitments ("MRC") requirements of our gas gathering agreements and certain other items.
The GAAP measure most directly comparable to EBITDA and Adjusted EBITDA is net income. Our non-GAAP financial measures of EBITDA and Adjusted EBITDA should not be considered as an alternative to net income. You should not consider EBITDA and Adjusted EBITDA in isolation or as a substitute for analysis of our results as reported under GAAP. EBITDA and Adjusted EBITDA have limitations as analytical tools and should not be considered as alternatives to, or more meaningful than, performance measures calculated in accordance with GAAP. Some of these limitations are: certain items excluded from EBITDA and Adjusted EBITDA are significant components in understanding and assessing our financial performance, such as our cost of capital and tax structure; EBITDA and Adjusted EBITDA do not reflect our cash expenditures or future requirements for capital expenditures or contractual commitments; EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs; although depreciation and amortization are non-cash charges, the assets being depreciated and amortized will often have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect any cash requirements for such replacements; and our computations of EBITDA and Adjusted EBITDA may not be comparable to other similarly titled measures of other companies.
The following table presents a reconciliation of EBITDA and Adjusted EBITDA to net income (loss) for each of the periods indicated.
Azure System | Azure System Predecessor | |||||||||||||||||||
(in thousands) (unaudited) | Year Ended December 31, 2014 | Period from November 15, 2013 to December 31, 2013 | Period from January 1, 2013 to November 14, 2013 | Year Ended December 31, 2012 2011 | ||||||||||||||||
Reconciliation of EBITDA to Net Income (Loss) | ||||||||||||||||||||
Net income (loss) | $ | (6,820 | ) | $ | (1,323 | ) | $ | (7,886 | ) | $ | (10,525 | ) | $ | (17,337 | ) | |||||
Add: | ||||||||||||||||||||
Depreciation and amortization | 7,961 | 958 | 9,999 | 11,229 | 17,093 | |||||||||||||||
Interest expense | 15,149 | 1,855 | 3,167 | 4,951 | 2,852 | |||||||||||||||
Income tax expense | 213 | 26 | 118 | 147 | 195 | |||||||||||||||
EBITDA | $ | 16,503 | $ | 1,516 | $ | 5,398 | $ | 5,802 | $ | 2,803 | ||||||||||
Asset impairments | 228 | — | 659 | 5,720 | 510 | |||||||||||||||
Other adjustments (1) | 2,799 | 502 | (902 | ) | 304 | 4,001 | ||||||||||||||
Deferred revenue (2) | 6,275 | 684 | ||||||||||||||||||
Adjusted EBITDA | $ | 25,805 | $ | 2,702 | $ | 5,155 | $ | 11,826 | $ | 7,314 | ||||||||||
(1) Other adjustments are primarily comprised of non-cash gains and losses associated with volumetric natural gas imbalance adjustments and gains and losses on sales of assets.
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(2) Adjustments related to deferred revenues associated with our MRC agreements account for our inclusion of expected cash receipts under these MRC agreements. With respect to our MRC agreement, the volumes supplied by the customer are currently less than the annual MRC requirement, and we are therefore entitled to receive an annual deficiency payment. The customer's deficiency payment to us may be credited against future volumes supplied by the customer in excess of the annual MRC. We record the cash receipts associated with the deficiency payments as deferred revenue because the customer is entitled to utilize the deficiency payment to offset future volumes supplied in excess of the annual MRC over the term of the contract. We include a proportional amount or the expected MRC cash receipts in each quarter in respect of the annual period for which we actually receive the payment to ensure our Adjusted EBITDA reflects the amount of cash we are entitled to receive on an annual basis under these MRC agreements.
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MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OF THE AZURE SYSTEM AND THE AZURE SYSTEM PREDECESSOR
The historical financial statements included in this filing reflect the assets, liabilities and operations of the Legacy gathering system entities and assets (the "Legacy System"), updated to include the contribution of the East Texas Gathering System (the "ETG System") as described below, and the Azure System Predecessor (collectively the "Azure System"). The term "Azure System Predecessor" refers to the Legacy System, which has been deemed to be the historical predecessor of Azure Midstream Partners, LP (the "Partnership") for financial reporting purposes. As a result, the following historical discussion and analysis of financial condition and results of operations and the related financial and operational information will update the Partnership's previously reported historical information to include the Azure System financial results.
In accordance with the applicable business combination accounting guidance, the Legacy System is considered the Predecessor of the Partnership because Azure Midstream Energy LLC and Azure Midstream Holdings LLC (collectively, "Azure") obtained control of the Partnership through its acquisition of 100% of the ownership interest in Azure Midstream Partners GP, LLC, formerly Marlin Midstream Partners GP, LLC, the sole general partner of the Partnership (the "General Partner"), concurrently with the consummation of the transactions described below and the contribution of the Legacy System to the Partnership. The Legacy System is comprised of midstream assets and operations primarily located within Harrison, Panola and Rusk counties in Texas and Caddo parish in Louisiana and currently serves the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation.
On November 15, 2013, Azure acquired 100% of the equity interest in the Legacy System and the ETG System. Azure contributed the ETG System to the Partnership on August 6, 2015. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Azure System to include the financial results of the ETG System for periods beginning November 15, 2013, the date Azure acquired the ETG System. The ETG System is comprised of midstream assets and operations primarily located within Shelby, Nacogdoches, San Augustine and Sabine counties in Texas and currently serves multiple formations including the Haynesville, Bossier and the liquids-rich James Lime formation.
You should read this discussion in conjunction with the historical and pro forma financial statements and accompanying notes included in this filing. All references in this section to the Partnership, as well as the terms “our,” “we,” “us” and “its,” refer to Azure Midstream Partners, LP, together with its consolidated subsidiaries, including the Azure System, when used in the present or future tense.
This management’s discussion and analysis of financial condition and results of operations contains forward-looking statements that involve risks, uncertainties and assumptions. See “Disclosure Regarding Forward-Looking Statements” for a discussion of the risks, uncertainties and assumptions associated with those statements. Our actual results may differ materially from those discussed in the forward-looking statements as a result of various factors, including but not limited to those in “Risk Factors” and included in other portions of this filing.
Overview
The Partnership is a fee-based, growth-oriented Delaware limited partnership formed to develop, own, operate and acquire midstream energy assets. We currently provide natural gas gathering, compression, dehydration, treating, processing and hydrocarbon dew-point control and transportation services, which we refer to as our midstream natural gas business, and crude oil transloading services, which we refer to as our logistics business.
Acquisition of the Legacy System
On February 27, 2015, we completed the transactions (the “Transactions”) described in detail below pursuant to a Transaction Agreement, dated January 14, 2015 (the “Transaction Agreement”), by and among us, Azure, the General Partner, NuDevco Partners, LLC and its affiliates ("NuDevco") and Marlin IDR Holdings, LLC, a Delaware limited liability company and wholly-owned subsidiary of NuDevco (“IDRH”). Pursuant to the Transaction Agreement, the Legacy System was contributed to the Partnership from Azure and Azure acquired all of the equity interests in the General Partner and 90% of the Partnership's IDR Units (as defined below) from NuDevco.
The following transactions were consummated on February 27, 2015, in connection with the closing of the Transactions (the “Closing”):
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• | we amended and restated the limited partnership agreement of the Partnership to reflect the unitization of the Partnership's incentive distribution rights (as unitized, the “IDR Units”) and recapitalized the incentive distribution rights owned by IDRH into 100 IDR Units; |
• | we redeemed 90 IDR Units held by IDRH in exchange for a payment by the Partnership of $63 million to IDRH (the “Redemption”); |
• | the Legacy System was contributed to the Partnership from Azure through the contribution, indirectly or directly, of (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure ("Talco"), and (ii) certain assets owned by TGG Pipeline, Ltd., a Texas limited liability company and subsidiary of Azure ("TGG" and, collectively with Talco, "TGGT"), in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of (i) $99.5 million in cash and (ii) the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”); and |
• | Azure purchased from NuDevco (i) all of the outstanding membership interests in the General Partner and (ii) an option to acquire up to 20% of common and subordinated units held by NuDevco as of the execution date of the Transaction Agreement. |
Following the Closing, Azure controls us through its ownership of all of our outstanding general partner units, which represents an approximate 2% economic general partner interest in us. Azure also owns 90 IDR Units, which represent 90% of our IDR Units. NuDevco owns 60.2% of our outstanding limited partner interest and 10 IDR Units, which represent 10% of our IDR Units.
Azure is considered the accounting acquirer of the General Partner, and therefore will record its acquisition of the General Partner as a business combination within Azure’s consolidated financial statements. The Legacy System is deemed to be the accounting acquirer of the Partnership because its parent company, Azure, obtained control of the Partnership through its ownership of all of the equity interests in the General Partner. Consequently, the Legacy System is deemed to be the predecessor of the Partnership for financial reporting purposes and the historical consolidated financial statements of the Partnership for the three years ended December 31, 2014 have been recast and now reflect those of the Legacy System, as the accounting acquirer. The Legacy System's assets and liabilities will retain their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Legacy System in the business combination will be recorded at their fair values measured as of the acquisition date.
Contribution of the ETG System
On August 6, 2015, we entered into a contribution agreement (the “Contribution Agreement”) with Azure, which is the sole member of the general partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in the ETG System to the Partnership in exchange for the consideration described below. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of the ETG System was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | as consideration for the membership interests of the ETG System, we paid Azure $80.0 million in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure; and |
• | we entered into a gas gathering agreement (the “Gas Gathering Agreement”) with TGG an indirect subsidiary of Azure . |
The contribution of the ETG System was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Legacy System to include the financial results of the ETG System from the period November 15, 2013 to December 31, 2013 and the year ended December 31, 2014.
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Azure System Operations
Legacy System Operations
The Legacy System is primarily located within Harrison, Panola and Rusk Counties in Texas and Caddo Parish in Louisiana and currently serves the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation.
As of December 31, 2014, the Legacy System consisted of approximately 658 miles of high- and low-pressure gathering lines and served approximately 100,000 dedicated acres. The Legacy System has ten 1,340 horsepower compressors and two additional compressors comprising 725 horsepower, for a total of 14,125 horsepower of compression. The Legacy System has an aggregate capacity of approximately 500 MMcf/d.
The Legacy System gathers high-Btu natural gas with an NGL content between 2.0 and 5.2 GPM. Our major customers contracted on the Legacy System are BG, BP plc, Devon Energy Corporation, Endeavor Energy Resources, L.P., EXCO, Sabine Oil & Gas LLC and Samson Resources Corporation. These contracts have a remaining life varying from one year to life of lease. The Legacy System has access to seven major downstream markets, three third-party processing plants, including the Carthage Hub, and our Panola Processing plants. In addition, the Legacy System affords multiple opportunities to access high-NGL content horizontal gas from Cotton Valley.
The Legacy System's primary revenue producing activities are the sales of natural gas and NGLs purchased from third parties and the sale of condensate liquids. The sales of natural gas and NGLs are associated with contract agreements with limited commodity price exposure. The Legacy System receives a market price per barrel on revenue from natural gas condensate liquids. Secondarily, the Legacy System earns gathering services and other fee revenues from the gathering, compression and treating of natural gas. These gathering services and other fees are generally provided on a fixed fee basis per unit based on the volumes (Mcf) or heating content (MMBtu) of natural gas.
ETG System Operations
The ETG System is primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby Counties in East Texas and currently serves multiple formations including the Haynesville, Bossier and the liquids-rich James Lime formation. The ETG System consists of approximately 255 miles of gathering lines and serves approximately 336,000 gross dedicated acres. The system has two owned treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. The new Fairway processing plant is designed to extract NGL content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Azure System and Azure System Predecessor
The Azure System and the Azure System Predecessor's operating results and the majority of the assets and liabilities have been derived from the accounting records of Azure and Azure Midstream Holdings Predecessor (the "Azure System Predecessor") on a carve-out basis, and has been based on the existing divisional organization of Azure and the Azure System Predecessor. Certain assets, liabilities and expenses presented in the carve-out statements of financial position and statements of operations represent allocations and estimates of the costs of services incurred by either Azure or the Azure System Predecessor. These allocations and estimates were based on methodologies that management believes to be reasonable, and include items such as outstanding debt and related expenses associated with the Azure and Azure System Predecessor credit agreements and general and administrative expenses incurred by Azure and the Azure System Predecessor on behalf of the Azure System. Revenues have been identified by contracts that are specifically identifiable to the Azure System and the Azure System Predecessor. Depreciation and amortization are based upon assets specifically identified to the Azure System and Azure System Predecessor. Salaries, benefits and other general and administrative costs have been allocated to the Azure System and the Azure System Predecessor based on management’s use of a reasonable allocation methodology as such costs were historically not allocated to the Azure System and the Azure System Predecessor.
Azure
Azure is a midstream company with a focus on owning, operating, developing and acquiring midstream energy infrastructure in core producing areas in the United States. Azure currently provides natural gas gathering, compression, treating and processing services in Northern Louisiana and East Texas in the Haynesville and Bossier Shale formations. Prior to the Transactions, Azure operated three main gathering systems: Holly, Legacy and Center, the latter of which was comprised of
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the Azure Shelby and Azure ETG subsystems. As described above, the Legacy System was contributed to the Partnership in connection with the Transactions and the ETG System was contributed to the Partnership pursuant to the Contribution Agreement. The two remaining gathering systems, Holly and Center, the latter of which is comprised of the Azure Shelby subsystem, may potentially be available, in whole or in part, to the Partnership as future dropdown acquisitions, although Azure has no obligation to offer the Partnership those assets.
On November 15, 2013, Azure acquired 100% of the equity interests in TGGT for an aggregate sales price of $910.0 million, plus customary working capital adjustments, from EXCO Resources, Inc. (“EXCO”) and BG Group plc (“BG”). As part of the acquisition of TGGT, members of Azure management, Energy Spectrum Partners VI LP, and its parallel and
co-investment funds (“Energy Spectrum Partners”), a group of co-investors affiliated with Energy Spectrum Partners (the “Co-Investors”) and an affiliate of Tenaska Capital Management, LLC (“Tenaska Capital Management” and, collectively with the members of management, Energy Spectrum Partners and the Co-Investors, the “Azure Members”) contributed a combined $410.0 million in cash for an ownership interest in Azure. In a related transaction, TPF II East Texas Gathering, LLC , a business managed by Tenaska Capital Management, was contributed to Azure in exchange for an additional ownership interest in Azure valued at $90.0 million (the “ETG Contribution”). The acquisition of TGGT and the ETG Contribution are collectively referred to as the Acquisition.
The Azure System is a part of TGGT, and has been carved-out and derived from the accounting records of Azure for periods subsequent to the Acquisition.
Azure Predecessor
The Azure Predecessor was formed on August 14, 2009, arising from a transaction between EXCO and BG. EXCO contributed TGGT in exchange for a membership interest in the Azure Predecessor. EXCO then sold 50% of its membership interest in the Azure Predecessor to BG for cash consideration. Upon formation, EXCO and BG each funded initial operations of the Azure Predecessor. The Azure Predecessor’s consolidated financial statements are comprised of the TGGT assets, liabilities and results of operations as of and for all periods prior to the Acquisition as TGGT is the predecessor of Azure for accounting purposes.
The Azure System Predecessor was a part of the Azure Predecessor, TGGT, and has been carved-out and derived from the accounting records of the Azure Predecessor for the periods prior to the Acquisition.
General Trends and Outlook
In 2015, we will continue to be focused on maintaining the Partnership's stable distributable cash flows from our assets and executing on growth opportunities to increase our long-term distributable cash flows. We believe the transformative combination of Azure’s substantial dropdown inventory, demonstrated by Azure's contribution of the ETG System in August of 2015 and discussed elsewhere in this Current Report, as well as the combination of the Legacy System with the Partnership's existing midstream assets, creates a diversified platform of midstream services and establishes us as one of the largest gathering and processing systems in the Haynesville and horizontal Cotton Valley plays in East Texas and North Louisiana. The Cotton Valley formation has historically been a natural gas play, although improvements in technology have increased production of oil and NGLs in the area. The Cotton Valley formation is productive when accessed through horizontal drilling and fracture stimulation technologies. We believe these qualities, when combined with the liquids rich nature of the natural gas, concentrated oil content, high initial rates of production and competitive well costs, make the formation attractive for producers in the area.
Azure's acquisition of the General Partner is also expected to offer the potential for enhanced scale and diversification that we anticipate will provide additional financial flexibility that will allow us to more effectively compete for greenfield development and acquisition opportunities across the midstream value chain. Further, the combination of a significant portfolio of long-term, fee-based contracts with high-quality producers, coupled with the potential for organic capital opportunities across multiple geographies, provides meaningful visibility to long-term growth. The complementary services offered by Azure are also expected to create attractive operational and financial synergies for both entities.
We believe the key elements to stable distributable cash flows are our significant fee-based business plus our assets that are strategically positioned to capitalize on drilling activity and related demand for midstream natural gas services. We expect to continue to pursue a multi-faceted growth strategy, which includes maximizing opportunities provided by our relationship with Azure, pursuing strategic and accretive third party acquisitions and capitalizing on organic expansion opportunities in order to grow our distributable cash flows.
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How the Azure System Evaluates its Operations
Our management uses a variety of financial and operational metrics to analyze the Azure System's performance. These metrics include: (i) throughput volume; (ii) EBITDA and Adjusted EBITDA; (iii) distributable cash flow; (iv) operating expenses; and (v) capital spending.
Throughput Volume
The volume of natural gas that we gather depends on the level of production from natural gas wells connected to our gathering systems. Aggregate production volumes are impacted by the overall amount of drilling and completion activity because production must be maintained or increased by new drilling or other activity as the production rate of a natural gas well declines over time. Producers’ willingness to engage in new drilling is determined by a number of factors, the most important of which are the prevailing and projected prices of natural gas and NGLs, the cost to drill and operate a well, the availability and cost of capital, and environmental and government regulations. We generally expect the level of drilling to positively correlate with long-term trends in commodity prices. Similarly, production levels nationally and regionally generally tend to positively correlate with drilling activity, and we actively monitor producer drilling activity in the areas served by our gathering systems to pursue new supply opportunities.
We must continually obtain new supplies of natural gas to maintain or increase the throughput volume on our systems. Our ability to maintain or increase existing throughput volumes and obtain new supplies of natural gas is impacted by:
• | successful drilling activity within our dedicated acreage; |
• | the level of work-overs and recompletions of wells on existing pad sites to which our gathering systems are connected; |
• | the number of new pad sites in our dedicated acreage awaiting lateral connections; |
• | our ability to compete for volumes from successful new wells in the areas in which we operate outside of our existing dedicated acreage; |
• | our ability to utilize the remaining uncommitted capacity on, or add additional capacity to, our gathering systems; |
• | our ability to gather natural gas that has been released from commitments with our competitors; and |
• | our ability to acquire or develop new systems with associated volumes and contracts. |
EBITDA and Adjusted EBITDA
We define EBITDA as net income (loss), plus (1) interest expense, (2) income tax expense and (3) depreciation and amortization expense. We define Adjusted EBITDA as EBITDA, plus adjustments associated with certain non-cash and other items. EBITDA and Adjusted EBITDA are used as supplemental financial measures by management and external users of our financial statements, such as investors, commercial banks and research analysts, to assess the financial performance of our assets without regard to financing methods, capital structure or historical cost basis; our operating performance and return on capital as compared to those of other companies in the midstream energy sector, without regard to financing or capital structure; and the attractiveness of capital projects and acquisitions and the overall rates of return on alternative investment opportunities. Additionally, Adjusted EBITDA is used to assess the financial performance of our assets without the impact of certain non-cash and other items, including non-cash expenses, adjustments associated with cash received under the MRC requirements of our gas gathering agreements and certain other items.
Distributable Cash Flow
Although the Azure System and Azure System Predecessor have not quantified distributable cash flow on a historical basis, we intend to use distributable cash flow, which we define as Adjusted EBITDA less cash paid for interest expense, income tax expense and maintenance capital expenditures, to analyze our performance. Distributable cash flow will not reflect changes in working capital balances. Distributable cash flow is used as a supplemental financial measure by our management and by external users of our financial statements such as investors, commercial banks and research analysts, to assess the ability of our assets to generate cash sufficient to support our indebtedness and make future cash distributions to our unitholders, and the attractiveness of capital projects and acquisitions and the overall rates of return on our investment opportunities.
EBITDA, Adjusted EBITDA and Distributable Cash Flow are not financial measures presented in accordance with GAAP. We believe that the presentation of these non-GAAP financial measures will provide useful information to investors in assessing our financial condition and results of operations. Because EBITDA, Adjusted EBITDA and Distributable Cash Flow may be defined differently by other companies in our industry, our definitions of these non-GAAP financial measures may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.
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Operating Expenses
We seek to maximize the profitability of our operations in part by minimizing, to the extent appropriate, expenses directly tied to operating and maintaining our assets. Direct labor costs, repair and non-capitalized maintenance costs, integrity management costs, treating chemical costs, utilities and contract services are the most significant portion of the Azure System's operating expenses. These expenses are largely dependent on the volumes delivered through our gathering systems and may fluctuate depending on the activities performed during a specific period.
Capital Spending
Our management seeks to effectively manage our maintenance capital expenditures, including turnaround costs. These capital expenditures relate to the maintenance and integrity of our pipelines and facilities. We capitalize the costs of major maintenance activities, or turnarounds, and depreciate the costs over the period until the next planned turnaround of the affected unit. Historically, the Azure System has not made a distinction between maintenance and growth capital expenditures. In the future, we will categorize maintenance capital expenditures as those that are made to maintain our asset base, operating capacity or operating income, or to maintain the existing useful life of any of our capital assets, in each case over the long term. Examples of maintenance capital expenditures are expenditures for the repair, refurbishment and replacement of our assets, to maintain equipment reliability, integrity and safety and to address environmental laws and regulations. In addition, we may designate a portion of our maintenance capital expenditures to connect new wells to maintain throughput to the extent such capital expenditures are necessary to maintain, over the long term, our operating capacity or operating income. Expenditure levels will increase as pipelines age and require higher levels of inspection, maintenance and capital replacement.
Growth capital expenditures are cash expenditures to construct new midstream infrastructure, including those expenditures incurred in order to extend the useful lives of our assets, reduce costs, increase revenues, or increase system throughput or capacity from current levels. Examples of growth capital expenditures include the construction, development or acquisition of additional gathering pipelines, compressor stations, processing plants, and new well connections, in each case to the extent such capital expenditures are expected to expand our operating capacity or operating income. In the future, if we make acquisitions that increase system throughput or capacity, the associated capital expenditures will also be considered growth capital expenditures.
Items Affecting Comparability of the Azure System and Azure System Predecessor's Financial Results
The historical financial results of the Azure System and the Azure System Predecessor discussed below may not be: (i) comparable between the Azure System and the Azure System Predecessor's financial results; and (ii) may not be comparable to the Partnership's future financial results, for the reasons described below:
Items Affecting Comparability of Azure System to Azure System Predecessor
Ownership Structure
Prior to the Acquisition, the Azure System Predecessor operated approximately 1,060 miles of gathering pipelines that
transported natural gas from supply basins to major intrastate and interstate pipelines in the region. These gathering systems and treating facilities were operated primarily to provide midstream services to BG and EXCO to support their drilling and development programs, and the Azure System Predecessor’s management team did not pursue third-party volumes aggressively. As a result, our average daily throughput on our Azure System is currently below our daily throughput capacity. We believe this excess capacity creates an opportunity for us to significantly increase volumes on the existing Azure System with minimal incremental capital expenditures, thereby giving us substantial operating leverage. We intend to increase throughput volumes on the existing Azure System by continuing to work with our existing customers to enhance our service offerings to maximize the value of their production and our economics. Additionally, we intend to increase throughput volumes and diversify our customer base over time by aggressively competing for contracted volumes with new customers as their existing contracts with other pipeline operators expire. Consequently, the historical financial results of the Azure System reflect, and our future financial results are expected to reflect, the implementation of a significantly different operating strategy.
Operating Expenses
EXCO, BG and the Azure Predecessor had various services agreements in place whereby EXCO and BG would provide various services, including operational and general and administrative, to the Azure Predecessor and the Azure Predecessor would reimburse EXCO and BG for such services in accordance with the applicable services agreements. Azure
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terminated these services agreements with EXCO and BG following the Acquisition. As a result, the general and administrative expenses allocated to the Azure System will reflect the operating and general and administrative expenses under Azure management subsequent to the Acquisition and the Azure System Predecessor will reflect the general and administrative expenses under Azure Predecessor management.
Azure recorded the TGGT assets, including the Azure System, at fair value in accordance with GAAP in connection with the Acquisition on November 15, 2013. The fair value assigned to the Azure System assets was less than the Azure System Predecessor's book value of those assets, which had the effect of decreasing the depreciation expense associated with our assets subsequent to the Acquisition.
Financing
As described above, the long-term debt and related interest expense associated with the Azure and Azure Predecessor's credit agreements have been allocated to the Azure System and the Azure System Predecessor in accordance with applicable accounting guidance because the Azure System and the Azure System Predecessor's assets were pledged as collateral for the respective credit agreements.
There are differences in the way Azure financed its operations compared to the way the Azure Predecessor financed its operations. Historically, the Azure Predecessor’s operations were financed as part of BG and EXCO’s midstream joint venture operations. In addition, the Azure Predecessor largely relied on internally generated cash flows and capital contributions from BG and EXCO to satisfy its capital expenditure requirements. Azure entered into a term loan and revolving credit facility, described further below, in connection with the Acquisition. As a result, interest expense associated with the period Azure owned the Azure System assets is not comparable to the period in which the Azure Predecessor owned the Azure System assets.
Contribution of the ETG System
On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Azure System to include the financial results of the ETG System from the date of Azure's acquisition, November 15, 2013. Therefore, the financial results of the Azure System will not be comparable to the Azure System Predecessor for all periods prior to November 15, 2013.
Items Affecting Comparability of Azure System and Azure System Predecessor to the Partnership
The Partnership's future results of operations may not be comparable to the Azure System and the Azure System Predecessor's historical results of operations for the reasons described below:
Ownership
Following the closing of the Transactions, Azure controls the Partnership through its ownership of all of the outstanding general partner units, which represents an approximate 2% economic general partner interest in the Partnership. Azure also owns 90 IDR Units, which represent 90% of the Partnership's IDR Units. NuDevco owns 60.2% of the Partnership's outstanding limited partner interest and 10 IDR Units, which represent 10% of the Partnership's IDR Units.
In connection with the closing of the Transactions, the Partnership terminated its omnibus agreement, dated July 31, 2013 (the “Existing Omnibus Agreement”), by and between NuDevco and its affiliates, the General Partner and the Partnership.
Also in connection with the closing of the Transactions, the Partnership entered into an omnibus agreement (the “New Omnibus Agreement”) with the General Partner and Azure, pursuant to which, among other things:
• | Azure will provide corporate, general and administrative services (the “Services”) on behalf of the General Partner for the benefit of the Partnership and its subsidiaries; |
• | the Partnership is obligated to reimburse Azure and its affiliates for costs and expenses incurred by Azure and its affiliates in providing the Services on behalf of the Partnership, including, but not limited to, administrative costs and the compensation costs of the employees of Azure and its affiliates that provide Services to the Partnership; |
• | the General Partner or Azure may at any time temporarily or permanently exclude any particular Service from the scope of the New Omnibus Agreement upon 90 days’ notice; |
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• | the Partnership or Azure may terminate the New Omnibus Agreement in the event that Azure ceases to control the General Partner. Azure may also terminate the New Omnibus Agreement if the General Partner is removed without cause and the units held by the General Partner were not voted in favor of the removal; and |
• | the Partnership will have a right of first offer on any proposed transfer of any assets owned by Azure or its subsidiaries as of January 14, 2015. |
The Partnership's future results of operations will be comprised of our midstream natural gas segment, including the Azure System, and our logistics segment. The future results of operations will also be under Azure management, as it will control our general partner. As a result, the historical results of operations of the Azure System and the Azure System Predecessor will not be comparable to the Partnership's future results of operations.
Revenues
Subsequent to the closing of the Transactions, the revenues generated by the Partnership will consist of the revenues from the midstream natural gas segment, including the Azure System, and the logistics segment. The historical revenues included within the Partnership's financial statements will only be comprised of the Azure System and the Azure System Predecessor. The Azure System and Azure System Predecessor's primary revenue producing activities are the sales of natural gas and NGLs and the sale of condensate liquids. The Azure System also earns gathering services and other fee based revenues from the gathering, compression and treating of natural gas. The Partnership's revenues are derived from natural gas processing and fees earned from its gathering, processing and transloading operations. Therefore, the Partnership's future operating results will include incremental gathering, processing, transloading and other revenues compared with the historical revenues of the Azure System and the Azure System Predecessor.
General and Administrative Expenses
Under the New Omnibus Agreement, Azure has the ability to determine the Services and the amount of such Services it provides to the Partnership. These general and administrative expenses will not be comparable to the general and administrative expenses previously allocated to the Azure System from Azure and the Azure System Predecessor from the Azure Predecessor. The Partnership's general and administrative expenses will also not be comparable to the historical Azure System and Azure System Predecessor's general and administrative expenses because the Partnership's general and administrative expenses will include the expenses associated with being a publicly traded master limited partnership whereas the Azure System and the Azure System Predecessor were operated as private companies.
Financing
In connection with the Transactions, the Partnership entered into a new senior secured revolving credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC (collectively, the “Lenders”). The Credit Agreement has a maturity date of February 27, 2018 and up to $250.0 million in commitments. As a result, the Partnership's long-term debt and related charges will not be comparable to the Azure System and the Azure System Predecessor's historical long-term debt and related charges.
The Partnership expects ongoing sources of liquidity to include cash generated from operations, our new Credit Agreement and issuances of debt and equity securities.
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Results of the Azure System and the Azure System Predecessor's Operations
The following table presents the Azure System and the Azure System Predecessor's operating results for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013 (the "Azure 2013 Period"), the period from January 1, 2013 to November 14, 2013 (the "Predecessor 2013 Period") and the year ended December 31, 2012:
For a reconciliation of Adjusted EBITDA to its most directly comparable financial measure calculated in accordance with GAAP, please read "Non-GAAP Financial Measures".
Azure System (1) | Azure System Predecessor | |||||||||||||||
Year Ended December 31, | Period from November 15, 2013 | Period from January 1, 2013 | Year Ended December 31, | |||||||||||||
(in thousands, except volume information) | 2014 | to December 31, 2013 | to November 14, 2013 | 2012 | ||||||||||||
Statement of Operations Data: | ||||||||||||||||
Operating Revenues | ||||||||||||||||
Natural gas and NGL sales | $ | 51,484 | $ | 5,534 | $ | 31,749 | $ | 37,255 | ||||||||
Gathering services and other fees | 23,237 | 3,325 | 9,514 | 14,239 | ||||||||||||
Total operating revenues | 74,721 | 8,859 | 41,263 | 51,494 | ||||||||||||
Operating expenses: | ||||||||||||||||
Cost of purchased gas and NGLs sold | 38,042 | 4,505 | 21,054 | 22,793 | ||||||||||||
Operating expense | 13,714 | 2,643 | 11,330 | 11,183 | ||||||||||||
General and administrative | 5,812 | 195 | 3,629 | 5,692 | ||||||||||||
Asset impairments | 228 | — | 659 | 5,720 | ||||||||||||
Depreciation and amortization | 7,961 | 958 | 9,999 | 11,229 | ||||||||||||
Total expenses | 65,757 | 8,301 | 46,671 | 56,617 | ||||||||||||
Income (loss) from operations | 8,964 | 558 | (5,408 | ) | (5,123 | ) | ||||||||||
Interest expense | 15,149 | 1,855 | 3,167 | 4,951 | ||||||||||||
Other (income) expense, net | 422 | — | (807 | ) | 304 | |||||||||||
Net loss before income taxes | (6,607 | ) | (1,297 | ) | (7,768 | ) | (10,378 | ) | ||||||||
Income tax expense | 213 | 26 | 118 | 147 | ||||||||||||
Net loss | $ | (6,820 | ) | $ | (1,323 | ) | $ | (7,886 | ) | $ | (10,525 | ) | ||||
Balance Sheet Data (as of the period end): | ||||||||||||||||
Property, plant and equipment, net | $ | 304,175 | $ | 302,163 | $ | 341,848 | $ | 336,620 | ||||||||
Total assets | 319,203 | 324,563 | 351,102 | 345,381 | ||||||||||||
Parent company net investment | 116,151 | 107,028 | 218,531 | 189,547 | ||||||||||||
Key Performance Measures: | ||||||||||||||||
Adjusted EBITDA (2) | $ | 25,805 | $ | 2,702 | $ | 5,155 | $ | 11,826 | ||||||||
Capital expenditures | 14,233 | 1,068 | 13,989 | 9,887 | ||||||||||||
Operating Data: | ||||||||||||||||
Average throughput volumes of natural gas (MMcf/d) | 261 | 209 | 189 | 254 | ||||||||||||
(1) On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Azure System to include the financial results of the ETG System from the period November 15, 2013 to December 31, 2013 and the year ended December 31, 2014.
(2) For a definition of Adjusted EBITDA and a reconciliation to net income, its most directly comparable financial measure calculated in accordance with GAAP, please read "Non-GAAP Financial Measures" above.
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Year Ended December 31, 2014 Compared to the Period from November 15, 2013 to December 31, 2013 ("Azure 2013 Period") and the Period from January 1, 2013 to November 14, 2013 ("Predecessor 2013 Period")
Volumes
Average throughput volumes were 261 MMcf/d for the year ended December 31, 2014 compared to average throughput volumes of 209 MMcf/d for the Azure 2013 Period and 189 MMcf/d for the Predecessor 2013 Period. The increase in average throughput volumes resulted from higher natural gas and NGL sales volumes and higher weighted average natural gas and NGL sales prices during the year ended December 31, 2014 as compared to the Azure 2013 Period and the Predecessor 2013 Period.
Revenues
The Azure System and the Azure System Predecessor's revenues are primarily attributable to sales of natural gas and NGLs purchased from third parties. These sales are completed under contracts with limited commodity price exposure. Secondarily, the Azure System and the Azure System Predecessor's revenues are attributable to the volume of natural gas that it gathers, compresses and treats, and the fixed rates it charges per volume of natural gas for these services. The Azure System and the Azure System Predecessor delivers these volumes of natural gas to multiple interconnect and downstream access points or to third-party processing plants, which serve as connection points for a number of intrastate and interstate pipelines.
The Azure System's total operating revenues were $74.7 million for the year ended December 31, 2014 compared to total operating revenues of $8.9 million for the Azure 2013 Period and $41.3 million for the Predecessor 2013 Period. Natural gas and NGL sales were $51.5 million for the year ended December 31, 2014 compared to natural gas and NGL sales of $5.5 million for the Azure 2013 Period and $31.8 million for the Predecessor 2013 Period. The increase in total natural gas and NGL sales revenue period over period is due to: (i) higher natural gas and NGL sales volumes and higher weighted average natural gas and NGL sales prices during the year ended December 31, 2014 as compared to the Azure 2013 Period and the Predecessor 2013 Period; and (ii) increased sales attributable to the contribution of the ETG System of $8.6 million for the year ended December 31, 2014 and $1.6 million for the Azure 2013 Period. Gathering services and other fees were $23.2 million for the year ended December 31, 2014 compared to gathering services and other fees of $3.3 million for the Azure 2013 Period and $9.5 million for the Predecessor 2013 Period. The primary reason for the increase in gathering services and other fees revenue was the higher volumes and prices discussed above.
Cost of Purchased Gas and NGLs Sold
The Azure System's cost of purchased gas and NGLs sold were $38.0 million for the year ended December 31, 2014 compared to the cost of purchased gas and NGLs sold of $4.5 million for the Azure 2013 Period and $21.1 million for the Predecessor 2013 Period. The increase in cost of purchased gas and NGLs sold is due to: (i) higher natural gas prices and higher volumes period over period, and correlates to the increase in natural gas and NGL sales during the periods; and (ii) increased costs attributable to the contribution of the ETG System of $7.4 million for the year ended December 31, 2014 and $1.6 million for the Azure 2013 Period.
Operating Expense
The Azure System's operating expense was $13.7 million for the year ended December 31, 2014 compared to operating expense of $2.6 million for the Azure 2013 Period and $11.3 million for the Predecessor 2013 Period. The increase in operating expense was due to the contribution of the ETG System of $6.9 million for the year ended December 31, 2014 and $1.1 million for the Azure 2013 Period. This increase related to the ETG System was almost entirely offset by decreases in operating expense due to continued focus on asset optimization, including moving and consolidating compression facility locations and the release of under-utilized rental compression and treating equipment.
General and Administrative Expense
General and administrative expenses allocated to the Azure System were $5.8 million for the year ended December 31, 2014 compared to the $0.2 million amount allocated during the Azure 2013 Period and the $3.6 million amount allocated during the Predecessor 2013 Period. The increase was primarily driven by: (i) non-recurring transition and transaction expenses that have been allocated to the Azure System and were incurred by Azure during the year ended December 31, 2014; and (ii) increased general and administrative expense attributable to the contribution of the ETG System of $1.4 million for the year ended December 31, 2014. These costs were partially offset by a reduction in corporate personnel expenses as Azure reduced the number of corporate personnel to better align with the needs of its newly acquired assets.
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Asset Impairments
The Azure System recognized a $0.2 million impairment during the year ended December 31, 2014 compared to a $0.7 million impairment recognized during the Predecessor 2013 Period. These impairments resulted from adjusting the net book value of assets held for sale to their net realizable fair market value. There was no impairment recognized during the Azure 2013 Period.
Depreciation and Amortization Expense
The Azure System's depreciation and amortization expense was $8.0 million for the year ended December 31, 2014 compared to depreciation and amortization expense of $1.0 million for the Azure 2013 Period and $10.0 million for the Predecessor 2013 Period. As a result of the application of purchase accounting, the Legacy System assets acquired and liabilities assumed by Azure were adjusted to their fair market values on November 15, 2013, and Azure assigned useful lives based on various factors, including age and historical data associated with the assets acquired. The fair market values and useful lives assigned were different than the Azure Predecessor resulting in the decrease in depreciation and amortization expense. This decrease was partially offset by increased depreciation and amortization expense attributable to the contribution of the ETG System of $2.6 million for the year ended December 31, 2014 and $0.3 million for the Azure 2013 Period.
Interest Expense
Interest expense allocated to the Azure System was $15.1 million for the year ended December 31, 2014 compared to interest expense of $1.9 million for the Azure 2013 Period and $3.2 million for the Predecessor 2013 Period. The increase is primarily driven by: (i) increased outstanding borrowings under the Azure credit facility, which have been allocated to the Azure System, compared to outstanding borrowings under the Azure credit facility, which have been allocated to the Azure System Predecessor; and (ii) increased interest expense attributable to the contribution of the ETG System of $4.5 million for the year ended December 31, 2014 and $0.6 million for the Azure 2013 Period.
The Period from November 15, 2013 to December 31, 2013 ("Azure 2013 Period") and the Period from January 1, 2013 to November 14, 2013 ("Predecessor 2013 Period") Compared to the Year Ended December 31, 2012
Volumes
Average throughput volumes were 209 MMcf/d for the Azure 2013 Period and 189 MMcf/d for the Predecessor 2013 Period compared to average throughput volumes of 254 MMcf/d for the year ended December 31, 2012. The decrease in average throughput volumes resulted from lower natural gas and NGL sales volumes and lower weighted average natural gas and NGL sales prices for the Azure 2013 Period and the Predecessor 2013 Period as compared to the year ended 2012.
Revenues
The Azure System and Azure System Predecessor's total operating revenues were $8.9 million for the Azure 2013 Period and $41.3 million for the Predecessor 2013 Period compared to $51.5 million for the year ended December 31, 2012. Natural gas and NGL sales were $5.5 million for the Azure 2013 Period and $31.8 million for the Predecessor 2013 Period compared to $37.3 million for the year ended December 31, 2012. Natural gas and NGL sales revenue for the Azure 2013 Period and the Predecessor 2013 Period were comparable to the natural gas and NGL sales revenue for the year ended 2012 despite lower natural gas and NGL sales volumes and lower weighted average natural gas and NGL sales prices during the Azure 2013 Period and the Predecessor 2013 Period compared to the year ended December 31, 2012, primarily due to increased sales attributable to the contribution of the ETG System of $1.6 million for the Azure 2013 Period. Gathering services and other fees were $3.3 million for the Azure 2013 Period and $9.5 million for the Predecessor 2013 Period compared to $14.2 million for the year ended December 31, 2012.
Cost of Purchased Gas and NGLs Sold
The Azure System and Azure System Predecessor's cost of purchased gas and NGLs sold were $4.5 million for the Azure 2013 Period and $21.1 million for the Predecessor 2013 Period compared to $22.8 million for the year ended December 31, 2012. The primary reason for the decrease in gathering services and other fees revenue was the lower volumes and prices discussed above.
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Operating Expense
The Azure System and Azure System Predecessor's operating expense was $2.6 million for the Azure 2013 Period and $11.3 million for the Predecessor 2013 Period compared to $11.2 million for the year ended December 31, 2012. The increase in operating expenses period over period is due to: (i) higher repairs and maintenance and employee related expenses; (ii) increased operating expenses attributable to the contribution of the ETG System of $1.1 million for the Azure 2013 Period; partially offset by (iii) lower utilities and compression related expenditures.
General and Administrative Expense
General and administrative expenses allocated to the Azure System and Azure System Predecessor were $0.2 million during the Azure 2013 Period and $3.6 million during the Predecessor 2013 Period compared to $5.7 million for the year ended December 31, 2012. The decrease in general and administrative expenses were due to lower employee related expenses.
Asset Impairments
The Azure System Predecessor recognized a $0.7 million impairment during the Predecessor 2013 Period resulting from adjusting the net book value of assets held for sale to their net realizable fair market value. The Azure System Predecessor also recognized an impairment of $5.7 million related to the Danville Gathering System during the year ended December 31, 2012. There was no impairment recognized during the Azure 2013 Period.
Depreciation and Amortization Expense
The Azure System and Azure System Predecessor's depreciation and amortization expense was $1.0 million for the Azure 2013 Period and $10.0 million for the Predecessor 2013 Period compared to $11.2 million for the year ended December 31, 2012.
Interest Expense
The interest expense allocated to the Azure System and the Azure System Predecessor was $1.9 million for the Azure 2013 Period and $3.2 million for the Predecessor 2013 Period compared to $5.0 million for the year ended December 31, 2012. The slight increase is primarily driven by increased interest expense attributable to the contribution of the ETG System of $0.6 million for the Azure 2013 Period, partially offset by the difference in borrowings, of approximately $0.5 million, under the Azure credit facility, which have been allocated to the Azure System, compared to outstanding borrowings under the Azure Predecessor credit facility, which have been allocated to the Azure System Predecessor.
Liquidity and Capital Resources
Azure System and the Azure System Predecessor's Sources and Uses of Cash
The Azure System and the Azure System Predecessor utilized the Azure and Azure Predecessor’s centralized processes and systems for cash management, payroll, purchasing and expenditures. As a result, cash generated by and cash received by the Azure System and the Azure System Predecessor was deposited in and commingled with the general corporate funds of the respective period’s owner, and is or was not specifically allocated to the Azure System or the Azure System Predecessor. The net results of these cash transactions between the Azure System, the Azure System Predecessor and the respective period’s owner are reflected in parent company’s net investment in the carved-out balance sheets. Changes in long-term debt associated with the Azure and Azure Predecessor credit agreement that are allocated to the Azure System and Azure System Predecessor are assumed to be cash borrowings or repayments within the financing activities section of the statements of cash flows.
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The following table presents the Azure System and Azure System Predecessor's sources and uses of cash for the periods presented:
Azure System (1) | Azure System Predecessor | |||||||||||||||
Year Ended December 31, 2014 | Period from November 15, 2013 to December 31, 2013 | Period from January 1, 2013 to November 14, 2013 | Year Ended December 31, 2012 | |||||||||||||
(in thousands) | ||||||||||||||||
Net cash provided by (used in): | ||||||||||||||||
Operating activities | $ | 8,179 | $ | (384 | ) | $ | 3,590 | $ | 6,348 | |||||||
Investing activities | $ | (13,839 | ) | $ | (212,123 | ) | $ | (13,989 | ) | $ | (2,387 | ) | ||||
Financing activities | $ | 5,660 | $ | 212,507 | $ | 10,399 | $ | (3,961 | ) | |||||||
(1) On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Azure System to include the financial results of the ETG System from the period November 15, 2013 to December 31, 2013 and the year ended December 31, 2014.
Operating activities: Operating cash flow has been the source of liquidity for the Azure System and the Azure System Predecessor. Generally, the Azure System and Azure System Predecessor's operating cash flows increase or decrease due to the same factors that impact income (loss) from operations. Consequently, changes in operating cash flows since the year ended December 31, 2012 were primarily driven by the fluctuations in volume and price of the natural gas and NGLs purchased, sold, gathered, compressed and treated by the Azure System and Azure System Predecessor's assets.
Investing activities and Financing activities: Azure and the Azure Predecessor’s net investment in the operations of the Azure System and Azure System Predecessor is presented as parent company net investment within the respective period's financial statements. Parent company net investment represents the accumulated net earnings of the operations and the accumulated net contributions from Azure and the Azure Predecessor. Net contributions from Azure and Azure Predecessor during the periods presented were primarily comprised of intercompany operations and maintenance expense, cash clearing and other financing activities, and debt and general and administrative costs allocations to the Azure System and Azure System Predecessor.
The capital expenditures associated with the Azure System and Azure System Predecessor were $14.2 million, $1.1 million, $14.0 million and $9.9 million for the year ended December 31, 2014, the Azure 2013 Period, the Predecessor 2013 Period and the year ended December 31, 2012, respectively. The investing activities for the Azure 2013 Period includes the allocated Azure System purchase price of $212.5 million. The financing activities for the Azure 2013 Period includes the allocated borrowings under the Azure Credit Agreement, defined below, of $142.0 million and parent company net investment of $76.8 million to fund the Azure System purchase price.
Capital Requirements
The midstream business is capital intensive and can require significant investment to maintain and upgrade existing operations, connect new wells to the system, organically grow into new areas and comply with environmental and safety regulations. Going forward, our capital requirements will consist of the following:
• | Maintenance capital expenditures are cash expenditures that are made to maintain our asset base, operating capacity or operating income, or to maintain the existing useful life of any of our capital assets, in each case over the long term. Examples of maintenance capital expenditures are expenditures for the repair, refurbishment and replacement of our assets, to maintain equipment reliability, integrity and safety, and to address environmental laws and regulations. In addition, we may designate a portion of our maintenance capital expenditures to connect new wells to maintain throughput to the extent such capital expenditures are necessary to maintain, over the long term, our operating capacity or operating income. We capitalize the costs of major maintenance activities, or turnarounds, and depreciate the costs over the expected useful life of such maintenance cost. Expenditure levels will increase as pipelines age and require higher levels of inspection, maintenance and capital replacement; and |
• | Growth capital expenditures are cash expenditures to construct new midstream infrastructure, including those expenditures incurred in order to extend the useful lives of our assets, reduce costs, increase revenues, or increase system throughput or capacity from current levels. Examples of growth capital expenditures include the construction, |
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development or acquisition of additional gathering pipelines, compressor stations, processing plants, and new well connections, in each case to the extent such capital expenditures are expected to expand our operating capacity or operating income. In the future, if we make acquisitions that increase system throughput or capacity, the associated capital expenditures will also be considered growth capital expenditures.
Based on current market conditions, we expect to be able to fund our activities for 2015 with cash flows generated from our operations, available cash on hand and borrowings under our new Credit Agreement as well as accessing the capital markets for debt and equity capital. Our ability to pay distributions to our unitholders, and to fund planned capital expenditures and to make acquisitions will depend upon our future operating performance, which will be affected by prevailing economic conditions in the industry and financial, business and other factors, some of which are beyond our control.
Credit Agreement
On February 27, 2015, we entered into the Credit Agreement whereby the lenders agreed to extend to us a senior secured revolving credit facility of up to $250 million. Proceeds from the credit facility were used on the closing date for the repayment and termination of our then-existing credit facility and otherwise in connection with the Transactions, and future drawings will be used for working capital, permitted acquisitions and capital expenditures, quarterly distributions of available cash and other general corporate purposes. The maturity date of the Credit Agreement is February 27, 2018.
The Credit Agreement requires that (a) all domestic restricted subsidiaries guarantee our obligations and the obligations of the subsidiary guarantors under (i) the Credit Agreement and other loan documents and (ii) certain hedging agreements and cash management agreements with lenders and affiliates of lenders, and (b) all such obligations be secured by a security interest in substantially all of our assets and the assets of our subsidiary guarantors, in each case, subject to certain customary exceptions.
The Credit Agreement provides for a $15 million sublimit for letters of credit and a $15 million sublimit for swingline loans. Borrowings under the Credit Agreement bear interest at (a) the LIBOR Rate (as defined in the Credit Agreement) plus an applicable margin of 2.75% to 3.75% or (b) the Base Rate (as defined in the Credit Agreement) plus an applicable margin of 1.75% to 2.75%, in each case, based on the Consolidated Total Leverage Ratio (as defined in the Credit Agreement). Until such time as we receive gross cash proceeds of not less than $50 million from the consummation of a single issuance of common equity and prepay the loans under the Credit Agreement in an amount not less than $50 million (the “Availability Period”), the amount we may borrow under the Credit Agreement is limited to an amount (the “Availability”) equal to the sum of (a) the product of (i) 4.5 and (ii) Eligible Gas Gathering EBITDA (as defined in the Credit Agreement); plus (b) the lesser of (i) $15 million and (ii) Eligible Transloading EBITDA (as defined in the Credit Agreement). During the Availability Period, the Availability shall be determined periodically in connection with our delivery of annual and quarterly financial statements pursuant to the Credit Agreement and upon the occurrence of certain other events described in the Credit Agreement.
The Credit Agreement contains affirmative and negative covenants customary for credit facilities of its size and nature that, among other things, limit or restrict our ability and the ability of our subsidiaries to (a) incur additional debt; (b) grant certain liens; (c) make certain investments; (d) engage in certain mergers or consolidations; (e) dispose of certain assets; (f) enter into certain types of transactions with affiliates; (g) make distributions, with certain exceptions, including the distribution of Available Cash (as defined in the partnership agreement) if no default or event of default exists and, during the Availability Period, if an Availability deficiency exists, the aggregate amount of distributions of Available Cash made during such deficiency shall not exceed $10 million; (h) enter into certain restrictive agreements or amend certain material agreements and (i) prepay certain debt.
The Credit Agreement requires that our ratio of Consolidated Funded Indebtedness (as defined in the Credit Agreement) on the date of determination to Adjusted Consolidated EBITDA (as defined in the Credit Agreement) for a trailing four fiscal quarter period not to exceed 4.50 to 1.00 (or 5.00 to 1.00 for the period commencing on the date that a certain acquisition is consummated through the last day of the second full fiscal quarter following the date of such acquisition). In addition, the Credit Agreement requires our ratio of Adjusted Consolidated EBITDA for a trailing four fiscal quarter period to Consolidated Interest Expense (as defined in the Credit Agreement) for such period to be at least 2.50 to 1.00. As of February 27, 2015, we had outstanding borrowings of $180.8 million.
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Azure System and the Azure System Predecessor Long-term Debt and Related Expenses Allocation
The Azure Credit Agreement and the Predecessor Credit Agreement, described further below, served as the sole borrowing agreement applicable for the Azure System and the Azure System Predecessor during the periods presented. In addition, substantially all of Azure and the Azure Predecessor’s subsidiaries, including the Azure System and the Azure System Predecessor, served as guarantors and pledger's with respect to the Azure Credit Agreement and the Predecessor Credit Agreement. The Azure System and the Azure System Predecessor’s long-term debt and related expense balances represent an allocation of its proportionate share of the Azure and Azure Predecessor’s consolidated long-term debt as of and for all periods presented in accordance with applicable accounting guidance.
Substantially all of the Azure System and Azure System Predecessor’s capital expenditures, including $550.0 million used to fund a portion of the Acquisition, were financed by the Azure Credit Agreement or the Predecessor Credit Agreement during these respective periods. As a result, the debt and related expense balances presented within the Legacy System and ETG System financial statements represent the Azure System and the Azure System Predecessor’s proportionate share using proportional book value of the Azure System and the Azure System Predecessor’s assets as a percentage of total assets financed by the Azure Credit Agreement and the Predecessor Credit Agreement.
In connection with entering into the Azure Credit Agreement and the Predecessor Credit Agreement, Azure and the Azure Predecessor incurred financing costs. These deferred financing costs were being amortized to interest expense over the term of the loan and have also been allocated to the Azure System and the Azure System Predecessor's balance sheets, included within other non-current assets. The Azure System and Azure System Predecessor’s interest expense has also been calculated using a similar allocation methodology as long-term debt.
Azure and the Azure Predecessor Credit Agreements
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (the "TLB") maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (the "Revolver" and collectively with the TLB, the "Azure Credit Agreement") with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement are unconditionally guaranteed, jointly and severally, by all of the Azure subsidiaries, including the Azure System, and are collateralized by first priority liens on substantially all of existing and subsequently acquired assets and equity.
Under the TLB, borrowings bear interest at Azure’s option of either the (i) monthly Eurodollar Rate, which is the British Bankers Association London Inter Bank Offered Rate and cannot be less than 1% per year or (ii) the Alternative Base Rate (ABR), which is the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Rate; plus 0.50% or (c) the Eurodollar Rate; plus 1.0%; plus the applicable Eurodollar margin or the ABR margin which is 5.5% and 4.5%, respectively. Azure Eelected the Eurodollar Rate and Eurodollar margin for the TLB for the year ending December 31, 2014 and the Azure 2013 Period. For the Revolver, borrowings bear interest under the same terms as the TLB and the applicable Eurodollar margin and ABR margin vary quarterly based on Azure's consolidated leverage ratio. The weighted average interest rate for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 was 6.50%. Total outstanding borrowings associated with the Azure Credit Agreement were $522.5 million and $550.0 million as of December 31, 2014 and December 31, 2013, respectively, of which $27.5 million is due within one year. As of December 31, 2014 and 2013, all outstanding borrowings were associated with the TLB and there were no outstanding borrowings under the Revolver during either period.
In September 2014, Azure entered into the first amendment to the Azure Credit Agreement (the "First Amendment"). Among other things, the First Amendment reduced borrowing capacity under the Revolver from $50.0 million to $40.0 million and provided for more favorable financial condition covenants. A loss on the extinguishment of debt in the amount of $0.3 million was recognized by Azure as a result of the First Amendment, and a portion, $0.1 million, of the loss on the extinguishment of debt has been allocated to the Azure System and is included within interest expense during the year ended December 31, 2014.
The Azure Predecessor had a $600.0 million senior secured credit facility (the "Predecessor Credit Agreement"). Borrowings under the Predecessor Credit Agreement were unconditionally guaranteed, jointly and severally, by all of the Predecessor’s subsidiaries, including the Azure System Predecessor, and were collateralized by first priority liens on substantially all of the existing and subsequently acquired assets and equity. The weighted average interest rate associated with the Predecessor Credit Agreement for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012 was 2.42% and 2.72%. Outstanding borrowings associated with the Predecessor Credit Agreement averaged $446.6 million and $512.1 million for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012.
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Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements.
Contractual Obligations
The table below summarizes the Azure System's contractual obligations and other commitments as of December 31, 2014:
Less Than | More Than | ||||||||||||||||||
Total | 1 Year | 1 - 3 Years | 3 - 5 Years | 5 Years | |||||||||||||||
Contractual Obligations(1): | |||||||||||||||||||
Long-term debt and interest (2) | $ | 237,806 | $ | 19,554 | $ | 218,252 | $ | — | $ | — | |||||||||
Operating Leases | 4,861 | 2,584 | 1,375 | 320 | 582 | ||||||||||||||
Total | $ | 242,667 | $ | 22,138 | $ | 219,627 | $ | 320 | $ | 582 | |||||||||
(1) On August 6, 2015, Azure contributed the ETG System. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, the above table includes the contractual obligations related to the ETG System as of December 31, 2014.
(2) The long-term debt and interest expense is associated with the Azure Credit Agreement and has been allocated to the Azure System in accordance with applicable accounting guidance because the Azure System assets served as collateral under the Azure Credit Agreement. Azure contributed the Legacy System to the Partnership in connection with the Transactions and as a result the Legacy System does not serve as collateral for the Azure credit agreement subsequent to February 27, 2015. Azure contributed the ETG System to the Partnership in connection with the transactions contemplated by the Contribution Agreement and as a result the ETG System does not serve as collateral for the Azure Credit Agreement subsequent to August 6, 2015.
In connection with the closing of the Transactions, the closing of the transactions contemplated by the Contribution Agreement and the Partnership entering into the Credit Agreement, all domestic restricted subsidiaries, including the Legacy System and ETG System, guarantee the Partnership's obligations and the obligations of the subsidiary guarantors under: (i) the Credit Agreement and other loan documents; (ii) certain hedging agreements and cash management agreements with lenders and affiliates of lenders; and (iii) all such obligations be secured by a security interest in substantially all of the Partnership's assets and the assets of our subsidiary guarantors, in each case, subject to certain customary exceptions.
Credit Risk and Customer Concentration
The Azure System and Azure System Predecessor’s primary markets are in the North Louisiana and East Texas natural gas supply basins, and it delivers natural gas to major intrastate and interstate pipelines in these regions. The Azure System has a concentration of revenues and trade accounts receivable due from customers engaged in the production, trading, distribution and marketing of natural gas and condensate. These concentrations may affect overall credit risk in that these customers may be affected similarly by changes in the economic, regulatory, environmental or other factors. The Azure System analyzes its customers’ historical financial and operational information before extending credit. The Azure System Predecessor’s concentration of credit risk was not materially different than that of the Azure System.
The Azure System had four customers that individually represented greater than 10% of total operating revenues during the year ended December 31, 2014, specifically Conoco Phillips, BP plc, Texla Energy Management Inc., and Waskom Gas Processing Company LLC each represented 19%, 18%, 11%, and 11% of total operating revenues.
We examine the creditworthiness of third-party customers to whom we extend credit and manage our exposure to credit risk through credit analysis, credit approval, credit limits and monitoring procedures, and for certain transactions, we may request letters of credit, prepayments or guarantees. If one of the customers noted above were to default on their contractual obligations or if we were unable to renew our contract with these customers on favorable terms, we may not be able to replace these customers in a timely fashion, on favorable terms if at all. In any of these situations, our cash flows and our ability to make cash distributions to our unitholders may be adversely affected. We expect our exposure to concentrated risk of non-payment or non-performance to continue as long as we remain substantially dependent on a relatively small number of customers for a substantial portion of our revenue.
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Disclosure Regarding Forward-Looking Statements
This report contains forward-looking statements that are based on information currently available to management as well as management’s assumptions and beliefs. All statements, other than statements of historical fact, included herein constitute forward-looking statements, including but not limited to statements identified by the words “forecast,” “may,” “believe,” “will,” “should,” “plan,” “predict,”“anticipate,” “intend,” “estimate” and “expect” and similar expressions. Such statements reflect our current views with respect to future events, based on what we believe are reasonable assumptions; however, such statements are subject to certain risks and uncertainties. In addition to the specific uncertainties discussed elsewhere in this report, the risk factors set forth in our Annual Report on Form 10-K, filed with the SEC on March 11, 2015, may affect our performance and results of operations. Should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may differ materially from those in the forward-looking statements. We disclaim any intention or obligation to update or review any forward looking statements or information, whether as a result of new information, future events or otherwise.
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Exhibit 99.3
EXPLANATORY NOTE
The condensed consolidated financial statements included in this filing reflect the assets, liabilities and operations of Azure Midstream Partners, LP (the "Partnership"), updated to include the contribution of Azure ETG, LLC ("ETG") that owns and operates the East Texas Gathering System (the "ETG System").
On August 6, 2015, the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the condensed consolidated financial statements and footnotes of the Partnership to include the financial results of the ETG System for the three and six month periods ended June 30, 2015 and 2014.
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PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
AZURE MIDSTREAM PARTNERS, LP
CONDENSED CONSOLIDATED BALANCE SHEETS
(in thousands, except number of units)
(unaudited) | |||||||
June 30, 2015 | December 31, 2014 | ||||||
ASSETS | |||||||
Current assets: | |||||||
Cash and cash equivalents | $ | 5,179 | $ | — | |||
Accounts receivable, net | 9,542 | 8,354 | |||||
Accounts receivable—affiliates | 4,041 | 76 | |||||
Other current assets | 1,245 | 435 | |||||
Total current assets | 20,007 | 8,865 | |||||
Property, plant, and equipment, net | 491,614 | 304,175 | |||||
Intangible assets, net | 62,833 | — | |||||
Goodwill | 215,758 | — | |||||
Other assets | 5,260 | 6,163 | |||||
TOTAL ASSETS | $ | 795,472 | $ | 319,203 | |||
LIABILITIES, PARTNERS’ CAPITAL AND PREDECESSOR PARENT COMPANY NET INVESTMENT | |||||||
Current liabilities: | |||||||
Accounts payable and accrued liabilities | $ | 9,415 | $ | 5,630 | |||
Accounts payable—affiliates | 871 | 96 | |||||
Current portion of long-term debt allocated from the Azure Credit Agreement | 3,603 | 10,104 | |||||
Total current liabilities | 13,889 | 15,830 | |||||
Long-term debt | 191,611 | 181,871 | |||||
Deferred income taxes, net | 826 | — | |||||
Other long-term liabilities | 11,625 | 5,351 | |||||
Total liabilities | 217,951 | 203,052 | |||||
Partners' capital and predecessor parent company net investment: | |||||||
Common units (12,695,356 issued and outstanding as of June 30, 2015) | 266,330 | — | |||||
Subordinated units (8,724,545 issued and outstanding as of June 30, 2015) | 207,265 | — | |||||
General partner interest | 7,954 | — | |||||
Incentive distribution rights (100 issued and outstanding as of June 30, 2015) | 70,000 | — | |||||
Predecessor parent company net investment | 25,972 | 116,151 | |||||
Total partners’ capital and predecessor parent company net investment | 577,521 | 116,151 | |||||
TOTAL LIABILITIES, PARTNERS’ CAPITAL AND PREDECESSOR PARENT COMPANY NET INVESTMENT | $ | 795,472 | $ | 319,203 | |||
See the accompanying notes to the condensed consolidated financial statements.
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AZURE MIDSTREAM PARTNERS, LP
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per unit amounts)
(unaudited)
Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||
2015 | 2014 | 2015 | 2014 | ||||||||||||
Operating Revenues: | |||||||||||||||
Natural gas, NGLs and condensate revenue | $ | 5,919 | $ | 12,309 | $ | 11,321 | $ | 23,376 | |||||||
Natural gas, NGLs and condensate revenue—affiliates | 561 | 1,240 | 705 | 2,370 | |||||||||||
Gathering, processing, transloading and other fee revenue | 9,440 | 5,494 | 16,264 | 10,156 | |||||||||||
Gathering, processing, transloading and other fee revenue—affiliates | 8,452 | 246 | 11,762 | 514 | |||||||||||
Total operating revenues | 24,372 | 19,289 | 40,052 | 36,416 | |||||||||||
Operating Expenses: | |||||||||||||||
Cost of natural gas and NGLs | 3,636 | 6,408 | 7,954 | 11,803 | |||||||||||
Cost of natural gas and NGLs—affiliates | 1,358 | 3,603 | 1,843 | 6,176 | |||||||||||
Operation and maintenance | 5,777 | 3,575 | 10,435 | 7,757 | |||||||||||
General and administrative | 4,374 | 1,432 | 7,248 | 2,991 | |||||||||||
Depreciation and amortization expense | 5,884 | 2,035 | 9,078 | 3,916 | |||||||||||
Asset impairments | — | — | — | 150 | |||||||||||
Total operating expenses | 21,029 | 17,053 | 36,558 | 32,793 | |||||||||||
Operating income | 3,343 | 2,236 | 3,494 | 3,623 | |||||||||||
Interest expense | 3,225 | 3,704 | 6,698 | 7,482 | |||||||||||
Other expense, net | 581 | 75 | 1,680 | 186 | |||||||||||
Net loss before income tax expense | (463 | ) | (1,543 | ) | (4,884 | ) | (4,045 | ) | |||||||
Income tax expense | 540 | 53 | 499 | 101 | |||||||||||
Net loss | $ | (1,003 | ) | $ | (1,596 | ) | $ | (5,383 | ) | $ | (4,146 | ) | |||
Net income per unit and distributions declared: | |||||||||||||||
Net loss | $ | (1,003 | ) | $ | (5,383 | ) | |||||||||
Less: net loss attributable to Azure System Predecessor for the period January 1, 2015 to February 28, 2015 | — | (3,543 | ) | ||||||||||||
Net loss attributable to the Partnership | (1,003 | ) | (1,840 | ) | |||||||||||
Less: Net loss attributable to the General Partner | (2,672 | ) | (3,898 | ) | |||||||||||
Net income attributable to limited partners (1) | $ | 1,669 | $ | 2,058 | |||||||||||
Net income attributable to limited partner common units outstanding | $ | 871 | $ | 1,070 | |||||||||||
Net income attributable to limited partner subordinated units outstanding | $ | 798 | $ | 988 | |||||||||||
Net income per limited partner common and subordinated units - basic and diluted (1) | $ | 0.09 | $ | 0.11 | |||||||||||
Weighted average number of limited partner common units outstanding | 9,541,510 | 9,453,553 | |||||||||||||
Weighted average number of limited partner subordinated units outstanding | 8,724,545 | 8,724,545 | |||||||||||||
Distributions declared per limited partner common and subordinated units | $ | 0.37 | $ | 0.74 | |||||||||||
(1) For the six months ended June 30, 2015, net income per unit has been presented for the period March 1, 2015 to June 30, 2015, the period in which units were outstanding for accounting purposes (see Note 1). | |||||||||||||||
See the accompanying notes to the condensed consolidated financial statements.
3
AZURE MIDSTREAM PARTNERS, LP
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)
Six Months Ended June 30, | |||||||
2015 | 2014 | ||||||
CASH FLOWS FROM OPERATING ACTIVITIES: | |||||||
Net income (loss) | $ | (5,383 | ) | $ | (4,146 | ) | |
Adjustments to reconcile net loss to net cash flows provided by operating activities: | |||||||
Depreciation and amortization expense | 9,078 | 3,916 | |||||
Amortization of deferred financing costs | 823 | 782 | |||||
Asset impairments | — | 150 | |||||
Deferred income taxes | 415 | — | |||||
Gas imbalance mark-to-market | 135 | — | |||||
Changes in assets and liabilities, net of effects of business combination: | |||||||
Accounts receivable | (6,069 | ) | 3,428 | ||||
Other current assets | (371 | ) | (458 | ) | |||
Accounts payable and accrued liabilities | (5,894 | ) | (1,447 | ) | |||
Other long-term liabilities | 6,275 | 4,282 | |||||
Net cash (used in) provided by operating activities | (991 | ) | 6,507 | ||||
CASH FLOWS FROM INVESTING ACTIVITIES: | |||||||
Capital expenditures | (1,971 | ) | (5,673 | ) | |||
Cash received under aid in construction contracts | 1,958 | — | |||||
Assumed cash acquired in business combination | 117,268 | — | |||||
Net cash provided by (used in) investing activities | 117,255 | (5,673 | ) | ||||
CASH FLOWS FROM FINANCING ACTIVITIES: | |||||||
Borrowings of long-term debt under the Credit Agreement (See Note7) | 9,500 | — | |||||
Proceeds from public offering | 48,332 | — | |||||
Repayments of long-term debt under the Partnership's existing credit facility (See Note 7) | (18,741 | ) | (5,051 | ) | |||
Repayments of long-term debt under the Credit Agreement (See Note 7) | (47,320 | ) | — | ||||
Cash distribution related to the Transactions | (99,500 | ) | — | ||||
Distribution to unitholders | (6,763 | ) | — | ||||
Payment of deferred financing costs | (272 | ) | (48 | ) | |||
Predecessor parent company net investment | 3,679 | 4,265 | |||||
Net cash (used in) financing activities | (111,085 | ) | (834 | ) | |||
NET INCREASE IN CASH AND CASH EQUIVALENTS | 5,179 | — | |||||
CASH AND CASH EQUIVALENTS—Beginning of Period | — | — | |||||
CASH AND CASH EQUIVALENTS—End of Period | $ | 5,179 | $ | — | |||
See the accompanying notes to the condensed consolidated financial statements.
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AZURE MIDSTREAM PARTNERS, LP
CONDENSED CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL AND
PREDECESSOR PARENT COMPANY NET INVESTMENT
(in thousands)
(unaudited)
General Partner Interest | Incentive Distribution Rights | Limited Partner | Predecessor Parent Company Net Investment | Total | |||||||||||||||||||
Common Units | Subordinated Units | ||||||||||||||||||||||
Balance at December 31, 2014 | $ | — | $ | — | $ | — | $ | — | $ | 116,151 | $ | 116,151 | |||||||||||
Predecessor net loss for the period January 1, 2015 to February 28, 2015 | — | — | — | — | (3,543 | ) | (3,543 | ) | |||||||||||||||
Predecessor parent company net contribution for the period January 1, 2015 to February 28, 2015 | — | — | — | — | 2,754 | 2,754 | |||||||||||||||||
Deemed contribution associated with the Transactions | — | — | — | — | 126,481 | 126,481 | |||||||||||||||||
Issuance of IDR Units in connection with the Transactions | — | 63,000 | — | — | — | 63,000 | |||||||||||||||||
Distribution made in connection with the Transactions | — | — | — | — | (162,500 | ) | (162,500 | ) | |||||||||||||||
Allocation of Predecessor parent company net investment | — | — | 26,562 | 25,148 | (51,710 | ) | — | ||||||||||||||||
Acquisition of Marlin Midstream Partners, LP | 7,034 | 7,000 | 194,780 | 184,357 | — | 393,171 | |||||||||||||||||
Predecessor parent company net contribution associated with the ETG System | — | — | — | — | 2,278 | 2,278 | |||||||||||||||||
Public offering of common units | 1,012 | — | 47,320 | — | — | 48,332 | |||||||||||||||||
Quarterly distribution to unitholders | (133 | ) | — | (3,402 | ) | (3,228 | ) | — | (6,763 | ) | |||||||||||||
Net income for the period March 1, 2015 to June 30, 2015 | 41 | — | 1,070 | 988 | (3,939 | ) | (1,840 | ) | |||||||||||||||
Balance at June 30, 2015 | $ | 7,954 | $ | 70,000 | $ | 266,330 | $ | 207,265 | $ | 25,972 | $ | 577,521 | |||||||||||
5
AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. ORGANIZATION AND DESCRIPTION OF BUSINESS
General
In this report, the terms "Partnership," as well as the terms "our," "we," "us" and "its" are sometimes used as abbreviated references to Azure Midstream Partners, LP itself or Azure Midstream Partners, LP together with its consolidated subsidiaries, including the ETG System and the Azure System Predecessor. The term "Azure System Predecessor" is sometimes used to refer to the Azure Legacy gathering system entities and assets (the "Legacy System"), which has been deemed to be the predecessor of the Partnership for accounting and financial reporting purposes, updated to include the operations of the ETG System. On May 19, 2015, the Partnership changed its name from Marlin Midstream Partners, LP to Azure Midstream Partners, LP.
Organization and Description of Business
Azure Midstream Partners, LP is a publicly traded Delaware master limited partnership that was formed by NuDevco Partners, LLC and its affiliates ("NuDevco") to develop, own, operate and acquire midstream energy assets. We currently offer: (i) natural gas gathering, compression, dehydration, treating, processing, and hydrocarbon dew-point control and transportation services to producers, marketers and third-party pipeline companies through our gathering and processing business segment; and (ii) crude oil logistics services to Associated Energy Services, LP (“AES”), an affiliate, through our logistics business segment.
As of June 30, 2015, Azure Midstream Energy LLC, a Delaware limited liability company that is wholly owned by Azure Midstream Holdings LLC (collectively "Azure"), owned and controlled: (i) our general partner, Azure Midstream Partners GP, LLC (the "General Partner"), formerly Marlin Midstream GP, LLC, through its ownership of a 1.97% general partner interest in us; and (ii) 90% of our IDR Units (as defined below). As of June 30, 2015, NuDevco owned: (i) 1,939,265 of our common units, representing a 8.88% limited partner interest; (ii) 8,724,545 of our subordinated units, representing a 39.93% limited partner interest; and (iii) 10% of our IDR Units (as defined below). As of June 30, 2015, the public owned 10,756,091 of our common units, representing a 49.23% limited partner interest. Azure, through its ownership of our General Partner, controls us and is responsible for managing our business and operations.
Sale of General Partner Interest and Contribution of the Azure System Predecessor
On February 27, 2015, we consummated a transaction agreement (the “Transaction Agreement”) by and amongst us, Azure, our General Partner, NuDevco and Marlin IDR Holdings Inc, LLC, a wholly-owned subsidiary of NuDevco (“IDRH”). The consummation of the Transaction Agreement resulted in Azure contributing the Azure System Predecessor to us, and Azure receiving $92.5 million in cash and acquiring 100% of the equity interests in our General Partner and 90% of our incentive distribution rights.
The Transaction Agreement occurred in the following steps:
• | we (i) amended and restated the Agreement of Limited Partnership of Marlin Midstream Partners, LP (the "Partnership Agreement") for the second time to reflect the unitization of all of our incentive distribution rights (as unitized, the “IDR Units”); and (ii) recapitalized the incentive distribution rights owned by IDRH into 100 IDR Units; |
• | we redeemed 90 IDR Units held by IDRH in exchange for a payment of $63.0 million to IDRH (the “Redemption”); |
• | Azure contributed the Azure System Predecessor to us through the contribution, indirectly or directly, of: (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure (“Talco”); and (ii) certain assets (the “TGG Assets”) owned by TGG Pipeline, Ltd., a Texas limited liability company and subsidiary of Azure ("TGG" and, collectively with Talco, "TGGT"), in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of a cash payment of $99.5 million and in the form of the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”); and |
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
• | Azure purchased from NuDevco: (i) all of the outstanding membership interests in our General Partner (the “GP Purchase”) for $7.0 million: and (ii) an option to acquire up to 20% of each of the common units and subordinated units held by NuDevco as of the execution date of the Transaction Agreement (the “Option” and, together with the Redemption, Contribution and GP Purchase, the “Transactions”). |
Contribution of the ETG System
On August 6, 2015, we entered into a contribution agreement (the “Contribution Agreement”) with Azure, which is the sole member of the general partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in ETG, a Delaware limited liability company, to the Partnership in exchange for the consideration described below. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of ETG was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | as consideration for the membership interests of ETG, we paid Azure $80.0 million in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure; and |
• | we entered into a gas gathering agreement (the “Gas Gathering Agreement”) with TGG. |
Listing of Common Units on New York Stock Exchange
On May 20, 2015, we submitted written notice to NASDAQ Global Market to voluntarily delist our common units and applied to list our common units on the New York Stock Exchange ("NYSE"). The delisting became effective following the close of business on May 28, 2015, and our common units commenced trading on the NYSE at market open on May 29, 2015 under the ticker "AZUR".
Public Offering of Partnership Common Units
On June 17, 2015, we and the General Partner entered into an underwriting agreement with Merrill Lynch, Pierce, Finner & Smith Incorporated, Wells Fargo Securities, LLC, J.P. Morgan Securities LLC and RBC Capital Markets, LLC, as representatives of the several underwriters named therein (the “Underwriting Agreement”) relating to the public offering of 3,500,000 common units representing limited partner interests in the Partnership at a price to the public of $14.17 per common unit (the “Offering”). Pursuant to the Underwriting Agreement, we also granted the underwriters a 30-day option to purchase up to an additional 525,000 common units at the same price.
The Offering closed on June 22, 2015. We received net proceeds from the sale of the common units sold in the Offering of approximately $48.3 million, including the proportionate capital contribution by the General Partner to maintain its 1.97% general partner interest and after deducting the underwriting discount and estimated offering expenses payable by the Partnership.
Azure System Predecessor
The Azure System Predecessor consists of approximately 658 miles of high-and low-pressure gathering lines and serves approximately 100,000 dedicated acres within the Harrison, Panola and Rusk counties in Texas and Caddo parish in Louisiana and currently serves the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation. The Azure Sysem Predecessor has access to seven major downstream markets, three third-party processing plants and our Panola County processing plants.
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Azure
Azure is a midstream company with a focus on owning, operating, developing and acquiring midstream energy infrastructure in core producing areas in the United States. Azure currently provides natural gas gathering, compression, treating and processing services in Northern Louisiana and East Texas in the Haynesville and Bossier Shale formations. Prior to the Transactions, Azure operated three main gathering systems: Holly, Legacy and Center, the latter of which was comprised of the Azure Shelby and Azure ETG subsystems. As described above, the Legacy System was contributed to us in connection with the Transactions and the ETG System was contributed to the Partnership pursuant to the Contribution Agreement. The two remaining gathering systems, Holly and Center, the latter of which is comprised of the Azure Shelby subsystem may potentially be available, in whole or in part, to us as future dropdown acquisitions, although Azure has no obligation to offer the Partnership these assets.
2. SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
Azure Midstream Partners, LP
The unaudited consolidated financial statements give effect to the business combination and the Transactions discussed above under the acquisition method of accounting, and the business combination was accounted for in accordance with the applicable reverse merger accounting guidance. Azure acquired a controlling financial interest in us through the acquisition of our General Partner. As a result, the Azure System Predecessor is deemed to be the accounting acquirer of the Partnership because its parent company, Azure, obtained control of the Partnership through its control of the General Partner. Consequently, the Azure System Predecessor is deemed to be the predecessor of the Partnership for financial reporting purposes, and the historical financial statements of the Partnership were recast and reflect the Azure System Predecessor for all periods prior to the closing of the Transactions. The closing of the Transactions occurred on February 27, 2015, and are reflected in the consolidated financial statements of the Partnership using, for accounting purposes, a date of convenience of February 28, 2015 (the "Transactions Date"). The effect of recording the Transactions as of February 27, 2015 would not have been material to the condensed consolidated financial statements.
The Azure System Predecessor's assets and liabilities retained their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Azure System Predecessor in the business combination were recorded at their fair values measured as of the Transactions Date. The excess of the assumed purchase price of the Partnership over the estimated fair values of the Partnership's net assets acquired was recorded as goodwill. The assumed purchase price or enterprise value of the Partnership was determined using acceptable fair value methods, and was partially derived from the consideration Azure paid for the General Partner and 90 of the IDR Units. Additionally, because the Azure System Predecessor was reflected at Azure’s historical cost, the difference between the $162.5 million in consideration paid by the Partnership and Azure's historical carrying values (net book value) at the Transactions Date was recorded as an increase to partners’ capital in the amount of $51.7 million.
The contribution of the ETG System by Azure to the Partnership was determined to be a transaction between entities under common control for financial reporting purposes. Because the contribution of the ETG System is considered to be a transaction amongst entities under common control, the ETG System is reflected at Azure's historical cost and the difference between that historical cost and the purchase price is recorded as an adjustment to partners' capital. In addition, we have recast the financial results of the Partnership to include the financial results of the ETG System for the three and six month periods ended June 30, 2015.
The condensed consolidated financial statements were prepared in accordance with generally accepted accounting principles in the United States (“GAAP”) and pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As noted above, the historical condensed financial statements of the Partnership were recast to reflect the historical condensed financial statements of the Azure System Predecessor in accordance with the applicable accounting and financial reporting guidance. Therefore, the historical condensed financial statements are comprised of the condensed consolidated balance sheets and statements of operations of the Azure System Predecessor as of and for periods prior to the Transactions Date. The historical condensed financial statements are also comprised of the condensed consolidated balance sheets and statements of operations of the Partnership, which includes the Azure System Predecessor, as of and for all periods subsequent to the Transactions Date.
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
In preparing financial statements in accordance with GAAP, management makes informed judgments and estimates that affect the reported amounts of assets, liabilities, revenues, and expenses. Management evaluates its estimates and related assumptions regularly, utilizing historical experience and other methods considered reasonable under the particular circumstances. Changes in facts and circumstances or additional information may result in revised estimates and actual results may differ from these estimates. Effects on the business, financial condition and results of operations resulting from revisions to estimates are recognized when the facts that give rise to the revision become known. The information furnished herein reflects all normal recurring adjustments which are, in the opinion of management, necessary for a fair presentation of the condensed consolidated financial statements. Operating results for the three and six month periods ended June 30, 2015 and 2014 are not necessarily indicative of the results which may be expected for the full year or for any interim period. The condensed consolidated financial statements include the accounts of the Partnership and its wholly-owned subsidiaries. All significant intercompany transactions and balances have been eliminated in consolidation.
Certain information and note disclosures commonly included in annual financial statements have been condensed or omitted pursuant to the rules and regulations of the SEC. Accordingly, the accompanying condensed consolidated financial statements and notes should be read in conjunction with the Partnership’s annual report on Form 10-K for the year ended December 31, 2014 (the “Annual Report”). Management believes that the disclosures made are adequate to make the information not misleading.
Azure System Predecessor
The operating results and the majority of the assets and liabilities of the Azure System Predecessor were specifically identified based on the existing divisional organization of Azure. Certain assets, liabilities and expenses presented in the carve‑out statements of financial position and statements of operations prior to the Transactions Date represent allocations and estimates of the costs of services incurred by Azure. These allocations and estimates were based on methodologies that management believes to be reasonable, and include items such as outstanding debt and related expenses associated with the Azure credit agreement and general and administrative expenses incurred by Azure on behalf of the Azure System Predecessor.
Revenues were identified by contracts that are specifically identifiable to the Azure System Predecessor. Depreciation and amortization are based upon assets specifically identified to the Azure System Predecessor. Salaries, benefits and other general and administrative costs were allocated to the Azure System Predecessor based on management’s use of a reasonable allocation methodology as such costs were historically not allocated to the Azure System Predecessor. Azure’s direct investment in the Azure System Predecessor is presented as Predecessor Parent Company Net Investment and includes the accumulated net earnings and accumulated net contributions from Azure, including allocated long‑term debt, interest expense and general and administrative expenses.
Significant Accounting Policies
We have updated our significant accounting policies described in our Annual Report as a result of the Transactions described above. The following serves to update our significant accounting policies and to provide our significant accounting policies effective before and after the Transactions Date.
Cash and Cash Equivalents
Cash and cash equivalents consist of all unrestricted demand deposits and funds invested in highly liquid instruments with original maturities of three months or less. We periodically assess the financial condition of the institutions where these funds are held and believe that the credit risk is minimal.
The Azure System Predecessor utilized Azure’s centralized processes and systems for cash management, payroll, purchasing and expenditures. As a result, cash generated by and cash received by the Azure System Predecessor was deposited in and commingled with the general corporate funds of Azure and was not specifically allocated to the Azure System Predecessor. The net results of these cash transactions between the Azure System Predecessor and Azure are reflected in Predecessor Parent Company Net Investment.
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Trade accounts receivable arise from our natural gas gathering, compression, dehydration, treating, processing, and hydrocarbon dew-point control and transportation services and our crude oil logistics services. Amounts collected on trade accounts receivable are included in net cash provided by operating activities in the condensed consolidated statements of cash flows. The Partnership and the Azure System Predecessor had an immaterial allowance for doubtful accounts as of June 30, 2015 and December 31, 2014. There were no write-offs of trade accounts receivable during the six month periods ended June 30, 2015 and 2014.
Concentration of Credit Risk
Financial instruments that potentially subject us to concentrations of credit risk are primarily trade accounts receivables. We perform ongoing credit evaluations of our customers’ financial condition. Declines in oil and natural gas prices have resulted in reductions in capital expenditure budgets of oil and natural gas exploration and development companies and could affect the financial condition of our customers.
Property, Plant and Equipment
Property, plant and equipment are stated at cost. Depreciation on property, plant and equipment is recorded on a straight-line basis for groups of property having similar economic characteristics over the estimated useful lives. Uncertainties that may impact these estimates include, but are not limited to, changes in laws and regulations relating to environmental matters, including air and water quality, restoration and abandonment requirements, economic conditions and supply, and demand in the area. When assets are placed into service, management makes estimates with respect to useful lives. However, subsequent events could cause a change in estimates, thereby affecting future depreciation amounts.
When items of property, plant and equipment are sold or otherwise disposed of, gains or losses are reported in the condensed consolidated statements of operations.
The Partnership capitalizes all construction-related direct labor and material costs, as well as indirect construction costs. Indirect construction costs include general engineering, insurance, taxes and the cost of funds used during construction. Capitalized interest is calculated by multiplying the Partnership’s monthly weighted average interest rate on outstanding debt by the amount of qualifying costs. After major construction projects are completed, the associated capitalized costs including interest are depreciated over the estimated useful life of the related asset. There was no capitalized interest recognized by the Partnership or the Azure System Predecessor during the three and six month periods ended June 30, 2015 and 2014.
Costs, including complete asset replacements and enhancements or upgrades that increase the original efficiency, productivity or capacity of property, plant and equipment, are also capitalized. In addition, certain of the Partnership’s plant assets require periodic and scheduled maintenance, such as overhauls. The cost of these scheduled maintenance projects are capitalized and depreciated on a straight-line basis until the next planned maintenance, which generally occurs every five years.
Costs for planned integrity management projects are expensed in the period incurred. The costs of repairs, minor replacements and maintenance projects, which do not increase the original efficiency, productivity or capacity of property, plant and equipment, are expensed as incurred.
Impairment of Long‑Lived Assets
Relevant accounting guidance requires long-lived assets to be reviewed whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In order to determine whether an impairment has occurred, we compare the net book value of the asset to the estimated undiscounted future net cash flows related to the asset. Our estimate of undiscounted cash flows is based on assumptions regarding the purchase and resale margins on natural gas, volume of gas or crude oil available to the asset, markets available to the asset, operating expenses, and prices of NGLs. The amount of availability of natural gas or crude oil to an asset is sometimes based on assumptions regarding a producer’s future drilling activity, which may be dependent in part on natural gas and crude oil prices. Projections of natural gas and oil volumes and future commodity prices are inherently subjective and contingent upon a number of variable factors. Any significant variance in any of the above assumptions or factors could materially affect our cash flows, which could require us to record an impairment of an asset.
10
AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
If an impairment has occurred, the amount of the impairment is determined based on the expected future net cash flows discounted using a rate management believes a market participant would assume is reflective of the risk associated with achieving the underlying cash flows. There were no impairments recognized during the three and six month periods ended June 30, 2015. The Azure System Predecessor recognized no impairment in the three months ended June 30, 2014 and a $0.2 million impairment during the six months ended June 30, 2014 related to an adjustment of assets held for sale to their realizable fair value.
Intangible Assets
Intangible assets consist of the Partnership's existing customer relationships, and were identified as part of the purchase price allocation to the Partnership's assets acquired by the Azure System Predecessor. The customer relationship intangible assets are amortized on a straight-line basis over the expected period of benefit of the customer relationship, which we have concluded is a ten year period. The Azure System Predecessor had no such intangible assets.
Goodwill
Goodwill represents consideration paid in excess of the fair value of the identifiable assets acquired in a business combination. We evaluate goodwill for impairment on an annual basis, and whenever events or changes indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Goodwill is tested for impairment using a two-step quantitative test. The first step compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit exceeds the carrying amount, the goodwill is not considered impaired. If the fair value of the reporting unit does not exceed the carrying amount of the reporting unit, the second step compares the implied fair value of goodwill to the carrying value of goodwill. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, the excess of the carrying value over the implied value is recognized as an impairment in the statement of operations.
Deferred Financing Costs
Financing costs incurred in connection with the issuance of debt are capitalized and amortized as interest expense under the effective interest method over the term of the related debt. The unamortized balance of deferred financing costs is included within other assets within the Condensed Consolidated Balance Sheets. The Partnership incurred $3.2 million in financing costs as a result of entering into the Credit Agreement, and these costs were deferred and will be amortized over the maturity period of the Credit Agreement (see Note 7). All deferred financing costs included within the Azure System Predecessor's statement of financial position and the ETG System's statement of financial position have been allocated from Azure and are associated with the Azure Credit Agreement (see Note 7).
Segment Reporting
The Partnership's chief operating decision maker ("CODM") is the Chief Executive Officer of our General Partner. Our CODM evaluates the performance of our business by assessing our gathering and processing business segment and our logistics segment. Accordingly, the Partnership has two operating segments, gathering and processing and logistics, for financial reporting purposes.
Revenues and Cost of Revenues
The Partnership’s revenues are derived primarily from natural gas processing and fees earned from its gathering and processing operations. Revenues are recognized by the Partnership using the following criteria: (i) persuasive evidence of an exchange arrangement exists; (ii) delivery has occurred or services have been rendered; and (iii) the buyer’s price is fixed or determinable and collection is reasonably assured. Utilizing these criteria, revenues are recognized when the commodity is delivered or services are rendered. Similarly, cost of revenues is recognized when the commodity is purchased or delivered.
The Partnership’s fee-based contracts provide for a fixed fee arrangement for one or more of the following midstream services: natural gas gathering, compression, dehydration, treating, processing and hydrocarbon dew-point control and transportation services to producers, third-party pipeline companies and marketers. Under these arrangements, the Partnership is paid a fixed fee based on the volume of the natural gas the Partnership gathers and processes, and recognizes revenues for its
11
AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
services in the month such services are performed. Substantially all of these fee-based agreements contain minimum volume commitments and annual inflation adjustments.
Under our commercial agreements that do not require us to deliver NGLs to the customer in kind, we provide NGL transportation services to our customers whereby we purchase the NGLs from the customer at an index price, less fractionation and transportation fees, and simultaneously sell the NGLs to third parties at the same index price, less fractionation fees. The revenue generated by these activities is offset by a corresponding cost of revenues that is recorded when we compensated the customer for its share of the NGLs.
Producers’ wells and other third-party gathering systems are connected to the Partnership’s gathering systems for delivery of natural gas to the Partnership’s processing and treating plants, where the natural gas is processed to extract NGLs and condensate or treated in order to satisfy downstream natural gas pipeline specifications. Under percentage of liquids (“POL”) arrangements, the Partnership retained a percentage of the liquids processed, and remits a portion back to the producer. Revenues are directly correlated to the commodity’s market value. POL contracts also include fee-based revenues for gathering and other midstream services. Under both fixed fee and POL arrangements, the counterparties’ share of NGLs, if not delivered as a commodity, is recorded as cost of revenues.
Under our keep-whole contracts, the Partnership is required to gather or purchase raw natural gas at current market rates. The volume of gas gathered or purchased is based on the measured volume at an agreed upon location (generally at the wellhead). The volume of gas redelivered or sold at the tailgate of the Partnership’s processing facility would be lower than the volume purchased at the wellhead primarily due to NGLs extracted through processing. The Partnership would make up or “keep the producer whole” for the condensate and NGL volumes through the delivery of or payment for a thermally equivalent volume of residue gas. The cost of these natural gas volumes is recorded as a cost of natural gas, NGLs and condensate revenue. The keep-whole contract conveyed an economic benefit to the Partnership when the combined value of the individual NGLs is greater in the form of liquids than as a component of the natural gas stream; however, the Partnership is adversely affected when the value of the NGLs is lower as liquids than as a component of the natural gas stream. Certain contracts also included fee-based revenues for gathering and other midstream services. Cost of revenues were derived primarily from the purchase of natural gas, NGLs and condensates. There were no material costs categorized as cost of revenue directly identified with gathering, processing and other revenue.
The Azure System Predecessor's primary revenue producing activities are the sales of natural gas and NGLs purchased from third parties, for which the Azure System Predecessor takes title, and the sale of condensate liquids. Natural gas revenues arise from transactions that are completed under contracts with limited commodity price exposure, and the Azure System Predecessor elects the normal purchases and normal sales exemption on all such transactions for accounting purposes. The Azure System Predecessor receives a market price per barrel on our revenue from natural gas condensate liquids. The Azure System Predecessor recognizes the natural gas and condensate revenues and the associated purchases and expenses on a gross basis within its statement of operations. The cost of natural gas purchased from third parties is reported as a component of operating costs and expenses. Secondarily, the Azure System Predecessor earns gathering services and other fee revenues from the transportation, gathering, compression and treating of natural gas. These gathering services and other fees are generally provided on a fixed fee basis per unit based on the volumes (Mcf) or heating content (MMBtu) of natural gas.
Revenue from all services and activities are recognized when all of the following criteria are met: (i) persuasive evidence of an exchange arrangement exists; (ii) delivery has occurred or services have been rendered; (iii) the price is fixed or determinable; and (iv) collectability is reasonably assured.
The ETG System has a natural gas gathering agreement with a customer that provides for a minimum revenue commitment (“MRC”). Under the MRC, our customer agrees to pay a minimum monetary amount over certain periods during the term of the MRC. The customer must make a deficiency payment to us at the end of the contract year if its actual revenues are less than its MRC for that year. The customer is entitled to utilize the deficiency payments to offset gathering fees in the following periods to the extent that such customer’s revenues in the following periods exceed its MRC for that period. This contract provision ranges for the entire duration of the gas gathering agreement, which is ten years. We record customer billings for obligations under the MRC (solely with respect to this natural gas gathering agreement) as deferred revenue when the customer has the right to utilize deficiency payments to offset gathering fees in subsequent periods. We recognize deferred revenue under this arrangement as revenue once all contingencies or potential performance obligations associated with the related revenues have either (i) been satisfied through the gathering of future excess volumes of natural gas, or (ii) expired (or lapsed) through the passage of time pursuant to the terms of the natural gas gathering agreement. We classify deferred revenue
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
as noncurrent where the expiration of the customer’s right to utilize deficiency payments is greater than one year. As of Juine 30, 2015 and December 31, 2014, deferred revenue under the MRC agreement was $11.6 million and $5.4 million, respectively, and is included within other long term liabilities. No deferred revenue amounts under these arrangements were recognized as revenue during the six months ended June 30, 2015 and 2014.
Accounts Payable and Accrued Liabilities
The Partnership's accounts payable and accrued liabilities as of June 30, 2015 consist of obligations arising during the normal course of the Partnership's business operations and are expected to be settled within a period of twelve months. The Azure System Predecessor's accounts payable and accrued liabilities as of December 31, 2014 primarily represents open invoices as of period end that are specifically identifiable to the Azure System Predecessor based on Azure's authorization for expenditures. Accrued liabilities are allocated to the Azure System Predecessor from Azure based on historical analysis of invoices by authorization for expenditures in the period of services rendered.
Fair Value of Financial Instruments
Accounting guidance requires the disclosure of the fair value of all financial instruments that are not otherwise recorded at fair value in the financial statements. The carrying amount of long-term debt reported within the condensed consolidated balance sheets as of June 30, 2015 and December 31, 2014 approximates fair value, because of the variable rate nature of the long-term debt.The fair value of the debt is considered a Level 2 fair value measurement. The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities reported within the condensed consolidated balance sheets approximate fair value due to the short-term nature of these items.
Transactions with Affiliates
In connection with the Transactions, we terminated our omnibus agreement, dated July 31, 2013 (the “Existing Omnibus Agreement”), by and between NuDevco, the General Partner and us (together with the General Partner, the “Partnership Parties”). NuDevco released each of the Partnership Parties, and each of the Partnership Parties released NuDevco, from any claims or liabilities arising from or under the terms of the Omnibus Agreement (other than any obligations under the Transaction Agreement).
Also in connection with the Transactions, we entered into an omnibus agreement (the “New Omnibus Agreement”) with the General Partner and Azure, pursuant to which, among other things, Azure will provide corporate, general and administrative services (the “Services”) on behalf of the General Partner and for our benefit and we are obligated to reimburse Azure and its affiliates for costs and expenses incurred by Azure and its affiliates in providing the Services on our behalf, including, but not limited to, administrative costs and the compensation costs of the employees of Azure and its affiliates that provide Services to us. The New Omnibus Agreement also provides us with a right of first offer on any proposed transfer of any assets owned by Azure or its subsidiaries as of January 14, 2015.
Asset Retirements Obligations
Applicable accounting guidance requires us to evaluate whether any future asset retirement obligations exist as of June 30, 2015 and December 31, 2014, and whether the expected retirement date of the related costs of retirement can be estimated. We have concluded that our natural gas gathering system assets, which include pipelines and processing and treating facilities, have an indeterminate life because they are owned and will operate for an indeterminate future period when properly maintained. A liability for these asset retirement obligations will be recorded only if and when a future retirement obligation with a determinable life is identified. The Partnership and the Azure System Predecessor have not recognized any asset retirement obligations as of June 30, 2015 and December 31, 2014 because we have no current intention of discontinuing use of any significant assets.
Environmental Expenditures
Our operations and the operations of the Azure System Predecessor are subject to various federal, state and local laws and regulations relating to the protection of the environment. Although we believe that we are in compliance with applicable environmental regulations, the risk of costs and liabilities are inherent in pipeline ownership and operation, and there can be no assurances that significant costs and liabilities will not be incurred by us.
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Environmental expenditures related to operations that generate current or future revenues are expensed or capitalized, as appropriate. Liabilities are recorded when the necessity for environmental remediation or other potential environmental liabilities become probable and the costs can be reasonably estimated. Management is not aware of any contingent liabilities that currently exist with respect to environmental matters for either the Partnership or the Azure System Predecessor.
Commitments and Contingencies
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties and other sources are recorded when it is probable that a liability has been incurred and the amount can be reasonably estimated. Legal costs incurred in connection with loss contingencies are expensed as incurred. Recoveries of environmental remediation costs from third parties that are probable of realization are separately recorded as assets, and are not offset against the related environmental liability.
Accruals for estimated losses from environmental remediation obligations generally are recognized no later than completion of the remedial feasibility study. Such accruals are adjusted as further information develops or circumstances change. Costs of expected future expenditures for environment remediation obligations are not discounted to their present value.
Income Taxes
The Partnership and the Azure System Predecessor are not taxable entities for U.S. federal income tax purposes or for the majority of states that impose an income tax. Generally, income taxes are not levied at the entity level, but rather on the individual partners of the Partnership and the Azure System Predecessor. The Partnership and the Azure System Predecessor are subject to the Revised Texas Franchise Tax (“Texas Margin Tax”). The Texas Margin Tax is computed on modified gross margin, and is recorded as income tax expense in the condensed consolidated statements of operations. In June 2013, the State of Texas enacted certain changes to the Texas Margin Tax which lowered the tax rate and expanded the scope of depreciation deductions. As a result of these changes, current income tax expense and our deferred income tax expense (related to book/tax depreciation timing differences) increased $0.5 million in the three months ended June 30, 2015 as compared to the three months ended June 30, 2014. The Partnership and the Azure System Predecessor do not do business in any other state where a similar tax is applied. As of June 30, 2015, the Partnership had a net liability of $0.8 million for deferred taxes. Of this amount, $1.0 million of deferred tax liability relates to the Legacy System and $0.2 million of deferred tax asset relates to the ETG System As of December 31, 2014, the Azure System Predecessor had no amounts recorded for deferred taxes.
Parent Company Net Investment
Azure’s net investment in the operations of the Azure System Predecessor is presented as Predecessor parent company net investment within the statement of financial position. Parent company net investment represents the accumulated net earnings of the operations and the accumulated net contributions from Azure. Net contributions for the period January 1, 2015 to February 28, 2015 and the six month period ended June 30, 2014 were primarily comprised of intercompany operations and maintenance expense, cash clearing and other financing activities, and debt and general and administrative costs allocations to the Azure System Predecessor. The Predecessor parent company net investment was eliminated upon the contribution of the Azure System Predecessor to the Partnership.
At June 30, 2015, the balance in Predecessor parent company net investment represents the net book value of the ETG System contributed by Azure.
Net Income Per Unit
Net income per unit is presented for the period from March 1, 2015 to June 30, 2015 as this is the period in which the Partnership's results of operations are included within net income. The Azure System Predecessor had no units and therefore net income per unit is not presented for periods in which net income consists only of the Azure System Predecessor. In calculating net income per unit we have applied recent accounting guidance which requires all earnings (losses) of a transferred business be allocated entirely to the general partner when computing earnings per unit ("EPU") for periods before the dropdown transaction occurred. Accordingly, when computing EPU as of June 30, 2015, we have applied all losses related to the ETG System, contributed on August 6, 2015, to the general partner interest. See "Recent Accounting Pronouncements" below.
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AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Subsequent Events
Subsequent events have been evaluated through the date these financial statements are issued. Any material subsequent events that occurred prior to such date have been properly recognized or disclosed in the condensed consolidated financial statements.
Recent Accounting Pronouncements
Accounting standard‑setting organizations frequently issue new or revised accounting rules and pronouncements. We regularly review new accounting rules and pronouncements to determine their impact, if any, on our financial statements.
In May 2014, the Financial Accounting Standards Board ("FASB") and International Accounting Standards Board (IASB) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards ("IFRS"). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. The Partnership is required to adopt this standard beginning in the first quarter of 2017. The adoption could have a significant impact on the Partnership's financial statements, however management of the Partnership is currently unable to quantify the impact.
In April 2015, the FASB issued a new accounting standard that simplifies the presentation of debt issuance costs. The amended guidance requires that debt issuance costs related to a recognized debt liability be presented within the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The Partnership will be required to adopt the guidance effective January 1, 2016. The standard will only affect the presentation of the Partnership's condensed consolidated balance sheet and does not affect any of the Partnership's other financial statements.
In April 2015, the FASB issued a new accounting standard requiring a master limited partnership ("MLP") to allocate earnings (losses) of a transferred business entirely to the general partner when computing EPU for periods before the dropdown transaction occurred. The EPU that the limited partners previously reported would not change as a result of the dropdown transaction. The standard also requires an MLP to disclose the effects of the dropdown transaction on EPU for the periods before and after the dropdown transaction occurred. The standard is effective for the fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. The standard requires retrospective application and early adoption is permitted. We have adopted this new accounting standard effective July 1, 2015.
There are currently no other recent accounting pronouncements that have been issued that we believe will materially affect our consolidated financial statements.
3. PARTNERSHIP EQUITY AND DISTRIBUTIONS
Outstanding Units
As of June 30, 2015, our general partner interests consisted of 429,365 general partner units. As of June 30, 2015, the Partnership had common units outstanding of 12,695,356 and subordinated units outstanding of 8,724,545. Azure owned 100% of the interest in our general partner, representing an approximate 1.97% general partner interest in us, and 90% of our IDR Units. As of June 30, 2015, NuDevco owned: (i) 1,939,265 of our outstanding common units, representing an 8.88% limited partner interest; (ii) all of our subordinated units, representing an 39.93% limited partner interest; and (iii) 10% of our IDR Units. As of June 30, 2015, the public owned 10,756,091 of our common units, representing an 49.23% limited partner interest.
Distributable Cash and Distributions
The Partnership Agreement, which was amended and restated for the second time on February 27, 2015 for, among other things, the Transactions, requires that within 45 days after the end of each quarter, we distribute all of our available cash to unitholders of record on the applicable record date, as determined by our General Partner. We intend to make at least the minimum quarterly distribution of $0.35 per unit, or $1.40 per unit on an annual basis, to holders of our common and subordinated units, to the extent we have sufficient cash from our operations after the establishment of cash reserves and the payment of costs and expenses, including reimbursement of expenses to our General Partner. However, there is no guarantee that we will pay the minimum quarterly distribution on our units in any quarter.
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Partnership declared the following cash distributions to its unitholders of record for the periods presented:
In thousands, except per-unit amounts | ||||||||||
Quarter ended: | Total Quarterly Distribution per Unit | Total Cash Distribution (1) | Date of Distribution | |||||||
June 30, 2015 | $ | 0.370 | $ | 8,213 | August 14, 2015 (2) | |||||
March 31, 2015 | $ | 0.370 | $ | 6,763 | May 15, 2015 | |||||
December 31, 2014 | $ | 0.365 | $ | 6,593 | February 11, 2015 | |||||
September 30, 2014 | $ | 0.365 | $ | 6,593 | November 4, 2014 | |||||
June 30, 2014 | $ | 0.360 | $ | 6,469 | August 5, 2014 | |||||
March 31, 2014 | $ | 0.355 | $ | 6,375 | May 6, 2014 | |||||
December 31, 2013 | $ | 0.350 | $ | 6,341 | February 3, 2014 | |||||
(1) Total distribution amount includes the distributions paid to our general partner and does not include the payment associated with the distribution equivalent rights ("DER") that accrue on all unvested phantom units that have been issued under our LTIP. | ||||||||||
(2) Anticipated date of distribution to unitholders of record on August 7, 2015. | ||||||||||
General Partner Interest
As of June 30, 2015, Azure owned 100% of our general partner interest. If we issue additional units, our General Partner has the right, but not the obligation, to contribute a proportionate amount of capital to us in order to maintain its general partner interest. The general partner interest, and the percentage of our cash distributions to which our General Partner is entitled from such interest, will be proportionately reduced if we issue additional units in the future (other than the issuance of common units upon conversion of outstanding subordinated units or the issuance of common units upon a reset of the incentive distribution rights) and our General Partner does not contribute a proportionate amount of capital to the Partnership in order to maintain its general partner interest. As of June 30, 2015, the general partner interest was the equivalent of 1.97% because our General Partner elected not to make a contribution in connection with the previous issuances of common units as a result of the vesting of awards under the Marlin Midstream Partners, LP 2013 Long-Term Incentive Plan ("LTIP") (See Note 11).
Incentive Distribution Rights Units
As of June 30, 2015, Azure owned 90 of our IDR Units and NuDevco owned 10 of our IDR Units. The IDR Units entitle the holder to receive an increasing percentage (13%, 23% and 48%) of quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and certain target distribution levels have been achieved. The target distribution levels are defined within the Partnership Agreement as: (i) the First Target Distribution of $0.4025 per unit per quarter; (ii) the Second Target Distribution of $0.4375 per unit per quarter; and (iii) the Third Target Distribution of $0.5250 per unit per quarter. The maximum distribution of 48% does not include any distributions that our General Partner, Azure or NuDevco may receive on common, subordinated or general partner units that they own.
Common Units
Our common units represent limited partner interests in us. The holders of our common units are entitled to participate in distributions and are entitled to exercise the rights and privileges available to limited partners under our Partnership Agreement. Our partnership agreement provides that, during the Subordination Period (as defined in the Partnership Agreement), the common units have the right to receive distributions of available cash from operating surplus each quarter in an amount that is at least equal to $0.35 per common unit before any distributions of available cash from operating surplus may be made on the subordinated units.
Subordinated Units
Our subordinated units represent limited partner interests in us and convert to common units at the end of the Subordination Period (as defined within the Partnership Agreement). The principal difference between our common units and our subordinated units is that in any quarter during the Subordination Period, holders of the subordinated units are not entitled
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
to receive any distribution of available cash until the common units have received the minimum quarterly distribution plus any arrearages in the payment of the minimum quarterly distribution from prior quarters. Subordinated units do not accrue arrearages.
4. NET INCOME PER UNIT
The Partnership's condensed consolidated statements of operations were recast to reflect the Azure System Predecessor for periods prior to March 1, 2015 in accordance with applicable accounting and financial reporting guidance. The Azure System Predecessor had no units outstanding prior to the Transactions Date. Therefore, net income per unit will be presented for the period March 1, 2015 to June 30, 2015, which is the period the Partnership's results of operations are included within these condensed consolidated financial statements and the period in which the Partnership's units were reflected as outstanding within these condensed consolidated financial statements.
The Partnership’s net income for the period March 1, 2015 to June 30, 2015 is allocated to the General Partner and our limited partners in accordance with their respective ownership percentages and, when applicable, giving effect to the IDR Units. The ETG Systems net losses have been allocated to the General Partner as the period end date of June 30, 2015 preceded the contribution date of August 6, 2015. Basic and diluted net income per unit is calculated by dividing the partner’s interest in net income by the weighted average number of units outstanding during the period. There were no units or awards issued or outstanding during the period March 1, 2015 to June 30, 2015 that would be considered dilutive to the net income per unit calculation, and, therefore, basic and diluted net income per unit are the same for the period presented.
The following table illustrates the Partnership’s calculation of net income per unit for common and subordinated partner units for the periods presented:
In thousands, except per unit data | Three Months Ended June 30, 2015 | March 1, 2015 to June 30, 2015 | |||||
Net loss | $ | (1,003 | ) | $ | (5,383 | ) | |
Less: net loss attributable to Marlin Midstream Predecessor for the period January 1, 2015 to February 28, 2015 | — | (3,543 | ) | ||||
Net loss attributable to the Partnership | (1,003 | ) | (1,840 | ) | |||
Less: net loss attributable to the General Partner | (2,672 | ) | (3,898 | ) | |||
Net income attributable to limited partners | $ | 1,669 | $ | 2,058 | |||
Net income attributable to limited partner common units outstanding | $ | 871 | $ | 1,070 | |||
Net income attributable to limited partner subordinated units outstanding | 798 | 988 | |||||
Limited partner interest in net loss | $ | 1,669 | $ | 2,058 | |||
Net income per limited partner common and subordinated unit - basic and diluted | $ | 0.09 | $ | 0.11 | |||
Weighted average limited partner units outstanding - basic and diluted: | |||||||
Common units | 9,541,510 | 9,453,553 | |||||
Subordinated units | 8,724,545 | 8,724,545 | |||||
Total | 18,266,055 | 18,178,098 | |||||
5. ACQUISITION
Acquisition of the Legacy System
Effective as of the Transactions Date, Azure contributed the Azure System Predecessor to the Partnership in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of: (i) $99.5 million in cash; and (ii) the issuance of 90 of our IDR Units. The cash portion of the contribution was funded through borrowings under the Partnership's new senior secured revolving credit facility (See Note 7).
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AZURE MIDSTREAM PARTNERS, LP AND
AZURE SYSTEM PREDECESSOR
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The Azure System Predecessor has been deemed to be the accounting acquirer of the Partnership in the business combination because its parent company, Azure, obtained control of the Partnership through the indirect control of the General Partner. Consequently, the Azure System Predecessor's assets and liabilities retained their historical carrying values. The Partnership's assets acquired and liabilities assumed by the Azure System Predecessor have been recorded at their fair values measured as of the Transactions Date. The excess of the assumed purchase price over the estimated fair values of the Partnership's net assets acquired were recorded as goodwill. The assumed purchase price and fair value of the Partnership has been determined by using a combination of an income, market and cost valuation methodology and considered the evaluation of comparable company transactions, the Partnership's discounted future cash flows, the fair value of the Partnership's common units as of the Transactions Date and the consideration paid by Azure for the general partner interest and IDR Units. The purchase price allocation has been prepared on a preliminary basis pending receipt of a final valuation report and could be subject to change.
The property, plant and equipment of the Azure System Predecessor has been reflected at their historical net carrying value, which is greater than the consideration paid for the business. The excess of the historical carrying value over the consideration paid was $51.7 million and is reflected as an increase to Partners' Capital in the condensed consolidated statement of partners' capital. Additionally, the Partnership did not assume certain liabilities of the Azure System Predecessor as part of the Contribution, and, as a result, the amount of such liabilities not assumed is considered a deemed contribution within the statement of partners' capital.
The Partnership incurred $2.6 million in transaction related expenses prior to the Transactions Date as a result of the Transactions. These transaction related expenses were recognized by the Partnership when incurred in the periods prior to the Transactions Date, and therefore are not included within the results of operations presented within the condensed consolidated financial statements for the six months ended June 30, 2015.
For the period from March 1, 2015 to June 30, 2015, we recognized $19.9 million in revenues and $8.9 million in operating income attributable to the Partnership's historical midstream assets.
The following tables summarize the assumed purchase price and fair value and the allocation to the assets acquired and liabilities assumed at February 28, 2015 (in thousands):
Total assumed purchase price and fair value of Marlin Midstream Partners, LP | $ | 393,171 | ||||
The allocation of the assumed purchase price is as follows (in thousands):
Assumed purchase price allocation to Marlin Midstream Partners, LP: | ||||||
Current assets | $ | 123,022 | ||||
Property, plant and equipment | 193,316 | |||||
Identifiable intangible assets | 65,000 | |||||
Goodwill | 215,758 | |||||
Other assets | 3,418 | |||||
Current liabilities | (11,161 | ) | ||||
Long-term debt | (195,771 | ) | ||||
Deferred income tax liability | (411 | ) | ||||
Total assumed consideration and fair value of Marlin Midstream Partners, LP | $ | 393,171 | ||||
Goodwill recognized from the business combination primarily relates to the value attributed to additional growth opportunities, synergies and operating leverage within the Partnership's areas of operation. The goodwill is allocated to our gathering and processing segment and our logistics segment. The assumed purchase price and fair values are preliminary and have been prepared with the assistance of our external fair value specialists, and represent management's best estimate of the enterprise value and fair values of the Partnership as of this date.
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AZURE MIDSTREAM PARTNERS, LP AND
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Amendment to Transloading Services Agreements
Upon the closing of the Transactions, we entered into amendments to our: (i) Wildcat Transloading Services Agreement associated with our transloading facility located in Carbon County, Utah; (ii) Big Horn Transloading Services Agreement associated with our transloading facility located in Big Horn County, Wyoming; and (iii) our Ladder Transloading Services Agreement, all of which are transloading services agreements with AES. The amendments extend the minimum volume commitments associated with these services agreements until February 27, 2020, or an additional five years from the date of the amendment.
Transition Services Agreement
In connection with the closing of the Transactions, we entered into an agreement with NuDevco and its affiliates pursuant to which NuDevco has and will provide certain services to us with respect to the business and operations of the Partnership's existing midstream assets, including information technology, accounting, asset integrity, compliance management, and procurement services, for a period of two months following the closing of the Transactions. Expenses associated with the transition services agreement were $0.5 million and $0.7 million for the three and six months periods ended June 30, 2015.
Unaudited Pro Forma Financial Information
The following unaudited pro forma condensed financial information for the three and six months periods ended June 30, 2015 and 2014, gives effect to the Transactions as if they had occurred on January 1, 2014. The unaudited pro forma condensed financial information has been included for comparative purposes only and is not necessarily indicative of the results that might have occurred had the Transactions taken place on the dates indicated and is not intended to be a projection of future events. The pro forma adjustments for the periods presented consist of: (i) adjustments to combine the Azure System Predecessor and the Partnership's historical results of operations for the periods; (ii) adjustments to interest expense to remove the previously recognized interest expense and include the interest expense associated with our Credit Agreement (see Note 7); and (iii) adjustments to depreciation and amortization expense attributable to adjustments recorded as a result of the purchase price allocation to the Partnership's assets and liabilities.
The following table presents the unaudited pro forma revenues, net income (loss) and basic and diluted net income (loss) per unit information for each period related to the Legacy System acquisition:
Three Months Ended | Six Months Ended | |||||||||||||||
In thousands, except per-unit amounts | June 30, 2015 | June 30, 2014 | June 30, 2015 | June 30, 2014 | ||||||||||||
Pro forma operating revenues | $ | 21,466 | $ | 36,743 | $ | 44,154 | $ | 68,038 | ||||||||
Pro forma net income (loss) | $ | 1,702 | $ | 5,022 | $ | (8,146 | ) | $ | 8,006 | |||||||
Pro forma net income (loss) attributable to limited partners | $ | 1,669 | $ | 4,923 | $ | (7,986 | ) | $ | 7,849 | |||||||
Pro forma net income (loss) per limited partner common and subordinated units - basic and diluted | $ | 0.09 | $ | 0.26 | $ | (0.44 | ) | $ | 0.43 | |||||||
The pro forma net loss for the six months ended June 30, 2015 includes expenses that were a direct result of the Transactions, including $4.2 million in compensation expense associated with the vesting of phantom unit awards issued under our LTIP (see Note 11), $3.9 million in employee severance related expenses attributable to those employees who were not retained by the Partnership subsequent to the Transactions and $2.6 million in transaction expenses, including advisory, audit and legal fees. These expenses were recognized by the Partnership as they were incurred during the period from January 1, 2015 to February 27, 2015 and, as a result, the condensed consolidated financial statements presented in accordance with GAAP for the six months ended June 30, 2015 do not reflect such expenses incurred as a direct result of the Transactions.
Contribution of the ETG System
On August 6, 2015, in connection with the execution of the Contribution Agreement, Azure contributed the ETG System to the Partnership in consideration for $80.0 million in cash and the issuance of 255,319 common units. In connection with the Contribution Agreement we entered into a Gas Gathering Agreement with TGG.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The contribution of the ETG System by Azure to the Partnership was determined to be a transaction between entities under common control for financial reporting purposes. Because the contribution of the ETG System is considered to be a transaction amongst entities under common control, the ETG System is reflected at Azure's historical cost and the difference between that historical cost and the purchase price is recorded as an adjustment to partners' capital.
As of June 30, 2015, the Partnership incurred $0.1 million in transaction related expenses prior to the date of the Contribution Agreement.
Gas Gathering Agreement
Pursuant to the terms of the Gas Gathering Agreement, the Partnership has agreed to provide gathering services to TGG on a priority basis for quantities of gas designated by TGG. Azure Midstream Energy LLC ("AME"), which is the sole member of the General Partner, has guaranteed TGG's obligations under the Gas Gathering Agreement.
6. PROPERTY, PLANT AND EQUIPMENT, INTANGIBLE ASSETS AND GOODWILL
Property, plant and equipment, net
Property, plant and equipment, net is comprised of the following as of each period presented:
In thousands | Estimated Useful Lives (Years) | June 30, 2015 | December 31, 2014 | ||||||
Gathering pipelines and related equipment | 45 | $ | 319,358 | $ | 278,547 | ||||
Gas processing and compression facilities | 20 | 173,085 | 28,358 | ||||||
Buildings | 30 | 2,454 | 2,058 | ||||||
Other depreciable assets | 5 - 15 | 3,077 | 2,405 | ||||||
Land and rights of way | 9,027 | 827 | |||||||
Construction in progress | 683 | 895 | |||||||
Total property, plant and equipment | 507,684 | 313,090 | |||||||
Accumulated depreciation | (16,070 | ) | (8,915 | ) | |||||
Total property, plant and equipment, net | $ | 491,614 | $ | 304,175 | |||||
Depreciation expense was $4.3 million and $6.9 million for the three and six months periods ended June 30, 2015 and $2.0 million and $3.9 million for the three and six months periods ended June 30, 2014.
Intangible assets, net
Intangible assets consist of the Partnership's existing customer relationships, and were identified as part of the purchase price allocation to the Partnership's assets acquired by the Azure System Predecessor. The customer relationship intangible assets are amortized on a straight-line basis over the expected period of benefit of the customer relationship, which we have concluded is a ten year period. The amortization expense associated with the customer relationship intangible asset, which is included within depreciation and amortization expense within the statement of operations was $1.6 million and $2.2 million for the three and six months periods ended June 30, 2015. Amortization expense is expected to be $6.5 million annually over the ten year period. The Azure System Predecessor had no such intangible assets.
Goodwill
Goodwill represents the amount the assumed purchase price of the Partnership was in excess of the fair value of the Partnership's identifiable assets acquired in the business combination. We evaluate goodwill for impairment on an annual basis, and whenever events or changes indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. There were no impairments recognized during the six months ended June 30, 2015.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
As of June 30, 2015, the Partnership recognized $215.8 million of goodwill related to the Partnership's existing midstream assets and operations. The Partnership has allocated $123.0 million of the goodwill to the gathering and processing segment and $92.8 million to the logistics segment.
7. LONG-TERM DEBT
Long-term debt consists of the following:
In thousands | June 30, 2015 | December 31, 2014 | |||||
Long-term debt associated with the Partnership's Credit Agreement | $ | 142,951 | $ | — | |||
Long-term debt allocated to the Azure System Predecessor | — | 134,933 | |||||
Long-term debt allocated to the ETG System | 52,263 | 57,042 | |||||
Total debt | 195,214 | 191,975 | |||||
Less: Current portion of long-term debt allocated to the Azure System Predecessor | — | 7,102 | |||||
Less: Current portion of long-term debt allocated to the ETG System | 3,603 | 3,002 | |||||
Total long-term debt | $ | 191,611 | $ | 181,871 | |||
Credit Agreement
On February 27, 2015, we entered into a new senior secured revolving credit facility (the "Credit Agreement") with Wells Fargo Bank, National Association, as administrative agent, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC (collectively, the “Lenders”). The Credit Agreement has a maturity date of February 27, 2018, and up to $250.0 million in commitments.
We immediately borrowed $180.8 million under the Credit Agreement, of which $99.5 million was used in connection with the Contribution, $63.0 million was used in connection with the Redemption, $15.0 million was used to repay the outstanding balance as of February 27, 2015 under our existing senior secured revolving credit facility and $3.2 million was used to pay fees and expenses associated with the Credit Agreement.
Borrowings under the Credit Agreement bear interest at: (i) the LIBOR Rate (as defined in the Credit Agreement) plus an applicable margin of 2.75% to 3.75%; or (ii) the Base Rate (as defined in the Credit Agreement) plus an applicable margin of 1.75% to 2.75%, in each case, based on the Consolidated Total Leverage Ratio (as defined in the Credit Agreement).
All of the Partnership's domestic restricted subsidiaries guarantee our obligations under the Credit Agreement, and all such obligations are secured by a security interest in substantially all of our assets, in each case, subject to certain customary exceptions. The Credit Agreement contains affirmative and negative covenants customary for credit facilities of its size and nature that, among other things, limit or restrict our ability and the ability of our subsidiaries to: (i) incur additional debt; (ii) grant certain liens; (iii) make certain investments; (iv) engage in certain mergers or consolidations; (v) dispose of certain assets; (vi) enter into certain types of transactions with affiliates; and (vii) make distributions, with certain exceptions, including the distribution of Available Cash (as defined in the partnership agreement) if no default or event of default exists. As of June 30, 2015 we were in compliance with all of our covenants associated with the Credit Agreement.
As of June 30, 2015, we had outstanding borrowings under the Credit Agreement of $143.0 million. For the period March 1, 2015 to June 30, 2015 interest expense associated with the Credit Agreement was $2.3 million. We incurred $3.2 million in financing costs in connection with the Credit Agreement, and these financing costs were deferred and classified within other long-term assets and will be amortized to interest expense and related charges over the maturity period of the Credit Agreement.
Azure Credit Agreements
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (the "TLB") maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (the "Revolver" and collectively with the TLB, the "Azure Credit Agreement") with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement were unconditionally guaranteed, jointly and severally, by all of the Azure subsidiaries and are collateralized by first priority liens on
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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substantially all of existing and subsequently acquired assets and equity. The Azure Credit Agreement weighted average interest rate for the period from January 1, 2015 to February 28, 2015 and the six months ended June 30, 2014 was 6.50%.
Azure System Predecessor Long-term Debt and Related Expense Allocations
The Azure Credit Agreement served as the sole borrowing agreement applicable for the Azure System Predecessor during the periods presented. In addition, substantially all of Azure’s subsidiaries, including the Azure System Predecessor, served as guarantors and pledger's with respect to the Azure Credit Agreement. The Azure System Predecessor’s long-term debt and related expense balances for the period from January 1, 2015 to February 28, 2015 and as of December 31, 2014 represent an allocation of its proportionate share of the Azure consolidated long-term debt presented in accordance with applicable accounting guidance. The allocation of long-term debt and related expense is based on the Azure System Predecessor's proportional carrying value of assets as a percentage of total assets financed by the Azure Credit Agreement.
In connection with entering into the Azure Credit Agreement, Azure incurred financing costs, which were deferred and amortized over the maturity period of the Azure Credit Agreement. These deferred financing costs have been allocated to the Azure System Predecessor's balance sheet, included within other non-current assets, as of December 31, 2014. The Azure System Predecessor's interest expense allocation has also been calculated using a similar allocation methodology as long-term debt.
The weighted average long-term debt allocated to the Azure System Predecessor for the period January 1, 2015 to February 28, 2015 and the six months ended June 30, 2014 was $134.9 million and $138.5 million. The interest expense allocated to the Azure System Predecessor for the period January 1, 2015 to February 28, 2015 and the six months ended June 30, 2014 was $1.7 million and $5.3 million of which $0.2 million and $0.6 million was associated with the allocation of deferred financing cost amortization expense.
The allocation of long-term debt and related expenses to the Azure System Predecessor were in accordance with applicable accounting guidance, and the long-term debt and related expenses were not assumed by the Partnership as part of the Contribution or Contribution Agreement. As a result, the allocation of long-term debt and related expenses is only applicable for the Azure System Predecessor and ETG System historical periods presented.
ETG System Long-term Debt and Related Expense Allocations
The Azure Credit Agreement served as the sole borrowing agreement applicable for the ETG System during the periods presented. In addition, substantially all of Azure Holdings subsidiaries, including the ETG System, served as guarantors and pledger's with respect to the Azure Credit Agreement.
The ETG System’s long‑term debt and related expense balances represent an allocation of its proportionate share of the Azure Midstream Holdings’ consolidated long‑term debt as of and for all periods presented. Substantially all of the ETG System capital expenditures, including $550 million used to fund a portion of the Acquisition, were financed by the Azure Credit Agreement during these respective periods. As a result, the long‑term debt and related expense balances presented within the ETG System Carve‑out Financial Statements represent the ETG System’s proportionate share using the proportional book value of the ETG System assets as a percentage of total assets financed by the Credit Agreement. The long-term debt allocated to the ETG System as of June 30, 2015 and December 31, 2014 was $52.3 million and $57.0 million.
In connection with entering into the Azure Credit Agreement, Azure incurred financing costs. These deferred financing costs were being amortized to interest expense over the term of the loan. Applying the same allocation methodology as the long‑term debt balances, the ETG System’s deferred finance costs as of June 30, 2015 and December 31, 2014 were $1.8 million for both periods. Amortization expense associated with these deferred finance costs was $0.3 million and $0.2 million for the six months periods ended June 30, 2015 and June 30, 2014.
The estimated remaining principal payments associated with the Azure Credit Agreement that will be allocated to the ETG System are $3.0 million for the fiscal years 2015, 2016 and 2017, and the remaining principal balance due upon maturity in 2018.
The ETG System’s interest expense has also been calculated in a similar allocation methodology as long‑term debt.
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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8. SEGMENT INFORMATION
The Partnership has two operating segments: (i) gathering and processing; and (ii) logistics. Our CODM is the Chief Executive Officer of our General Partner, and our CODM monitors these two operating segments separately to evaluate the overall operational and financial performance of our business. These segments have been identified based on the differing products and services, regulatory environment, and expertise required for their respective operations.
The financial information for our operating segments has been presented as of June 30, 2015 and for the three and six month periods ended June 30, 2015. The Azure System Predecessor had one operating segment, and therefore operating segment financial information has not been presented for the three and six month periods ended June 30, 2014.
The following table presents financial information by segment for the three months ended June 30, 2015:
In thousands | Gathering & Processing | Logistics | Corporate and Consolidation | Azure Midstream Partners, LP | |||||||||||
Total operating revenues | $ | 20,209 | $ | 4,163 | $ | — | $ | 24,372 | |||||||
Cost of natural gas and NGL's | 4,994 | — | — | 4,994 | |||||||||||
Gross margin | 15,215 | 4,163 | — | 19,378 | |||||||||||
Operation and maintenance | 5,149 | 628 | — | 5,777 | |||||||||||
General and administrative | — | — | 4,374 | 4,374 | |||||||||||
Depreciation and amortization expense | 4,224 | 22 | 1,638 | 5,884 | |||||||||||
Operating income | 5,842 | 3,513 | (6,012 | ) | 3,343 | ||||||||||
Interest expense | — | — | 3,225 | 3,225 | |||||||||||
Other expense | 581 | — | — | 581 | |||||||||||
Net income before income tax expense | 5,261 | 3,513 | (9,237 | ) | (463 | ) | |||||||||
Income tax expense | — | — | 540 | 540 | |||||||||||
Net income (loss) | $ | 5,261 | $ | 3,513 | $ | (9,777 | ) | $ | (1,003 | ) | |||||
The following table presents financial information by segment for the six months ended June 30, 2015:
In thousands | Gathering & Processing | Logistics | Corporate and Consolidation | Azure Midstream Partners, LP | |||||||||||
Total operating revenues | $ | 34,469 | $ | 5,583 | $ | — | $ | 40,052 | |||||||
Cost of natural gas and NGL's | 9,797 | — | — | 9,797 | |||||||||||
Gross margin | 24,672 | 5,583 | — | 30,255 | |||||||||||
Operation and maintenance | 9,437 | 998 | — | 10,435 | |||||||||||
General and administrative | — | — | 7,248 | 7,248 | |||||||||||
Depreciation and amortization expense | 6,851 | 589 | 1,638 | 9,078 | |||||||||||
Operating income | 8,384 | 3,996 | (8,886 | ) | 3,494 | ||||||||||
Interest expense | — | — | 6,698 | 6,698 | |||||||||||
Other expense | 1,680 | — | — | 1,680 | |||||||||||
Net income before income tax expense | 6,704 | 3,996 | (15,584 | ) | (4,884 | ) | |||||||||
Income tax expense | — | — | 499 | 499 | |||||||||||
Net income (loss) | $ | 6,704 | $ | 3,996 | $ | (16,083 | ) | $ | (5,383 | ) | |||||
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
The following table presents financial information by segment as of June 30, 2015:
In thousands | Gathering & Processing | Logistics | Corporate and Consolidation | Azure Midstream Partners, LP | |||||||||||
Assets: | |||||||||||||||
Current assets | $ | 11,246 | $ | 2,883 | $ | 5,878 | $ | 20,007 | |||||||
Property, plant and equipment, net | 490,315 | 922 | $ | 377 | 491,614 | ||||||||||
Intangible assets, net | — | 62,833 | — | 62,833 | |||||||||||
Goodwill | 122,982 | 92,776 | $ | — | 215,758 | ||||||||||
Other assets | 2,082 | — | 3,178 | 5,260 | |||||||||||
Total Assets | $ | 626,625 | $ | 159,414 | $ | 9,433 | $ | 795,472 | |||||||
Liabilities and Partners’ Capital | |||||||||||||||
Total current liabilities | $ | 6,426 | $ | 66 | $ | 7,397 | $ | 13,889 | |||||||
Total long-term liabilities | 11,414 | — | 192,648 | 204,062 | |||||||||||
Total Liabilities | 17,840 | 66 | 200,045 | 217,951 | |||||||||||
Partners’ Capital | 608,785 | 159,348 | (190,612 | ) | 577,521 | ||||||||||
Total Liabilities and Partners’ Capital | $ | 626,625 | $ | 159,414 | $ | 9,433 | $ | 795,472 | |||||||
9. COMMITMENTS AND CONTINGENCIES
The Partnership had a fee-based commercial agreement with AES (See Note 10), for reserve capacity at a third-party fractionator, which expired April 30, 2015. Under the former fee-based commercial agreement, if the Partnership failed to deliver 95% of the reserve capacity, the Partnership was obligated to pay a fixed fee for the shortfall of NGL production up to 95% of the reserve capacity. The maximum total fee was capped on an annual basis at $2.2 million. In addition, the Partnership was reimbursed for a majority of any deficiency payments accrued under the former fee-based commercial agreement. The Partnership recorded $0.2 million of expense for the three months ended June 30, 2015 and $0.4 million of expense for the period from March 1, 2015 to June 30, 2015 of accrued deficiency payments under delivered volumes. The Partnership also received reimbursements for deficiency payments from AES of $0.1 million for the three months ended June 30, 2015 and $0.2 million for the period March 1, 2015 to June 30, 2015.
From time to time, the Partnership may be involved in legal, tax, regulatory and other proceedings in the ordinary course of business. Management does not believe that the Partnership is a party to any litigation that will have a material impact on its financial condition or results of operations.
The Partnership, the Azure System Predecessor and the ETG System lease compression and treating equipment and these leases are accounted for as operating leases. Total rent expense for operating leases, including those with terms of less than one year, was $0.9 million and $1.7 million for the three and six month periods ended June 30, 2015. Total rent expense for operating leases, including those with terms of less than one year, was $0.8 million and $1.6 million for the three and six month periods ended June 30, 2014.
The Partnership and its subsidiaries are guarantors of the Credit Agreement as of June 30, 2015 (See Note 7).
10. TRANSACTIONS WITH AFFILIATES
From time to time, we enter into transactions with affiliated entities that are deemed affiliated entities because of common ownership. These affiliated entities include: (i) Azure and its owners, affiliates and subsidiaries, including our General Partner; and (ii) NuDevco and its affiliates and subsidiaries, including AES.
Transactions Related to the Azure System Predecessor
Revenues and Cost of Revenues
The Partnership has a fee-based commercial agreement with AES, requiring a minimum monthly volume commitment of 80 MMcf/d. The minimum volume commitment can be periodically increased at the election of AES. This agreement became
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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effective August 1, 2013 and is a three-year agreement expiring on August 1, 2016. The Partnership’s results of operations include gathering, processing and other revenues attributable to AES in the amount of $4.5 million for the three months ended June 30, 2015 and $6.6 million for the period March 1, 2015 to June 30, 2015. The Partnership's results of operations also include the related cost of natural gas, NGLs and condensate attributable to the AES agreement in the amount of $1.4 million for the three months ended June 30, 2015 and $1.9 million for the period March 1, 2015 to June 30, 2015.
In connection with the Transactions, the Partnership entered into amendments to its: (i) Wildcat Transloading Services Agreement associated with its transloading facility located in Carbon County, Utah; (ii) Big Horn Transloading Services Agreement associated with its transloading facility located in Big Horn County, Wyoming; and (iii) Ladder Transloading Services Agreement, all of which are transloading services agreements with AES. The amendments extend the minimum volume commitments associated with these services agreements until February 27, 2020, or an additional five years from the date of the amendment. Included in the Partnership’s results of operations are transloading and other fee based revenues related to these agreements in the amount of $4.2 million for the three months ended June 30, 2015 and $5.6 million for the period March 1, 2015 to June 30, 2015.
The Azure System Predecessor provides midstream services to affiliates of Azure, and therefore these affiliates are also considered affiliates of the Partnership subsequent to the Transactions. The Azure System Predecessor recognized revenues from these affiliates in the amount of $0.2 million and $0.3 million for the three and six month periods ended June 30, 2015 and $0.1 million and $0.3 million for the three and six month periods ended June 30, 2014.
Accounts Receivable From and Accounts Payable to Affiliates
The Partnership and the Azure System Predecessor had receivables due from these affiliates in the amount of $4.0 million and $0.1 million at June 30, 2015 and December 31, 2014. Receivables due from affiliates primarily related to the Partnership and the Azure System Predecessor's fee-based gathering and processing agreements, and the Partnership's fee-based transloading services agreement with AES. Payables to affiliates were $0.9 million at June 30, 2015. Payables to affiliates primarily related to settlements under the Partnership's gathering and processing agreements and reimbursement to an affiliate of NuDevco for certain general and administrative and operating costs under the Existing Omnibus Agreement with NuDevco.
Cost Allocations and Termination of Existing Omnibus Agreement and Entering into New Omnibus Agreement
In connection with the Transactions, the Partnership terminated its omnibus agreement, dated July 31, 2013 (the “Existing Omnibus Agreement”), by and between NuDevco and its affiliates, the General Partner and the Partnership (together with the General Partner, the “Partnership Parties”). NuDevco and its affiliates released each of the Partnership Parties, and each of the Partnership Parties released NuDevco and its affiliates, from any claims or liabilities arising from or under the terms of the Existing Omnibus Agreement (other than any obligations under the Transaction Agreement).
Also in connection with the Transactions, the Partnership entered into an omnibus agreement (the “New Omnibus Agreement”) with the General Partner and Azure, pursuant to which, among other things:
• | Azure will provide corporate, general and administrative services (the “Services”) on behalf of the General Partner for the benefit of the Partnership and its subsidiaries; |
• | The Partnership is obligated to reimburse Azure and its affiliates for costs and expenses incurred by Azure and its affiliates in providing the Services on behalf of the Partnership, including, but not limited to, administrative costs and the compensation costs of the employees of Azure and its affiliates that provide Services to the Partnership; |
• | The General Partner or Azure may at any time temporarily or permanently exclude any particular Service from the scope of the New Omnibus Agreement upon 90 days’ notice; |
• | The Partnership or Azure may terminate the New Omnibus Agreement in the event that Azure ceases to control the General Partner. Azure may also terminate the New Omnibus Agreement if the General Partner is removed without cause and the units held by the General Partner were not voted in favor of the removal; and |
• | The Partnership will have a right of first offer on any proposed transfer of any assets owned by Azure or its subsidiaries as of January 14, 2015. |
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Expenses under the New Omnibus Agreement, which are included within general and administrative expenses within the condensed consolidated statements of operations, were $0.7 million for the three months ended June 30, 2015 and $1.1 million for the period March 1, 2015 to June 30, 2015. These expenses are reimbursed by the Partnership to Azure and its affiliates. As of June 30, 2015, the Partnership owed no amounts to Azure for various expenses Azure incurred on behalf of the Partnership. In addition, Azure and its affiliates plan to allocate certain overhead costs associated with general and administrative services, including facilities, information services, human resources and other support departments to the Partnership. Where costs incurred on the Partnership’s behalf could not be determined by specific identification, the costs were primarily allocated to the Partnership based on percentage of departmental usage, wages or headcount. The Partnership believes these allocations are a reasonable reflection of the utilization of services provided. However, the allocations may not fully reflect the expenses that would have been incurred had the Partnership been a stand-alone company during the periods presented.
Substantially all of the Azure System Predecessor’s senior management are employed by Azure, and certain functions critical to the Azure System Predecessor's operations are centralized and managed by Azure. As a result, Azure's consolidated general and administrative expenses have been allocated to the Azure System Predecessor for the periods prior to March 1, 2015. The allocated general and administrative expenses from Azure were $1.4 million for the period January 1, 2015 to March 1, 2015 and $1.1 million and $2.3 million for the three and six month periods ended June 30, 2014. This allocation represents Azure’s best estimate of the general and administrative expenses incurred on behalf of the Azure System Predecessor and was determined after consideration of multiple operating metrics, including dedicated operating personnel, pipeline mileage and system throughput as a percentage of each total consolidated Azure’s operating metric. Management believes these allocations reasonably reflect the utilization of services provided and benefits received. The allocated costs are included within general and administrative expense in the statements of operations. See Note 7 for further discussion of the long-term debt and interest expense allocated to the Azure System Predecessor.
Transactions Related to the ETG System
EXCO Resources, Inc. ("EXCO") and BG Group, plc ("BG") are considered related parties of the ETG System for financial reporting purposes as a result of their combined 7% ownership interest in Azure Holdings. The ETG System also provides services to an affiliate of Tenaska Capital Management, which is also considered a related party. For the six month periods ended June 30, 2015 and the six monthsperiods ended June 30, 2014, the ETG System recorded revenues from these affiliates in the amount of $0.1 million and $2.4 million. For the period ended June 30, 2015, accounts receivable from these affiliates were immaterial, with no outstanding balance as of December 31, 2014.
Allocated Expenses
Substantially all of the ETG System’s senior management is employed by Azure Holdings, and certain functions critical to the ETG System’s operations are centralized and managed by Azure Holdings. Additionally, the ETG System resides in office space provided by Azure Holdings. As a result, 14.8% of the total consolidated Azure Holdings’ general and administrative expenses have been allocated to the ETG System for the periods presented. The ETG System allocated general and administrative expenses from Azure were $0.9 million and $0.7 million for the six month periods ended June 30, 2015 and the six month periods ended June 30, 2014. The ETG System allocated operating expense labor from Azure were $0.5 million and $0.6 million for the six month periods ended June 30, 2015 and the six month periods ended June 30, 2014.
This allocation represents management’s best estimate of the general and administrative expenses and operating expense labor incurred on behalf of the ETG System and was determined after consideration of multiple operating metrics, including dedicated operating personnel, pipeline mileage and system throughput as a percentage of each total consolidated Azure’s operating metric. Management of the ETG System and Azure believe these allocations reasonably reflect the utilization of services provided and benefits received. The allocated costs are included within general and administrative expense and operating expense of the statements of operations. See Note 7 for further discussion of the long-term debt and interest expense allocated to the ETG System.
11. EQUITY BASED COMPENSATION
The board of directors of the Partnership’s general partner have adopted the LTIP. Individuals who are and were eligible to receive awards under the LTIP include: (i) employees of the Partnership, Azure and its affiliates, and NuDevco and its affiliates; (ii) directors of the Partnership’s general partner; and (iii) consultants. The LTIP provides for the grant of unit options,
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
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unit appreciation awards, restricted units, phantom units, distribution equivalent rights, unit awards, profits interest units, and other unit-based awards. The maximum number of common units issuable under the LTIP is 1,750,000.
The Partnership had 278,400 phantom unit awards outstanding immediately prior to the Transactions that had been awarded to certain employees of NuDevco and its affiliates who provide direct or indirect services to the Partnership pursuant to affiliate agreements.
All of the phantom unit awards granted were considered non-employee equity based awards, issued to individuals who were not deemed to be employees of the Partnership. The applicable accounting guidance required that the phantom unit awards be remeasured at fair market value at each reporting period and amortized to compensation expense on a straight-line basis over the vesting period of the phantom units with a corresponding increase in a liability as management intended to settle the awards by allowing the recipient to choose between issuing the net amount of common units due, less common units equivalent to pay withholding taxes, due upon vesting with the Partnership paying the amount of withholding taxes due in cash or issuing the gross amounts of common units due with the recipient paying the withholding taxes. Distribution equivalent rights were accrued for each phantom unit award as the Partnership declares cash distributions and was recorded as a decrease in partners’ capital with a corresponding liability in accordance with the vesting period of the underlying phantom unit, which will be settled in cash when the underlying phantom units vest. The phantom units awarded to employees of NuDevco and its affiliates had vesting terms of five equal annual installments.
The acquisition of our General Partner by Azure resulted in a Change in Control Event (as defined in the LTIP) for the holders of our phantom units, and, as a result, all of the outstanding phantom units immediately vested as of the date of the Change in Control Event. As a result of the vesting of the phantom units, the Partnership immediately recognized compensation expense of $4.2 million and issued 196,108 common units. The Partnership was also required to make a cash payment of $1.9 million associated with the withholding taxes on these units and a cash payment of $0.2 million related to the distribution equivalent rights associated with these phantom units. The compensation expense has not been reflected within the Partnership's consolidated financial statements for the period from March 1, 2015 to June 30, 2015, but rather have been considered an expense incurred immediately prior to the Transactions and therefore is reflected within the Partnership's operating results prior to the business combination. The liability associated with the withholding tax and distribution equivalent rights payments were included within the liabilities assumed by the Azure System Predecessor as part of the business combination.
Azure, as our General Partner, plans to continue to operate under the LTIP in the future. However, there were no awards issued under the LTIP in connection with or immediately following the closing of the Transactions, and Azure, as our General Partner, has the ability to determine the terms and conditions of the awards issued under the LTIP, which may differ from those previously issued.
12. SUBSEQUENT EVENTS
On August 6, 2015, the Partnership announced it has acquired the equity interest of ETG for total cash consideration of $83.0 million, subject to customary purchase price adjustments. ETG was financed with an $80.0 million draw from the Credit Agreement and the issuance of 255,319 common units to our General Partner. The assets of ETG include certain natural gas gathering pipelines located in Nacogdoches and Shelby Counties in Texas. The acquisition is effective immediately and the Partnership's financial results will retrospectively include the financial results attributable to the acquired gas gathering pipelines for all periods beginning July 1, 2015.
On July 27, 2015, the Partnership announced that the board of directors of our General Partner declared a quarterly cash distribution of $0.37 per unit, or $1.48 on an annualized basis, to unitholders of record on August 7, 2015. The Partnership will pay the quarterly distribution to unitholders on August 14, 2015.
On July 17, 2015, the underwriters of the Partnership's Offering, exercised their option to purchase an additional 90,000 common units at a price to the public of $14.17 per common unit. Total net proceeds from the sale of these additional common units, including the General Partner's proportionate capital contribution and after deducting underwriting discounts and commissions and estimated offering expenses, was approximately $1.2 million.
On July 9, 2015, the Partnership awarded 378,565 phantom units under the LTIP to certain named executive officers and employees of the General Partner. Each phantom unit is the economic equivalent of one common unit of the Partnership and entitles the grantee to receive one common unit or an amount of cash equal to the fair market value of a common unit upon the
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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
vesting of the phantom unit. The phantom units vest in three equal annual installments with the first installment vesting on July 1, 2016. In addition, the Partnership awarded 3,522 common units under the LTIP, to an employee of the General Partner, which vested immediately upon issuance.
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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The historical financial statements included in this filing reflect the assets, liabilities and operations of Azure Midstream Partners, LP (the "Partnership"), updated to include the contribution of Azure ETG, LLC ("ETG") that owns and operates the East Texas Gathering System (the "ETG System") described below. On May 19, 2015 the Partnership changed its name from Marlin Midstream Partners, LP to Azure Midstream Partners, LP.
Following the transactions described under - "Acquisition of the Legacy System" ("the Transactions") the Azure Legacy gathering system (the "Legacy System" or the "Azure System Predecessor") was determined to be the historical predecessor of Azure Midstream Partners, LP , for financial reporting purposes. The Legacy System is considered the predecessor of the Partnership because Azure Midstream Energy LLC and Azure Midstream Holdings LLC (collectively, "Azure") obtained control of the Partnership through its acquisition of 100% of the ownership interest in Azure Midstream Partners GP, LLC, the sole general partner of the Partnership (the "General Partner"), formerly Marlin Midstream GP, LLC.
The closing of Transactions occurred on February 27, 2015, and were reflected in the condensed consolidated financial statements of the Partnership using, for accounting purposes, a date of convenience of February 28, 2015 (the "Transactions Date"). The effect of recording the Transactions as of February 27, 2015 was not material to the information presented.
On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for the three and six month periods ended June 30, 2015.
You should read this discussion and analysis of financial condition and results of operations in conjunction with the historical financial statements and accompanying notes included elsewhere in this report. All references in this section to the Azure System Predecessor, as well as the terms “our,” “we,” “us” and “its,” refer to the Legacy System when used in historical context or in reference to the periods prior to the Transactions Date. All references in this section to the Partnership, as well as the terms “our,” “we,” “us” and “its,” refer to Azure Midstream Partners, LP, together with its consolidated subsidiaries, including the Legacy System and ETG System, when used in the present or future tense and for periods subsequent to the Transactions Date.
OVERVIEW
General
We are a fee-based, growth-oriented Delaware limited partnership formed to develop, own, operate and acquire midstream energy assets. We currently provide natural gas gathering, compression, dehydration, treating, processing and hydrocarbon dew-point control and transportation services, which we refer to as our gathering and processing business segment, and crude oil transloading services, which we refer to as our logistics business segment.
Acquisition of the Legacy System
On February 27, 2015, we completed the Transactions pursuant to a Transaction Agreement, dated January 14, 2015 (the “Transaction Agreement”), by and among us, Azure, the General Partner, NuDevco Partners, LLC and its affiliates ("NuDevco") and Marlin IDR Holdings, LLC, a Delaware limited liability company and wholly-owned subsidiary of NuDevco (“IDRH”). Pursuant to the Transaction Agreement, Azure contributed the Marlin Midstream Predecessor to us and Azure acquired all of the equity interests in our General Partner and 90% of our IDR Units (as defined below) from NuDevco.
The following transactions were consummated in connection with the closing of the Transactions (the “Closing”):
• | we amended and restated our limited partnership agreement to reflect the unitization of our incentive distribution rights (as unitized, the “IDR Units”) and we recapitalized the incentive distribution rights owned by IDRH into 100 IDR Units; |
• | we redeemed 90 IDR Units held by IDRH in exchange for a payment of $63.0 million to IDRH (the “Redemption”); |
• | Azure contributed the Azure System Predecessor to us through the contribution, indirectly or directly, of: (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure ("Talco"); and (ii) certain assets owned by TGG Pipeline, Ltd., a Texas limited liability |
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company and subsidiary of Azure ("TGG" and, collectively with Talco, "TGGT"), in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of: (i) $99.5 million in cash; and (ii) the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”); and
• | Azure purchased from NuDevco: (i) all of the outstanding membership interests in the General Partner for $7.0 million; and (ii) an option to acquire up to 20% of our common and subordinated units held by NuDevco as of the execution date of the Transaction Agreement. |
Contribution of the ETG System
On August 6, 2015, we entered into a contribution agreement (the “Contribution Agreement”) with Azure, which is the sole member of the general partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in ETG, a Delaware limited liability company , to the Partnership in exchange for the consideration described below. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of ETG was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | as consideration for the membership interests of ETG, we paid Azure $80.0 million in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure; and |
• | we entered into a gas gathering agreement (the “Gas Gathering Agreement”) with TGG an indirect subsidiary of Azure. |
Listing of Our Common Units on the New York Stock Exchange
On May 20, 2015, we submitted written notice to NASDAQ Global Market to voluntarily delist our common units and applied to list our common units on the New York Stock Exchange ("NYSE"). The delisting became effective following the close of business on May 28, 2015, and our common units commenced trading on the NYSE at market open on May 29, 2015 under the ticker "AZUR".
Public Offering of Our Common Units
On June 17, 2015, we and the General Partner entered into an underwriting agreement with Merrill Lynch, Pierce, Fenner & Smith Incorporated, Wells Fargo Securities, LLC, J.P. Morgan Securities LLC and RBC Capital Markets, LLC, as representatives of the several underwriters named therein (the “Underwriting Agreement”) relating to the public offering of 3,500,000 common units representing limited partner interests in the Partnership at a price to the public of $14.17 per common unit (the “Offering”). Pursuant to the Underwriting Agreement, we also granted the underwriters a 30-day option to purchase up to an additional 525,000 common units at the same price.
The Offering closed on June 22, 2015. We received net proceeds from the sale of the common units sold in the Offering of approximately $48.3 million, including the proportionate capital contribution by the General Partner to maintain its 1.97% general partner interest and after deducting the underwriting discount and estimated offering expenses payable by the Partnership.
Ownership
As of June 30, 2015, Azure owned and controlled: (i) the General Partner, representing a 1.97% general partner interest in us; and (ii) 90% of our IDR Units. As of June 30, 2015, NuDevco owned: (i) 1,939,265 of our common units, representing a 8.88% limited partner interest; (ii) 8,724,545 of our subordinated units, representing a 39.93% limited partner interest; and (iii) 10% of our IDR Units (as defined below). As of June 30, 2015, the public owned 10,756,091 of our common units, representing a 49.23% limited partner interest. Azure, through its ownership of our General Partner, controls us and is responsible for managing our business and operations.
Basis of Presentation
The following financial information gives effect to the business combination and the Transactions and the transactions contemplated by the Contribution Agreement discussed above.
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Under the acquisition method of accounting, the business combination was accounted for in accordance with the applicable reverse merger accounting guidance. Azure acquired a controlling financial interest in us through the acquisition of our General Partner. As a result, the Azure Sytem Predecessor is deemed to be the accounting acquirer of the Partnership because its parent company, Azure, obtained control of the Partnership through its control of our General Partner. Consequently, the Azure System Predecessor is deemed to be the predecessor of the Partnership for financial reporting purposes, and the historical financial statements of the Partnership were recast and reflect the Azure System Predecessor for all periods prior to the Transactions Date.
The Azure System Predecessor's assets and liabilities retained their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Azure System Predecessor in the business combination were recorded at their fair values measured as of the Transactions Date. The excess of the assumed purchase price of the Partnership over the estimated fair values of the Partnership's net assets acquired were recorded as goodwill. The assumed purchase price or enterprise value of the Partnership was determined using acceptable fair value methods, and is partially derived from the consideration Azure paid for our General Partner and 90% of our IDR Units. Additionally, because the Azure System Predecessor is reflected at Azure’s historical cost, the difference between the $162.5 million in consideration paid by the Partnership and Azure's historical carrying values (net book value) at the Transactions Date was recorded as an increase to partners’ capital in the amount of $51.7 million. The assumed purchase price and fair values are preliminary and were prepared with the assistance of our external fair value specialists, and represent management's best estimate of the enterprise value and fair values of the Partnership.
The contribution of the ETG System by Azure to the Partnership was determined to be a transaction between entities under common control for financial reporting purposes. Because the contribution of the ETG System is considered to be a transaction amongst entities under common control, the ETG System is reflected at Azure's historical cost and the difference between that historical cost and the purchase price is recorded as an adjustment to partners' capital. In addition, we have recast the financial results of the Partnership to include the financial results of the ETG System for the three and six month periods ended June 30, 2015.
OUR ASSETS
Our assets and operations are organized into the following two operating segments:
Gathering and Processing Segment
Our gathering and processing segment consists primary of midstream natural gas assets, including: (i) two related natural gas processing facilities located in Panola County, Texas with an approximate design capacity of 220 MMcf/d; (ii) a natural gas processing facility located in Tyler County, Texas with an approximate design capacity of 80 MMcf/d; (iii) 747 miles of high-and low-pressure gathering lines that currently serve approximately 100,000 dedicated acres and have access to seven major downstream markets, our Panola County processing plants and three third-party processing plants; and (iv) two NGL transportation pipelines with an approximate design capacity of 20,000 Bbls/d that connect our Panola County and Tyler County processing facilities to third party NGL pipelines.
Our primary gathering and processing segment assets are located in long-lived oil and natural gas producing regions in East Texas and gather and process NGL-rich natural gas streams associated with production primarily from the Cotton Valley Sands, Haynesville Shale, Austin Chalk and Eaglebine formations.
Subsequent to June 30, 2015, we completed the contribution of the ETG system, the results of operations of which will be included within our gathering and processing segment. The ETG system is primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby Counties in East Texas and currently serves multiple formations including the Haynesville, Bossier and the liquids-rich James Lime formation. The ETG system consists of approximately 255 miles of gathering lines and serves approximately 336,000 gross dedicated acres. The system has two owned treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. The new Fairway processing plant is designed to extract NGL content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Logistics Segment
Our logistics segment consists of three crude oil transloading facilities: (i) our Wildcat facility located in Carbon County, Utah, where we currently operate two skid transloaders and four ladder transloaders; (ii) our Big Horn facility located in Big Horn County, Wyoming, where we currently operate two skid transloaders and two ladder transloaders; and (iii) our East
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New Mexico facility located in Sandoval County, New Mexico, where we currently operate two skid transloaders and two ladder transloaders. Our transloaders are used to unload crude oil from tanker trucks and load crude oil into railcars. Our facilities provide transloading services for production originating from well-established crude oil producing basins, such as the Uinta, San Juan and Powder River Basins, which we believe are currently underserved by our competitors. Our combined transloading capacity is 31,200 Bbls/d in normal operating conditions.
HOW WE EVALUATE OUR OPERATIONS
Our management uses a variety of financial and operational metrics to analyze the Partnership's performance. These metrics include: (i) throughput volume; (ii) Adjusted EBITDA; (iii) operating expenses; and (iv) capital spending.
Throughput Volume
The volume of natural gas and crude oil that we gather and transport depends on the level of production from natural gas and oil wells connected to our gathering systems and transloading facilities. Aggregate production volumes are impacted by the overall amount of drilling and completion activity because production must be maintained or increased by new drilling or other activity as the production rate of a natural gas and oil wells decline over time. Producers’ willingness to engage in new drilling is determined by a number of factors, the most important of which are the prevailing and projected prices of natural gas, oil and NGLs, the cost to drill and operate a well, the availability and cost of capital, and environmental and government regulations. We generally expect the level of drilling to positively correlate with long-term trends in commodity prices. Similarly, production levels nationally and regionally generally tend to positively correlate with drilling activity, and we actively monitor producer drilling activity in the areas served by our gathering systems and transloading facilities to pursue new supply opportunities.
We must continually obtain new supplies of natural gas and crude oil to maintain or increase the throughput volume on our systems and our transloading facilities. Our ability to maintain or increase existing throughput volumes and obtain new supplies of natural gas and crude oil is impacted by:
• | successful drilling activity within our dedicated acreage and areas of operations; |
• | the level of work-overs and recompletions of wells on existing pad sites to which our gathering systems and transloading facilities are connected; |
• | the number of new pad sites in our dedicated acreage awaiting lateral connections; |
• | our ability to compete for volumes from successful new wells in the areas in which we operate outside of our existing dedicated acreage; |
• | our ability to utilize the remaining uncommitted capacity on, or add additional capacity to, our gathering and processing systems and our transloading facilities; |
• | our ability to gather natural gas and crude oil volumes that have been released from commitments with our competitors; and |
• | our ability to acquire or develop new systems with associated volumes and contracts. |
Adjusted EBITDA
We believe that Adjusted EBITDA is a widely accepted financial indicator of our operational performance and our ability to incur and service debt, fund capital expenditures and make distributions. Adjusted EBITDA is used as supplemental financial measures by management and external users of our financial statements, such as investors, commercial banks and research analysts, to assess the financial performance of our assets without regard to financing methods, capital structure or historical cost basis; our operating performance and return on capital as compared to those of other companies in the midstream energy sector, without regard to financing or capital structure; and the attractiveness of capital projects and acquisitions and the overall rates of return on alternative investment opportunities.
We define EBITDA as net income (loss), plus (1) interest expense, (2) income tax expense, and (3) depreciation and amortization expense. We define Adjusted EBITDA as EBITDA, plus adjustments associated with certain non-cash and other items.
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The following table presents a reconciliation of the non-GAAP financial measure of Adjusted EBITDA to the GAAP financial measure of net income (loss):
In thousands | Three Months Ended June 30, 2015(1) | Six Months Ended June 30, 2015(1) | |||||
Net income | $ | (1,003 | ) | $ | (5,383 | ) | |
Add (Deduct): | |||||||
Interest expense | 3,225 | 6,698 | |||||
Income tax expense | 540 | 499 | |||||
Depreciation and amortization expense | 5,884 | 9,078 | |||||
Other adjustments (2) | 2,507 | 4,476 | |||||
Deferred revenue (3) | 1,707 | 3,396 | |||||
Adjusted EBITDA | $ | 12,860 | $ | 18,764 | |||
(1) On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for the periods represented above. | |||||||
(2) Other adjustments consists of non-recurring and non-cash items, including: (i) non-recurring expenses associated with the Transactions and Transition Services Agreement between the Partnership and Azure; and (ii) non-cash volumetric natural gas imbalance adjustments. | |||||||
(3) Adjustments related to deferred revenues associated with our MRC agreements account for our inclusion of expected cash receipts under these MRC agreements. With respect to our MRC agreement, the volumes supplied by the customer are currently less than the annual MRC requirement, and we are therefore entitled to receive an annual deficiency payment. The customer's deficiency payment to us may be credited against future volumes supplied by the customer in excess of the annual MRC. We record the cash receipts associated with the deficiency payments as deferred revenue because the customer is entitled to utilize the deficiency payment to offset future volumes supplied in excess of the annual MRC over the term of the contract. We include a proportional amount or the expected MRC cash receipts in each quarter in respect of the annual period for which we actually receive the payment to ensure our Adjusted EBITDA reflects the amount of cash we are entitled to receive on an annual basis under these MRC agreements. | |||||||
Adjusted EBITDA is not a financial measure presented in accordance with GAAP. We believe that the presentation of this non-GAAP financial measure will provide useful information to investors in assessing our financial condition and results of operations. The GAAP measure most directly comparable to Adjusted EBITDA is net income (loss). This measure should not be considered as an alternative to operating income, net income (loss), or any other measure of financial performance presented in accordance with GAAP. The non-GAAP financial measure has important limitations as an analytical tool because it excludes some but not all items that affect net income. You should not consider this non-GAAP financial measure in isolation or as a substitute for analysis of our results as reported under GAAP. Additionally, because the non-GAAP financial measure may be defined differently by other companies in our industry, our definition of may not be comparable to similarly titled measures of other companies, thereby diminishing their utility.
Operating Expenses
We seek to maximize the profitability of our operations in part by minimizing, to the extent appropriate, expenses directly tied to operating and maintaining our assets. Direct labor costs, repair and non-capitalized maintenance costs, integrity management costs, treating chemical costs, utilities and contract services are the most significant portion of our operating expenses. These expenses are largely dependent on the volumes delivered through our gathering systems, processing plants and transloading facilities, and these expenses may fluctuate depending on the type of activities, such as repairs and maintenance and integrity management, performed during a specific period.
Capital Spending
Our management seeks to effectively manage our maintenance capital expenditures, including turnaround costs. These capital expenditures relate to the maintenance and integrity of our pipelines and processing and transloading facilities. We capitalize the costs of major maintenance activities, or turnarounds, and depreciate the costs over the period until the next planned turnaround of the affected unit. We categorize maintenance capital expenditures as those that are made to maintain our asset base, operating capacity or operating income, or to maintain the existing useful life of any of our capital assets, in each case over the long term. Examples of maintenance capital expenditures are expenditures for the repair, refurbishment and replacement of our assets, to maintain equipment reliability, integrity and safety and to address environmental laws and regulations. In addition, we may designate a portion of our maintenance capital expenditures to connect new wells to maintain throughput to the extent such capital expenditures are necessary to maintain, over the long term, our operating capacity or operating income.
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Expenditure levels will increase as pipelines age and require higher levels of inspection, maintenance and capital replacement. Growth capital expenditures are cash expenditures to construct new midstream infrastructure, including those expenditures incurred in order to extend the useful lives of our assets, reduce costs, increase revenues, or increase system throughput or capacity from current levels. Examples of growth capital expenditures include the construction, development or acquisition of additional gathering pipelines, compressor stations, processing plants, transloading facilities and new well connections, in each case to the extent such capital expenditures are expected to expand our operating capacity or operating income. In the future, if we make acquisitions that increase system throughput or capacity, the associated capital expenditures will also be considered expansion capital expenditures.
FACTORS AFFECTING THE COMPARABILITY OF OUR OPERATING RESULTS
As described above, the Azure System Predecessor was deemed to be the accounting acquirer of the Partnership in accordance with applicable business combination accounting guidance and, as a result, the historical financial statements of the Partnership were recast to reflect the statement of position and results of operations of the Azure System Predecessor for periods prior to the Transactions Date. Therefore, the Partnership's future results of operations may not be comparable to the Azure System Predecessor's historical results of operations for the reasons described below.
Ownership
Azure controls us through its ownership of our General Partner, and Azure is responsible for the management of the operations of our business. In connection with the closing of the Transactions, the Partnership terminated its Omnibus Agreement, dated July 31, 2013 (the “Existing Omnibus Agreement”), by and between NuDevco and its affiliates, the General Partner and the Partnership. Also in connection with the closing of the Transactions, the Partnership entered into an omnibus agreement (the “New Omnibus Agreement”) with the General Partner and Azure, pursuant to which, among other things:
• | Azure will provide corporate, general and administrative services (the “Services”) on behalf of the General Partner for the benefit of the Partnership and its subsidiaries; |
• | the Partnership is obligated to reimburse Azure and its affiliates for costs and expenses incurred by Azure and its affiliates in providing the Services on behalf of the Partnership, including, but not limited to, administrative costs and the compensation costs of the employees of Azure and its affiliates that provide Services to the Partnership; |
• | the General Partner or Azure may at any time temporarily or permanently exclude any particular Service from the scope of the New Omnibus Agreement upon 90 days’ notice; |
• | the Partnership or Azure may terminate the New Omnibus Agreement in the event that Azure ceases to control the General Partner. Azure may also terminate the New Omnibus Agreement if the General Partner is removed without cause and the units held by the General Partner were not voted in favor of the removal; and |
• | the Partnership will have a right of first offer on any proposed transfer of any assets owned by Azure or its subsidiaries as of January 14, 2015. |
The Partnership's ongoing results of operations are comprised of our gathering and processing business segment, including the Azure System Predecessor, and our logistics business segment. The ongoing results of operations are under Azure management, as it controls our General Partner. As a result, the historical results of operations of the Azure System Predecessor will not be comparable to the Partnership's future results of operations.
Revenues
The revenues generated by the Partnership consist of the revenues from the gathering and processing segment, including the Azure System Predecessor, and the logistics segment subsequent to the Transactions Date. The historical revenues included within the Partnership's financial statements prior to the Transactions Date are comprised of the Azure System Predecessor. The Azure System Predecessor's primary revenue producing activities are the sales of natural gas and NGLs and the sale of condensate liquids. The Azure System Predecessor also earns gathering services and other fee based revenues from the gathering, compression and treating of natural gas. The Partnership's revenues are primarily derived from natural gas processing and fees earned from its gathering, processing and transloading operations. Therefore, our ongoing operating results
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include incremental gathering, processing and other fee-based revenues compared with the historical revenues of the Azure System Predecessor.
General and Administrative Expenses
Under the New Omnibus Agreement, Azure has the ability to determine the Services and the amount of such Services it provides to the Partnership. These general and administrative expenses are not comparable to the general and administrative expenses previously allocated to Azure System Predecessor from Azure. In addition, the Partnership's general and administrative expenses are not comparable to the historical Azure System Predecessor's general and administrative expenses because the Partnership's general and administrative expenses include the expenses associated with being a publicly traded master limited partnership whereas the Azure System Predecessor was operated as a component of a private company.
Financing
In connection with the Transactions, the Partnership entered into a new senior secured revolving credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC (collectively, the “Lenders”). The Credit Agreement has a maturity date of February 27, 2018 and up to $250.0 million in commitments. As a result, the Partnership's long-term debt and related charges are not comparable to the Azure System Predecessor's historical long-term debt and related charges. We expect ongoing sources of liquidity to include cash generated from operations, our new Credit Agreement and additional issuances of debt and equity securities.
Contribution of the ETG System
On August 6, 2015, Azure contributed the ETG System to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Legacy System to include the financial results of the ETG System from the date of Azure's acquisition, November 15, 2013. Therefore, the financial results of the Azure System will not be comparable to the Azure System Predecessor for all periods prior to November 15, 2013.
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RESULTS OF OPERATIONS
Three Months Ended June 30, 2015 Compared to Three Months Ended June 30, 2014
The following table presents selected financial data for each of the three months ended June 30, 2015 and 2014.
In thousands, except operating data | Three Months Ended June 30, | ||||||||||
2015 (1) | 2014 (1) | Change | |||||||||
Operating Revenues: | |||||||||||
Natural gas, NGLs and condensate revenue | $ | 6,480 | $ | 13,549 | $ | (7,069 | ) | ||||
Gathering, processing, transloading and other fee revenue | 17,892 | 5,740 | 12,152 | ||||||||
Total operating revenues | 24,372 | 19,289 | 5,083 | ||||||||
Operating Expenses: | |||||||||||
Cost of natural gas and NGLs | 4,994 | 10,011 | (5,017 | ) | |||||||
Operation and maintenance | 5,777 | 3,575 | 2,202 | ||||||||
General and administrative | 4,374 | 1,432 | 2,942 | ||||||||
Depreciation and amortization | 5,884 | 2,035 | 3,849 | ||||||||
Total operating expenses | 21,029 | 17,053 | 3,976 | ||||||||
Operating income | 3,343 | 2,236 | 1,107 | ||||||||
Interest expense | 3,225 | 3,704 | (479 | ) | |||||||
Other (income) expense | 581 | 75 | 506 | ||||||||
Net income (loss) before income tax expense | (463 | ) | (1,543 | ) | 1,080 | ||||||
Income tax expense | 540 | 53 | 487 | ||||||||
Net income (loss) | $ | (1,003 | ) | $ | (1,596 | ) | $ | 593 | |||
Key performance metrics: | |||||||||||
Adjusted EBITDA (1) | $ | 12,860 | |||||||||
Operating data: | |||||||||||
Average throughput volumes of natural gas (MMcf/d) | 338 | 273 | |||||||||
Average volume of processed gas (MMcf/d) | 185 | ||||||||||
Transloading Facilities (Bbls/d) | 22,496 | ||||||||||
(1) On August 6, 2015, the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for the three months ended June 30, 2015 and 2014. | |||||||||||
(2) Adjusted EBITDA is not a financial measure presented in accordance with GAAP. For a reconciliation of Adjusted EBITDA to its most directly comparable financial measure calculated and presented in accordance with GAAP, please see - “How We Evaluate Our Operations.” | |||||||||||
Revenues
Natural gas, NGLs and condensate revenue decreased by $7.1 million to $6.5 million for the three months ended June 30, 2015, as compared to $13.5 million for the three months ended June 30, 2014. This decrease was primarily attributed to: (i) the Azure System Predecessor, which recognized revenue of $3.3 million for the three months ended June 30, 2015 compared to $10.8 million for the three months ended June 30, 2014; and (ii) the ETG System, which recognized revenue of $1.0 million for the three months ended June 30, 2015 compared to $2.8 million for the three months ended June 30, 2014. This decrease was a result of declines in commodity prices period over period and a result of lower volumes period over period. The decrease in natural gas, NGLs and condensate revenue was partially offset by an increase of $2.2 million in revenue attributed to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date.
Gathering, processing, transloading and other fee revenue increased by $12.2 million to $17.9 million for the three months ended June 30, 2015, as compared to $5.7 million for the three months ended June 30, 2014. This increase was
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attributable to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date, partially offset by a decrease of $0.3 million related to the ETG System.
Cost of Revenues
Cost of natural gas and NGLs decreased by $5.0 million to $5.0 million for the three months ended June 30, 2015, as compared to $10.0 million for the three months ended June 30, 2014. This decrease was primarily attributed to: (i) the Azure System Predecessor, which recognized cost of $2.2 million for the three months ended June 30, 2015 compared to $7.7 million for the three months ended June 30, 2014; and (ii) the ETG System, which recognized cost of $0.9 million for the three months ended June 30, 2015 compared to $2.3 million for the three months ended June 30, 2014. This decrease was a result of lower commodity prices and volumes purchased period over period, and the decrease directly correlates to the decrease in natural gas, NGLs and condensate revenue for the period. The decrease in cost of natural gas and NGLs was partially offset by an increase of $1.9 million attributable to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date.
Operation and Maintenance Expense
Operation and maintenance expense increased by $2.2 million to $5.8 million for the three months ended June 30, 2015, as compared to $3.6 million for the three months ended June 30, 2014. This increase was a result of: (i) $2.5 million increase attributable to the Partnership's historical midstream assets, which are included within the condensed results of operations subsequent to the Transactions Date; and (ii) $0.4 million increase attributable to the ETG System. This increase was partially offset by a decrease of $0.7 million in the Azure System Predecessor's operations and maintenance expense period over period, and was a result of lower compression rental, asset integrity management and repairs and maintenance expenses.
General and Administrative Expense
General and administrative expense increased by $2.9 million to $4.4 million for the three months ended June 30, 2015, as compared to $1.4 million for the three months ended June 30, 2014. This increase was primarily the result of: (i) $4.0 million increase attributable to the Partnership's historical midstream assets, which are included within the condensed results of operations subsequent to the Transactions Date; partially offset by (ii) $1.1 million decrease in the Azure System Predecessor's general and administrative expense period over period.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $3.8 million to $5.9 million for the three months ended June 30, 2015, as compared to $2.0 million for the three months ended June 30, 2014. This increase was primarily the result of $3.7 million increase attributable to the Partnership's historical midstream assets, which were adjusted to fair value in connection with the business combination and are included within the condensed results of operations subsequent to the Transactions Date. In addition, depreciation and amortization expense increased $0.2 million related to the allocation of expense to the Azure System Predecessor period over period.
Interest Expense
Interest expense decreased by $0.5 million to $3.2 million for the three months ended June 30, 2015, as compared to $3.7 million for the three months ended June 30, 2014. This decrease was primarily a result of lower interest expense allocated to the Azure System Predecessor of $2.6 million period over period attributable to the Azure credit agreement. The decrease in interest expense was partially offset by $2.0 million in interest expense attributed to the Partnership and the Credit Agreement, which are included within the condensed results of operations subsequent to the Transactions Date and a $0.1 million increase in the allocation of interest expense attributed to the ETG System and the Azure credit agreement.
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Six Months Ended June 30, 2015 Compared to Six Months Ended June 30, 2014
The following table presents selected financial data for each of the six months ended June 30, 2015 and 2014.
In thousands, except operating data | Six Months Ended June 30, | ||||||||||
2015 (1) | 2014 (1) | Change | |||||||||
Operating Revenues: | |||||||||||
Natural gas, NGLs and condensate revenue | $ | 12,026 | $ | 25,746 | (13,720 | ) | |||||
Gathering, processing, transloading and other fee revenue | 28,026 | 10,670 | 17,356 | ||||||||
Total operating revenues | 40,052 | 36,416 | 3,636 | ||||||||
Operating Expenses: | |||||||||||
Cost of natural gas and NGLs | 9,797 | 17,979 | (8,182 | ) | |||||||
Operation and maintenance | 10,435 | 7,757 | 2,678 | ||||||||
General and administrative | 7,248 | 2,991 | 4,257 | ||||||||
Depreciation and amortization | 9,078 | 3,916 | 5,162 | ||||||||
Asset impairments | — | 150 | (150 | ) | |||||||
Total operating expenses | 36,558 | 32,793 | 3,765 | ||||||||
Operating income | 3,494 | 3,623 | (129 | ) | |||||||
Interest expense | 6,698 | 7,482 | (784 | ) | |||||||
Other (income) expense | 1,680 | 186 | 1,494 | ||||||||
Net income (loss) before income tax expense | (4,884 | ) | (4,045 | ) | (839 | ) | |||||
Income tax expense | 499 | 101 | 398 | ||||||||
Net income (loss) | $ | (5,383 | ) | $ | (4,146 | ) | $ | (1,237 | ) | ||
Key performance metrics: | |||||||||||
Adjusted EBITDA (2) | $ | 18,764 | |||||||||
Operating data: (3) | |||||||||||
Average throughput volumes of natural gas (MMcf/d) | 353 | 271 | |||||||||
Average volume of processed gas (MMcf/d) | 186 | ||||||||||
Transloading Facilities (Bbls/d) | 22,512 | ||||||||||
(1) On August 6, 2015, the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for the six months ended June 30, 2015 and 2014. | |||||||||||
(2) Adjusted EBITDA is not a financial measure presented in accordance with GAAP. For a reconciliation of Adjusted EBITDA to its most directly comparable financial measure calculated and presented in accordance with GAAP, please see - “How We Evaluate Our Operations.” | |||||||||||
(3) The operating data presented for the six months ended June 30, 2015, is for the period March 1, 2015 to June 30, 2015, the period in which the Partnership is included within the consolidated financial results. | |||||||||||
Revenues
Natural gas, NGLs and condensate revenue decreased by $13.7 million to $12.0 million for the six months ended June 30, 2015, as compared to $25.7 million for the six months ended June 30, 2014. This decrease was primarily attributed to: (i) the Azure System Predecessor, which recognized revenue of $7.2 million for the six months ended June 30, 2015 compared to natural gas sales of $20.6 million for the six months ended June 30, 2014; and (ii) the ETG System which recognized revenue of $2.0 million for the six months ended June 30, 2015 compared to natural gas sales of $5.1 million for the six months ended June 30, 2014. This decrease was primarily a result of declines in commodity prices period over period and a result of lower volumes period over period. This decrease was partially offset by an increase of $2.8 million in natural gas, NGLs and condensate revenue attributed to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date.
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Gathering, processing, transloading and other fee revenue increased by $17.4 million to $28.0 million for the six months ended June 30, 2015, as compared to $10.7 million for the six months ended June 30, 2014. This increase was attribuable to: (i) $17.1 million related to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date; (ii) $0.9 million due to increased revenue related to the Azure System Predecessor; partially offset by (iii) $0.7 million decrease related to the ETG System.
Cost of Revenues
Cost of natural gas and NGLs decreased by $8.2 million to $9.8 million for the six months ended June 30, 2015, as compared to $18.0 million for the six months ended June 30, 2014. This decrease was primarily attributed to: (i) the Azure System Predecessor, which recognized cost of $5.2 million for the six months ended June 30, 2015 compared to $13.8 million for the six months ended June 30, 2014; and (ii) the ETG System which recognized cost of $1.8 million for the six months ended June 30, 2015 compared to $4.2 million for the six months ended June 30, 2014. This decrease was a result of lower commodity prices and volumes purchased period over period, and the decrease directly correlates to the decrease in natural gas, NGLs and condensate revenue for the period. The decrease in cost of natural gas and NGLs attributed to the Azure System Predecessor was partially offset by an increase of $2.8 million attributable to the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date.
Operation and Maintenance Expense
Operation and maintenance expense increased by $2.7 million to $10.4 million for the six months ended June 30, 2015, as compared to $7.8 million for the six months ended June 30, 2014. The increase in operations and maintenance expense was a result of: (i) $3.8 million increase in operations and maintenance expense attributed to the Partnership's historical midstream assets, which are included within the condensed results of operations subsequent to the Transactions Date; and (ii) $0.3 million increase in operations and maintenance expense attributed to the ETG System period over period. The increase was offset by a decrease of $1.5 million in the Azure System Predecessor's operations and maintenance expense period over period. These increases in operation and maintenance expense were a result of lower compression rental, treating chemical usage, utilities usage, asset integrity management and repairs and maintenance expenses.
General and Administrative Expense
General and administrative expense increased by $4.3 million to $7.2 million for the six months ended June 30, 2015, as compared to $3.0 million for the six months ended June 30, 2014. This increase was primarily the result of: (i) $5.0 million increase attributed to the Partnership's historical midstream assets, which are included within the condensed results of operations subsequent to the Transactions Date; and (ii) $0.2 million increase attributed to the ETG System. This increase was partially offset by by a decrease of $0.9 million in the Azure System Predecessor's general and administrative expense period over period.
Depreciation and Amortization Expense
Depreciation and amortization expense increased $5.2 million to $9.1 million for the six months ended June 30, 2015, as compared to $3.9 million for the six months ended June 30, 2014. This increase was primarily a result of a $4.9 million increase attributed to the Partnership's historical midstream assets, which were adjusted to fair value in connection with the business combination and are included within the condensed results of operations subsequent to the Transactions Date. The remaining increase of $0.2 million was attributable to the Azure System Predecessor.
Interest Expense
Interest expense decreased by $0.8 million to $6.7 million for the six months ended June 30, 2015, as compared to $7.5 million for the six months ended June 30, 2014. This decrease was primarily a result of lower interest expense allocated to the Azure System Predecessor of $3.7 million period over period related to the Azure credit agreement. This decrease in interest expense was partially offset by $2.7 million increase in interest expense attributed to the Partnership and the Credit Agreement, which are included within the condensed results of operations subsequent to the Transactions Date and a $0.1 million increase in the allocation of interest expense attributed to the ETG System and the Azure credit agreement.
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LIQUIDITY AND CAPITAL RESOURCES
We closely manage our liquidity and capital resources. The key variables we use to manage our liquidity requirements include our discretionary operation and maintenance expense, general and administrative expense, capital expenditures, Credit Agreement capacity and availability, working capital levels, and the level of investments required to support our growth strategies.
We expect ongoing sources of liquidity to include cash generated from operations, our Credit Agreement and additional issuances of debt and equity securities. We believe that cash generated from these sources will be sufficient to sustain operations, to finance anticipated expansion plans and growth initiatives, and to make quarterly cash distributions on all of our outstanding units at our minimum quarterly distribution rate. However, in the event our liquidity is insufficient, we may be required to limit our spending on future growth plans or other business opportunities or to rely on external financing sources, including the issuance of additional debt and equity securities, to fund our growth.
Distributions
For the quarter ended June 30, 2015, we intend to pay a minimum quarterly distribution of $0.37 per unit, which equates to $8.2 million, or approximately $32.8 million on an annualized basis. However, other than the requirement in our partnership agreement to distribute all of our available cash each quarter, we have no obligation to make quarterly cash distributions in this or any other amounts, and our general partner has considerable discretion to determine the amount of our available cash each quarter.
Credit Agreement
On February 27, 2015, we entered into the Credit Agreement whereby the lenders agreed to extend to us a senior secured revolving credit facility of up to $250.0 million. We immediately borrowed $180.8 million under the Credit Agreement, of which $162.5 million was used in connection with the Transactions and $15.0 million was used for the repayment and termination of our then-existing credit facility. Future drawings will be used for working capital, permitted acquisitions and capital expenditure, and other general corporate purposes. The maturity date of the Credit Agreement is February 27, 2018. We had outstanding borrowings under the Credit Agreement of $143.0 million as of June 30, 2015.
On August 6, 2015, in connection with the Contribution Agreement, we borrowed $80.0 million under the Credit Agreement as consideration for the membership interest of ETG.
The Credit Agreement requires that (a) all domestic restricted subsidiaries guarantee our obligations and the obligations of the subsidiary guarantors under: (i) the Credit Agreement and other loan documents; and (ii) certain hedging agreements and cash management agreements with lenders and affiliates of lenders; and (b) all such obligations be secured by a security interest in substantially all of our assets and the assets of our subsidiary guarantors, in each case, subject to certain customary exceptions.
Borrowings under the Credit Agreement bear interest at (a) the LIBOR Rate (as defined in the Credit Agreement) plus an applicable margin of 2.75% to 3.75% or (b) the Base Rate (as defined in the Credit Agreement) plus an applicable margin of 1.75% to 2.75%, in each case, based on the Consolidated Total Leverage Ratio (as defined in the Credit Agreement).
All of the Partnership's domestic restricted subsidiaries guarantee our obligations under the Credit Agreement, and all such obligations are secured by a security interest in substantially all of our assets, in each case, subject to certain customary exceptions. The Credit Agreement contains affirmative and negative covenants customary for credit facilities of its size and nature that, among other things, limit or restrict our ability and the ability of our subsidiaries to: (a) incur additional debt; (b) grant certain liens; (c) make certain investments; (d) engage in certain mergers or consolidations; (e) dispose of certain assets; (f) enter into certain types of transactions with affiliates; and (g) make distributions, with certain exceptions, including the distribution of Available Cash (as defined in the partnership agreement) if no default or event of default exists. As of June 30, 2015, we were in compliance with all of our covenants associated with the Credit Agreement.
Azure System and the Azure System Predecessor Credit Agreements
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (the "TLB") maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (the "Revolver" and collectively with the TLB, the "Azure Credit Agreement") with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement are unconditionally guaranteed, jointly and severally, by all of the Azure subsidiaries and are collateralized by first priority liens
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on substantially all of existing and subsequently acquired assets and equity. The Azure Credit Agreement served as the sole borrowing agreement applicable for the Azure System and the Azure System Predecessor during the periods presented. In addition, substantially all of Azure's subsidiaries, including the Azure System and the Azure System Predecessor, served as guarantors and pledger's with respect to the Azure Credit Agreement.
Public Offering of Partnership Common Units
On June 17, 2015, we and the General Partner entered into the Underwriting Agreement related to the Offering. The Offering closed on June 22, 2015. The Partnership received net proceeds from the sale of the common units sold in the Offering of approximately $48.3 million including the proportionate capital contribution by the General Partner to maintain its 1.97% general partner interest and after deducting the underwriting discount and estimated offering expenses payable by the Partnership.
On July 17, 2015, underwriters exercised their option to purchase an additional 90,000 common units related to the Partnership's completed Offering. Total net proceeds from the sale of these additional common units, including the General Partner's proportionate capital contribution, and after deducting underwriting discounts and commissions and estimated offering expenses, was approximately $1.2 million.
Capital Requirements
The midstream business is capital intensive and can require significant investment to maintain and upgrade existing operations, connect new wells to the system, organically grow into new areas and comply with environmental and safety regulations. Our capital requirements include maintenance capital expenditures and expansion capital expenditures. The Azure System Predecessor did not historically designate between maintenance capital expenditures and expansion capital expenditures, and therefore historical maintenance capital expenditures and expansion capital expenditures information has not been provided.
Based on current market conditions, we expect to be able to fund our activities for 2015 with cash flows generated from our operations, available cash on hand and borrowings under our Credit Agreement as well as accessing the capital markets for debt and equity capital. Our ability to pay distributions to our unitholders, and to fund planned capital expenditures and to make acquisitions will depend upon our future operating performance, which will be affected by prevailing economic conditions in the industry and financial, business and other factors, some of which are beyond our control.
CASH FLOWS
Net cash flows provided by (used in) operating activities, investing activities and financing activities for the six months ended June 30, 2015 and 2014 were as follows:
In thousands | Six Months Ended June 30, | ||||||||||
2015 | 2014 | Change | |||||||||
Net cash provided by (used in): (1) | |||||||||||
Operating activities | $ | (991 | ) | $ | 6,507 | $ | (7,498 | ) | |||
Investing activities | $ | 117,255 | $ | (5,673 | ) | $ | 122,928 | ||||
Financing activities | $ | (111,085 | ) | $ | (834 | ) | $ | (110,251 | ) | ||
(1) On August 6, 2015, the the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have recast the financial results of the Partnership to include the financial results of the ETG System for the periods represented above. | |||||||||||
Operating Activities. Cash flows used in operations for the six months ended June 30, 2015 were $1.0 million compared to cash flows provided by operations of $6.5 million for the six months ended June 30, 2014. The change in cash flows from operations was primarily due to: a net use of cash of $14.4 million period over period from changes in operating assets and liabilities from the Partnership's historical midstream assets, which are included within the consolidated results of operations subsequent to the Transactions Date; (ii) net loss of $5.4 million recognized during the six months ended June 30, 2015 compared to a net loss of $4.1 million in the six months ended June 30, 2014; partially offset by (iii) higher depreciation and amortization expense of $5.2 million period over period primarily related to the Partnership's historical midstream assets, which were adjusted to fair value in connection with the business combination and are included within the consolidated results of operations subsequent to the Transactions Date; (iv) net source of cash of $2.5 million period over period from changes in operating assets and liabilities from ETG; and (iii) higher deferred income tax liability of $0.4 million.
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Investing Activities. Cash flows provided by investing activities were $117.3 million for the six months ended June 30, 2015 compared to cash flows used in investing activities of $5.7 million for the six months ended June 30, 2014. The cash flows provided by investing activities for the six months ended June 30, 2015 were primarily associated with the $117.3 million in cash acquired in the business combination, which represents the net cash held by the Partnership immediately prior to the business combination. The net cash balance held by the Partnership immediately prior to the business combination was assumed to be the $180.8 million in cash borrowed under the Credit Agreement less the $63.0 million paid in connection with the redemption of 90 IDR Units from NuDevco. In addition, lower capital expenditures period over period of $1.0 million incurred by the Azure System Predecessor and $2.7 million incurred by ETG contributed to the net cash provided by investing activities.
Financing Activities. Cash flows used in financing activities were $111.1 million for the six months ended June 30, 2015 compared to cash flows used in financing activities of $0.8 million for the six months ended June 30, 2014. The cash flows used in financing activities for the six months ended June 30, 2015 were primarily associated with: (i) $99.5 million in cash distribution related to the Transactions; (ii) $47.3 million repayment of long-term debt on our Credit Agreement from proceeds from the Offering; (iii) $15.0 million repayment of long-term debt under the Partnership's previous credit facility in connection with the Transactions; (iv) $6.8 million quarterly distribution to unitholders; (v) $3.7 million of allocated repayments of long-term debt under the Azure Credit Agreement related to ETG; (vi) $0.3 million payment of deferred financing costs related to the Credit Agreement; partially offset by (vii) $48.3 million proceeds from the Offering; (viii) $9.5 million of borrowings under our Credit Agreement; and (ix) $2.8 million in predecessor parent company net investment for the period January 1, 2015 to February 28, 2015 and $0.9 million in parent company net investment related to ETG. The cash flows used in financing activities for the six months ended June 30, 2014 were primarily associated with $5.1 million in allocated repayments of long-term debt under the Azure Credit Agreement, partially offset by $4.3 million in predecessor parent company net investment.
OFF-BALANCE SHEET ARRANGEMENTS
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a significant current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
CONTRACTUAL OBLIGATIONS
A summary of our contractual obligations as of June 30, 2015 is as follows:
In thousands | 2015 | 2016 | 2017 | 2018 | 2019 | Thereafter | Total | ||||||||||||||||||||
Contractual Obligations(1): | |||||||||||||||||||||||||||
Operating lease agreements (2) | $ | 1,588 | $ | 1,636 | $ | 374 | $ | 274 | $ | 274 | $ | 1,330 | $ | 5,476 | |||||||||||||
Long-term debt (3) | 4,235 | 8,400 | 8,400 | 198,965 | — | — | 220,000 | ||||||||||||||||||||
Total (3) | $ | 5,823 | $ | 10,036 | $ | 8,774 | $ | 199,239 | $ | 274 | $ | 1,330 | $ | 225,476 | |||||||||||||
(1) On August 6, 2015, the the ETG System was contributed to the Partnership. This transaction was determined to be a transaction between entities under common control for financial reporting purposes. Accordingly, we have included the contractual obligations related to the ETG System as of June 30, 2015. | |||||||||||||||||||||||||||
(2) The contractual obligations associated with operating lease agreements relate to various midstream property and equipment operating leases that are used in our gathering, processing and transloading operations and have terms of greater than one year. | |||||||||||||||||||||||||||
(3) The contractual obligations associated with long-term debt and interest expense relate to obligations under our Credit Agreement and amounts allocated to ETG under the Azure Credit Agreement. The Credit Agreement has a maturity date of February 27, 2018, and we have estimated the outstanding borrowings as of June 30, 2015 will be paid at maturity. We have estimated a weighted average interest rate of 3.50% in determining the future interest obligations associated with the Credit Agreement. The Azure Credit Agreement has a maturity date of November 15, 2018, and we have estimated the outstanding borrowings as of June 30, 2015 will be paid at maturity. We have estimated a weighted average interest rate of 6.50% in determining the future interest obligations associated with the Azure Credit Agreement | |||||||||||||||||||||||||||
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
We have updated our critical accounting policies described in our annual report on Form 10-K as a result of the Transactions described above and the resulting accounting and financial reporting effects. The following serves to update our critical accounting policies.
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Intangible Assets
Intangible assets consist of the Partnership's existing customer relationships, and were identified as part of the purchase price allocation to the Partnership's assets acquired by the Azure System Predecessor. The customer relationship intangible assets are amortized on a straight-line basis over the expected period of benefits of the customer relationship, which we have concluded is a ten year period.
Goodwill
Goodwill represents consideration paid in excess of the fair value of the identifiable assets acquired in a business combination. We evaluate goodwill for impairment on an annual basis, and whenever events or changes indicate that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Goodwill is tested for impairment using a two-step quantitative test. The first step compares the fair value of the reporting unit to its carrying value, including goodwill. If the fair value of the reporting unit exceeds the carrying amount, the goodwill is not considered impaired. If the fair value of the reporting unit does not exceed the carrying amount of the reporting unit, the second step compares the implied fair value of goodwill to the carrying value of goodwill. If the carrying amount of goodwill exceeds the implied fair value of that goodwill, the excess of the carrying value over the implied value is recognized as an impairment in the statement of operations.
Our Revenue Recognition Policies and Use of Estimates for Revenues and Expenses
In general, we recognize revenue from customers when all of the following criteria are met: persuasive evidence of an exchange arrangement exists; delivery has occurred or services have been rendered; the price is fixed or determinable; and collectability is reasonably assured.
We record revenue for natural gas and NGL sales and transportation services over the period in which they are earned (i.e., either physical delivery of product has taken place or the services designated in the contract have been performed). While we make every effort to record actual volume and price data, there may be times where we need to make use of estimates for certain revenues and expenses. If the assumptions underlying our estimates prove to be substantially incorrect, it could result in material adjustments in results of operations in future periods.
Depreciation Methods and Estimated Useful Lives of Property, Plant and Equipment
We calculate depreciation expense using the straight-line method over the estimated useful lives of our property, plant and equipment. We assign asset lives based on reasonable estimates when an asset is placed into service. We periodically evaluate the estimated useful lives of our property, plant and equipment and revise our estimates when and as appropriate. Because of the expected long useful lives of the property, plant and equipment, we depreciate our property, plant and equipment over periods ranging from 5 years to 45 years. Changes in the estimated useful lives of the property, plant and equipment could have a material adverse effect on our results of operations.
Impairment of Long-Lived Assets
We review property, plant and equipment and other long-lived assets for impairment whenever events or changes in business circumstances indicate the net book values of the assets may not be recoverable. Impairment is indicated when the undiscounted cash flows estimated to be generated by those assets are less than the assets’ net book value. If this occurs, an impairment loss is recognized for the difference between the fair value and net book value. Factors that indicate potential impairment include: a significant decrease in the market value of the asset, operating or cash flow losses associated with the use of the asset, and a significant change in the asset’s physical condition or use. No impairments of long-lived assets were recorded during the periods included in these financial statements.
Accounting for Awards under the Long-term Incentive Plan
In connection with the Partnership's IPO, in July 2013, the board of directors of the general partner adopted the Marlin Midstream Partners, LP 2013 Long-Term Incentive Plan (LTIP). Individuals who are eligible to receive awards under the LTIP include: (i) our employees and the employees of NuDevco Midstream Development and its affiliates; (ii) directors of the Partnership’s general partner; and (iii) consultants. The LTIP provides for the grant of unit options, unit appreciation awards, restricted units, phantom units, distribution equivalent rights, unit awards, profits interest units, and other unit-based awards. The maximum number of common units issuable under the LTIP is 1,750,000.
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All of the phantom unit awards granted to-date are considered non-employee equity based awards and are required to be remeasured at fair market value at each reporting period and amortized to compensation expense on a straight-line basis over the vesting period of the phantom units with a corresponding increase in a liability. We intend to settle the awards by allowing the recipient to choose between issuing the net amount of common units due, less common units equivalent to pay withholding taxes, due upon vesting with the Partnership paying the amount of withholding taxes due in cash or issuing the gross amount of common units due with the recipient paying the withholding taxes. The phantom unit awards were awarded to individuals who are not deemed to be employees of the Partnership.
Distribution equivalent rights are accrued for each phantom unit award as the Partnership declares cash distributions and are recorded as a decrease in partners’ capital with a corresponding liability in accordance with the vesting period of the underlying phantom unit, which will be settled in cash when the underlying phantom units vest.
As a result of the Transactions, the awards previously issued under the LTIP immediately vested due to the change in control of our general partner. Azure, as general partner, plans to continue to operate under the LTIP in the future. However, there were no awards issued under the LTIP in connection with or immediately following the closing of the Transactions, and Azure, as general partner, has the ability to determine the terms and conditions of the awards issued under the LTIP, which may differ from those previously issued.
Subsequent to the closing of the Transactions, we awarded phantom units under the LTIP to certain named executive officers and employees of the General Partner. Each phantom unit is the economic equivalent of one common unit of the Partnership and entitles the grantee to receive one common unit or an amount of cash equal to the fair market value of a common unit upon the vesting of the phantom unit. The phantom units shall vest in three equal annual installments with the first installment vesting on July 1, 2016. In addition, we awarded common units under the LTIP to an employee of the General Partner, which vested immediately upon issuance.
Item 3. Quantitative and Qualitative Disclosure about Market Risk
Interest Rate Risk
We have exposure to changes in interest rates under our new Credit Agreement. The credit markets continues to produce an environment of low interest rates. It is possible that monetary policy will tighten, resulting in higher interest rates to counter possible inflation. Interest rates on our Credit Agreement, which is under floating interest rates, and future debt offerings could be higher than current levels, causing our financing costs to increase accordingly. For the six months ended June 30, 2015, a 1% change in the interest rate under our Credit Agreement would have resulted in a $0.7 million change in interest expense.
Commodity Price Risk
Substantially all of our revenues and the related cost of natural gas, NGLs and condensate revenues will be generated under fee-based commercial agreements, the substantial majority of which will have minimum volume commitments. We believe these commercial arrangements will promote stable cash flows and minimal direct commodity price exposure. Accordingly, we have not entered into any derivative contracts to manage our exposure to commodity price risk, and, as a result of our limited exposure to commodity price risk under our fee-based commercial agreements, we do not plan to enter into hedging arrangements to manage such risk. Natural gas and NGL prices can affect our profitability indirectly by influencing the level of drilling and production activity by our producer customers, the willingness of our non-producer customers to purchase natural gas for processing and the volumes of natural gas delivered to us for processing by all of our customers.
Counterparty and Customer Credit Risk
For the six months ended June 30, 2015, the Azure System Predecessor and the Partnership had three customers that each accounted for more than 10% of our revenues. For the six months ended June 30, 2015, AES accounted for 30.8%, Anadarko Petroleum Company accounted for 15.0% and BP accounted for 14.7% of our revenues.
Our three-year fee-based gathering and processing agreement with AES at our Panola County processing facilities expires in July 2016. Under this agreement, AES pays us a fixed fee per Mcf (subject to an annual inflation adjustment) for gathering, treating, compression and processing services and a per gallon fixed fee for NGL transportation services. As this contract expires, we will have to renegotiate extensions or renewals with AES or replace the existing contract with new arrangements with other customers.
If any of the customers that account for more than 10% of our revenues were to default on their contract or if we were unable to renew a contract with them on favorable terms, we may not be able to replace such customers in a timely fashion, on
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favorable terms or at all. In any of these situations, our revenues and cash flows and our ability to make cash distributions to our unitholders would be materially and adversely affected.
In addition, AES is our sole customer with respect to our logistics business segment, and we continue to derive the substantial majority of our transloading revenues from AES. AES is contracted for 100% of the operational capacity at our Wildcat, Big Horn and East New Mexico facilities. Such concentration subjects us to increased risk in the case of nonpayment, nonperformance or nonrenewal by AES under the transloading services agreements that we entered into with AES. Any adverse developments concerning AES could materially and adversely affect our logistics business. In connection with the Transactions, we entered into amendments to these transloading services agreements with AES and extended the terms of the service agreements until February 27, 2020, or an additional five years from the date of the amendment. Additionally, as part of the Transactions, AES pledged $15.0 million as collateral in support of a letter of credit facility on behalf of the logistics business segment. We have the ability to access the letter of credit in the event of nonpayment or nonperformance by AES.
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Exhibit 99.4
AZURE ETG SYSTEM
Financial Statements
December 31, 2014 and the period from November 15, 2013 to December 31, 2013
(With Independent Auditors’ Report Thereon)
1
Independent Auditors’ Report
The Board of Directors
Azure Midstream Holdings LLC:
We have audited the accompanying financial statements of the Azure ETG System, which comprise the balance sheets as of December 31, 2014 and 2013, and the related statements of operations, parent company net investment, and cash flows for the year ended December 31, 2014, and the period from November 15, 2013 to December 31, 2013, and the related notes to the consolidated financial statements.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standard generally accepted in the United States of America. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Azure ETG System as of December 31, 2014 and 2013 and the results of its operations and its cash flows for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, in conformity with U.S. generally accepted accounting principles.
(signed) KPMG LLP
Dallas, Texas
October 5, 2015
2
Azure ETG System
Balance Sheets
As of December 31, 2014 and 2013
(In Thousands)
December 31, 2014 | December 31, 2013 | |||||
Current Assets: | ||||||
Cash and cash equivalents | $ | — | $ | — | ||
Trade accounts receivable | 1,738 | 4,218 | ||||
Trade accounts receivable - affiliates | — | 397 | ||||
Other current assets | 418 | 344 | ||||
Total current assets | 2,156 | 4,959 | ||||
Property, plant and equipment, net | 88,539 | 89,808 | ||||
Other non-current assets | 1,771 | 2,294 | ||||
Total Assets | $ | 92,466 | $ | 97,061 | ||
Current Liabilities: | ||||||
Accounts payable and accrued liabilities | $ | 563 | $ | 5,000 | ||
Current portion of long-term debt associated with the Azure Credit | ||||||
Agreement | 3,002 | 3,002 | ||||
Total current liabilities | 3,565 | 8,002 | ||||
Long-term debt associated with the Azure Credit Agreement | 54,040 | 57,042 | ||||
Other long-term liabilities | 5,351 | 1,068 | ||||
Total liabilities | 62,956 | 66,112 | ||||
Parent company net investment | 29,510 | 30,949 | ||||
Total liabilities and parent company net investment | $ | 92,466 | $ | 97,061 | ||
See accompanying notes to the financial statements.
3
Azure ETG System
Statement of Operations
For the year ended December 31, 2014 and for the period from November 15, 2013 to December 31, 2013
(In Thousands)
Year ended December 31, 2014 | Period From November 15, 2013 to December 31, 2013 | |||||
Operating Revenues: | ||||||
Natural gas and NGL sales | $ | 4,630 | $ | 791 | ||
Natural gas and NGL sales - affiliates | 4,000 | 806 | ||||
Gathering services and other fees | 8,953 | 1,457 | ||||
Gathering services and other fees - affiliates | 31 | — | ||||
Total operating revenues | 17,614 | 3,054 | ||||
Operating expenses: | ||||||
Cost of purchased gas and NGL's sold | 7,400 | 1,578 | ||||
Operating expense | 6,854 | 1,125 | ||||
General and administrative | 1,368 | 46 | ||||
Depreciation and amortization | 2,607 | 301 | ||||
Total expenses | 18,229 | 3,050 | ||||
Income (loss) from operations | (615 | ) | 4 | |||
Interest expense | 4,501 | 551 | ||||
Other expense | 464 | — | ||||
Net loss before income taxes | (5,580 | ) | (547 | ) | ||
Income tax expense | 50 | 9 | ||||
Net loss | $ | (5,630 | ) | $ | (556 | ) |
See accompanying notes to the financial statements.
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Azure ETG System
Statement of Cash Flows
For the year ended December 31, 2014 and for the period from November 15, 2013 to December 31, 2013
(In Thousands)
Year ended December 31, 2014 | Period From November 15, 2013 to December 31, 2013 | |||||
Operating activities: | ||||||
Net loss | $ | (5,630 | ) | $ | (556 | ) |
Adjustments to reconcile net loss to net cash provided by (used in) | ||||||
operating activities: | ||||||
Depreciation and amortization | 2,607 | 301 | ||||
Amortization of deferred financing costs | 523 | 60 | ||||
Changes in operating assets and liabilities: | ||||||
Accounts receivable, net | 2,876 | (1,551 | ) | |||
Other current assets | (73 | ) | (15 | ) | ||
Accounts payable and other current liabilities | (2,780 | ) | 1,541 | |||
Other long-term liabilities | 4,282 | — | ||||
Net cash provided by (used in) operating activities | 1,805 | (220 | ) | |||
Investing activities: | ||||||
Cash received in Acquisition | — | 1,460 | ||||
Capital expenditures | (2,994 | ) | (435 | ) | ||
Net cash provided by (used in) investing activities | (2,994 | ) | 1,025 | |||
Financing activities: | ||||||
Borrowings under Azure Credit Agreement | — | 60,044 | ||||
Repayments under Azure Credit Agreement | (3,002 | ) | — | |||
Payment of deferred financing costs | — | (2,354 | ) | |||
Parent company net investment | 4,191 | (58,495 | ) | |||
Net cash provided by (used in) financing activities | 1,189 | (805 | ) | |||
Increase (decrease) in cash and cash equivalents | — | — | ||||
Cash and cash equivalents - beginning of period | — | — | ||||
Cash and cash equivalents - end of period | $ | — | $ | — | ||
See accompanying notes to the financial statements.
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Azure ETG System
Statements of Parent Company Net Investment
For the year ended December 31, 2014 and for the period from November 15, 2013 to December 31, 2013
(In Thousands)
Initial investment from parent company | $ | 32,310 | |
Net loss for the period | (556 | ) | |
Net distribution from parent for the period | (805 | ) | |
Ending parent company net investment - December 31, 2013 | 30,949 | ||
Net loss for the period | (5,630 | ) | |
Net contribution from the parent for the period | 4,191 | ||
Ending parent company net investment - December 31, 2014 | $ | 29,510 | |
See accompanying notes to the financial statements.
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(1) | Organization and Nature of the Business |
Azure ETG System
The Azure ETG System Carve‑out Financial Statements (the “ETG System Carve‑out Financial Statements”) present the historical carve‑out financial position, results of operations, change in parent company net investment and cash flows of Azure ETG, LLC and certain related assets and liabilities of Azure Midstream Holdings, LLC (“Azure Holdings”), (the “ETG System” or “Company”) as of December 31, 2014 and 2013, for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013. The ETG System Carve‑out Financial Statements have been derived from the accounting records of Azure Holdings, defined further below, on a carve‑out basis.
On November 15, 2013, TPF II East Texas Gathering, LLC (“ETG”), a business managed by Tenaska Capital Management, LLC (“Tenaska Capital Management”), was contributed to Azure Holdings in exchange for an interest in Azure Holdings valued at $90 million (the “ETG Contribution”). The acquisition of the ETG Contribution is referred to as the (“Acquisition”).
Subsequent to the Acquisition, ETG has been indirectly owned and operated by Azure Holdings through its wholly owned subsidiary, Azure Midstream Energy, LLC (“Azure”).
Nature of Business
The ETG System is comprised of midstream assets primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby counties in East Texas and currently serves multiple formations, including the Haynesville, Bossier and the liquids-rich James Lime formation. These midstream assets currently serve the Deep Bossier formation, Cotton Valley formation, and the Haynesville shale. As of December 31, 2014, the ETG System consisted of approximately 255 miles of high-pressure pipeline. Approximately 98% of the natural gas transported on this system requires treating for carbon dioxide (“CO2”), which we treat for an additional fee. As of December 31, 2014, the system included five amine treating plants with combined capacity of 780 MMcf/d and access to four major interconnect access points that offer our customers superior deliverability. The system also includes our new Fairway processing plant with a processing capacity of 10 MMcf/d, which is designed to extract natural gas liquid (“NGL”) content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Basis of Presentation
The operating results and the majority of the assets and liabilities of the ETG System have been specifically identified based on the existing divisional organization of Azure Holdings. Certain assets, liabilities and expenses presented in the balance sheets and statements of operations represent allocations and estimates of the costs of services incurred by Azure Holdings. These allocations and estimates were based on methodologies that management believes to be reasonable, and include items such as outstanding debt and related expenses associated with the Azure Credit Agreement (See Note 6) and general and administrative expenses incurred by Azure Holdings on behalf of the ETG System. See the accompanying notes for discussions of the specific allocation methodology applied to debt and related charges and others. Revenues have been identified by contracts that are specifically identifiable to the ETG System. Depreciation and amortization are based upon assets specifically identified to the ETG System. Salaries, benefits and other general and administrative costs have been allocated to the ETG System based on management’s use of a reasonable allocation methodology as such costs were historically not allocated to the ETG System.
Azure Holding’s direct investment in the ETG System is presented as parent company net investment in the ETG System Carve‑out Financial Statements and includes the accumulated net earnings and accumulated net contributions from Azure Holdings, including allocated long‑term debt, interest expense and general and administrative expenses.
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The ETG System Carve‑out Financial Statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These principles are established by the Financial Accounting Standards Board. The preparation of the ETG System Carve‑out Financial Statements in accordance with GAAP requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities for the periods presented herein. The ETG System Carve‑out Financial Statements reflect the application of purchase accounting related to the acquisition of the ETG System, effective as of November 15, 2013.
(2) | Summary of Significant Accounting Policies |
Use of Estimates
The ETG System Carve‑out Financial Statements have been prepared in conformity with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates, the reported amounts of revenue and expense, including fair value measurements, and disclosure of contingencies. Although management believes these estimates are reasonable, actual results could differ from its estimates.
Cash and Cash Equivalents
The ETG System utilizes Azure Holdings’ centralized processes and systems for cash management, payroll, purchasing and expenditures. As a result, cash generated by and cash received by the ETG System were deposited in and commingled with the general corporate funds of the respective period’s owner and is or was not specifically allocated to the ETG System. The net results of these cash transactions between the ETG System and the respective period’s owner are reflected in parent company net investment in the carved‑out balance sheets. Changes in long‑term debt associated with the Azure Credit Agreement is assumed as cash borrowings or repayments in the statements of cash flows.
Trade Accounts Receivable
Trade accounts receivables are specifically identified based on contracts assigned by Azure Holdings to the ETG System and primarily represent receivables for gathering, processing, compression, treating and other services provided to natural gas producers as well as natural gas and NGL sales receivable from third parties.
Allowance for Doubtful Accounts
In evaluating the collectability of accounts receivable, management performs ongoing credit evaluations of the ETG System’s customers and adjusts payment terms based upon payment history and each customer’s current creditworthiness, as determined by management’s review of such customer’s credit information, detailed analysis of the expected collectability of accounts receivable that are past due and the expected collectability of overall receivables. The ETG System did not have an allowance for doubtful accounts as of December 31, 2014 and 2013.
Concentration of Credit Risk
Financial instruments that potentially subject the ETG System to concentrations of credit risk are primarily trade accounts receivables. The ETG System performs ongoing credit evaluations of its customers’ financial condition. Declines in oil and gas prices have resulted in reductions in capital expenditure budgets of oil and gas exploration and development companies and could impact the financial condition of the ETG System’s customers.
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Property, Plant and Equipment, Net
Property, plant and equipment is specifically identified based on authorization for expenditures for the ETG System and is recorded at its original cost of construction or, upon acquisition, at fair value of the assets acquired. Expenditures for maintenance and repairs that do not add capacity or extend the useful life of an asset are expensed as incurred. Expenditures to extend the useful lives of the assets or enhance their productivity or efficiency from their original design are capitalized over the expected remaining period of use. The carrying value of the assets is based on estimates, assumptions and judgments relative to useful lives and salvage values. Sales or retirements of assets, along with the related accumulated depreciation, are removed from the accounts and any gain or loss on disposition is included in the statement of operations. The ETG System gas gathering asset capital expenditures for the periods presented have been reduced by amounts reimbursed by producers for well connection costs.
Depreciation of property, plant, and equipment is recorded on a straight‑line basis over the estimated useful lives of the assets. These estimates are based on various factors including age (in the case of acquired assets), manufacturing specifications, technological advances and historical data concerning the useful lives of similar assets. In connection with the Acquisition, purchase accounting was applied to the ETG System assets acquired and liabilities assumed and an appropriate estimate for the useful lives of the assets acquired was determined.
Impairment of Long-Lived Assets
Relevant accounting guidance requires long lived assets to be reviewed whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In order to determine whether an impairment has occurred, we compare the net book value of the asset to the estimated undiscounted future net cash flows related to the asset. Our estimate of undiscounted cash flows is based on assumptions regarding the purchase and resale margins on natural gas, volume of gas available to the asset, markets available to the asset, operating expenses, and prices of NGLs. The amount of availability of natural gas to an asset is sometimes based on assumptions regarding a producer’s future drilling activity, which may be dependent in part on natural gas prices. Projections of gas volumes and future commodity prices are inherently subjective and contingent upon a number of variable factors. Any significant variance in any of the above assumptions or factors could materially affect our cash flows, which could require us to record an impairment of an asset.
If an impairment has occurred, the amount of the impairment is determined based on the expected future net cash flows discounted using a rate management believes a market participant would assume is reflective of the risk associated with achieving the underlying cash flows.
Deferred Financing Costs
Deferred financing costs are capitalized and amortized as interest expense under the effective interest method over the term of the related debt. The unamortized balance of deferred financing costs is included in other assets on the balance sheets. All deferred financing costs have been allocated from Azure and are associated with the Azure Credit Agreement.
Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities primarily represents open invoices as of period end that are specifically identified for the ETG System based on authorization for expenditures using the same information as for property, plant and equipment. Accrued liabilities are allocated to the ETG System based on historical analysis of invoices by authorization for expenditures in the period of services rendered.
Fair Value of Financial Instruments
Accounting guidance requires the disclosure of the fair value of all financial instruments that are not otherwise recorded at fair value in the financial statements. As of December 31, 2014 and 2013, financial
9
instruments recorded at contractual amounts that approximate fair value include accounts receivable, accounts payable and accrued expenses. The fair values of such items are not materially sensitive to shifts in market interest rates because of the short term to maturity of these instruments. The fair value of the debt funded through the Azure Credit Agreement allocated to the ETG System approximates its carrying amount as of December 31, 2014 and 2013 primarily due to the variable nature of the interest rate of the instrument. The fair value of the debt is considered a Level 2 fair value measurement.
Asset Retirement Obligations
Accounting standards related to asset retirement obligations require us to evaluate whether any future asset retirement obligations exist as of December 31, 2014 and 2013, and whether the expected retirement date of the related costs of retirement can be estimated. We have concluded that the ETG System natural gas gathering and processing assets, which include pipelines, compression facilities and treating facilities, have an indeterminate life because they are owned and will operate for an indeterminate future period when properly maintained. A liability for these asset retirement obligations will be recorded only if and when a future retirement obligation with a determinable life is identified. The ETG System Carve‑out Financial Statements did not provide any asset retirement obligations as of December 31, 2014 or 2013 because management of the ETG System did not have sufficient information to reasonably estimate such obligations, and had no intention of discontinuing use of any significant assets.
Gas Imbalances
Quantities of natural gas over delivered or under delivered related to imbalance agreements are recorded monthly as accounts receivable or accounts payable using an estimated price based on current market prices, an index to current market prices or the weighted average prices of natural gas at the plant or system pursuant to imbalance agreements for which settlement prices have yet to be finalized. Dependent on imbalance contract terms within certain volumetric limits, imbalances may be settled by deliveries of natural gas.
Revenue Recognition
Primary revenue producing activities are the sales of natural gas and NGLs purchased from third parties, for which the ETG System takes title. Natural gas revenues arise from transactions that are completed under contracts with limited commodity price exposure, and we elect the normal purchases and normal sales exemption on all such transactions for accounting purposes. The ETG System receives a market price per barrel on our revenue from natural gas condensate liquids. Natural gas and condensate revenues and the associated purchases and expenses are reported on a gross basis within our statement of operations. The cost of natural gas purchased from third parties is reported as a component of operating costs and expenses.
Secondarily, the ETG System earns gathering services and other fee revenues from the transportation, gathering, processing, and treating of natural gas. These gathering services and other fees are generally provided on a fixed fee basis per unit based on the volumes (Mcf) or heating content (MMbtu) of natural gas.
Revenue from all services and activities is recognized when all of the following criteria are met: (i) persuasive evidence of an exchange arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) collectability is reasonably assured.
The ETG System has a natural gas gathering agreement with a customer that provides for a minimum revenue commitment (“MRC”). Under the MRC, the customer agrees to pay a minimum monetary amount over certain periods during the term of the MRC. The customer must make a deficiency payment to us at the end of the contract year if its actual revenues are less than its MRC for that year. The customer is entitled to utilize the deficiency payments to offset gathering fees in the following periods to the extent that such customer’s revenues in the following periods exceed its MRC for that period. This contract provision ranges for the entire duration of the gas gathering agreement, which is ten years. We record customer billings for obligations under the
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MRC (solely with respect to this natural gas gathering agreement) as deferred revenue when the customer has the right to utilize deficiency payments to offset gathering fees in subsequent periods. We recognize deferred revenue under this arrangement as revenue once all contingencies or potential performance obligations associated with the related revenues have either (i) been satisfied through the gathering of future excess volumes of natural gas, or (ii) expired (or lapsed) through the passage of time pursuant to the terms of the natural gas gathering agreement. We classify deferred revenue as noncurrent where the expiration of the customer’s right to utilize deficiency payments is greater than one year. As of December 31, 2014 and 2013, deferred revenue under the MRC agreement was $5.4 million and $1.1 million, respectively, and is included within other long term liabilities. No deferred revenue amounts under these arrangements were recognized as revenue during the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013.
Income Taxes
No provision for federal or state income taxes is included in the ETG System Carve‑out Financial Statements as such income is taxable directly to the partners owning the ETG System. Each partner is responsible for its share of federal and state income tax. Net earnings for financial statement purposes may differ significantly from taxable income reportable to each partner as a result of differences between the tax basis and financial reporting basis of assets and liabilities.
The ETG System is subject to the Texas gross margin tax. The taxes owed in respect of the ETG System is reflected in the ETG System’s parent’s consolidated Texas franchise tax return. The current tax liability is assessed based on the gross revenue apportioned to Texas. Differences in amounts included in the determination of taxable gross margin for book and tax purposes result in deferred tax assets and liabilities. There were no deferred tax amounts incurred or recorded as of December 31, 2014 or 2013.
Uncertain Tax Positions
The tax positions taken or expected to be taken in the course of preparing the financial statements are evaluated to determine whether the tax positions are more likely than not of being sustained by the applicable tax authority. Tax positions deemed not to meet the more likely than not threshold would be recorded as a tax benefit or expense in the current year. Management believes that there are no uncertain tax positions for the ETG System Carve‑out Financial Statements.
Environmental Liabilities
The operations of ETG System are subject to various federal, state, and local laws and regulations relating to the protection of the environment. Although the Company believes that it is in compliance with applicable environmental regulations, the risk of costs and liabilities are inherent in pipeline ownership and operation, and there can be no assurances that significant costs and liabilities will not be incurred by the Company. Management is not aware of any contingent liabilities that currently exist with respect to environmental matters.
The ETG System’s policy is to accrue for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. Accruals for estimated losses from environmental remediation obligations generally are recognized no later than completion of the remedial feasibility study. Such accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable.
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Commitments and Contingencies
The carve‑out financial results of the ETG System may be affected by judgments and estimates related to loss contingencies. Accruals for loss contingencies are recorded when management determines that it is probable that an asset has been impaired or a liability has been incurred and that such economic loss can be reasonably estimated. Such determinations are subject to interpretations of current facts and circumstances, forecasts of future events and estimates of the financial impacts of such events. There are no material commitments and contingencies as of December 31, 2014 and 2013 associated with the ETG System.
Parent Company Net Investment
Azure Holdings net investment in the operations of the ETG System is presented as parent company net investment in the ETG System Carve‑out Financial Statements. Parent company net investment represents the accumulated net earnings of the operations and the accumulated net contributions from Azure Holdings. Net contributions from Azure Holdings as of December 31, 2014 and 2013 were primarily comprised of intercompany operations and maintenance expense, cash clearing and other financing activities, and debt and general and administrative costs allocations to the ETG System.
Recent Accounting Pronouncements
Accounting standard‑setting organizations frequently issue new or revised accounting rules and pronouncements. We regularly review new accounting rules and pronouncements to determine their impact, if any, on our financial statements.
In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards (“IFRS”). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In July 2015, the FASB voted to approve a one-year deferral of the effective date for the new revenue standard, making the requirements of the standard effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The adoption could have a significant impact on the ETG System financial statements, however management of the ETG System is currently unable to quantify the impact.
There are currently no other recent pronouncements that have been issued that the Company believes will materially affect its financial statements.
(3) | Acquisitions |
ETG System
On November 15, 2013, Tenaska Capital Management contributed the ETG System to Azure Holdings for a total purchase price of $90 million, plus customary working capital adjustments. Tenaska Capital Management was issued a $90 million equity interest in Azure Holdings in exchange for the ETG System. The fair value of the equity interest issued was determined based upon the cash amount paid for the remaining interest in Azure Holdings.
The ETG System is engaged in natural gas gathering, processing, compression, treating, transportation and related services in North Louisiana and East Texas. The ETG System assets and operations have been carved‑out from the assets and operations of Azure Holdings.
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For purposes of the ETG System Carve‑out Financial Statements, we have allocated the total purchase price to the ETG System assets acquired and liabilities assumed based on their estimated fair values at the acquisition date. The fair values of the assets and liabilities are based on assumptions related to expected future cash flows, discount rates and asset lives using currently available information. We utilized a mix of the cost, income and market approaches to determine the estimated fair values of such assets and liabilities. The fair value measurements and models have been classified as nonrecurring Level 3 measurements. There was no goodwill allocated to the ETG System because it was determined that the purchase price allocated to the ETG System was equal to the fair value of the ETG System net assets acquired.
The following table summarizes the amount of consideration paid for in the acquisition and the amounts of estimated fair value of the assets acquired and liabilities assumed at the acquisition date that have been allocated to the ETG System for purposes of the ETG System Carve‑out Financial Statements.
Purchase price allocation (in thousands): | |||
Cash paid by Tenaska Capital | $ | (1,460 | ) |
Equity issued to Tenaska Capital | 90,000 | ||
Total purchase price | $ | 88,540 | |
Assets acquired: | |||
Current assets | $ | 3,392 | |
Property, plant and equipment | 90,000 | ||
Liabilities assumed: | |||
Current liabilities | (3,784 | ) | |
Other long-term liabilities | (1,068 | ) | |
Total purchase price | $ | 88,540 | |
Azure Holdings recognized $6.1 million of transaction costs during the period from November 15, 2013 to December 31, 2013 as a result of the Acquisition. These transaction costs have not been allocated to the ETG System Carve-out Financial Statements.
(4) | Accounts Receivable and Concentration of Credit Risk |
The ETG System’s primary markets are in the North Louisiana and East Texas natural gas supply basins, and it delivers natural gas to major intrastate and interstate pipelines in these regions. The ETG System has a concentration of revenues and trade accounts receivable due from customers engaged in the production, trading, distribution and marketing of natural gas and condensate. These concentrations may affect overall credit risk in that these customers may be affected similarly by changes in the economic, regulatory, environmental or other factors. The ETG System analyzes its customers’ historical financial and operational information before extending credit.
The ETG System had four customers that individually represented greater than 10% of total operating revenues during the year ended December 31, 2014. Company A, Company B, Company C, and Company D each represented 25%, 24%, 23%, and 11% of total operating revenues, respectively. Further, the ETG System had four customers that individually represented greater than 10% of total operating revenues during the period from November 15, 2013 to December 31, 2013. Company A, Company B, Company C and Company D each represented 27%, 22%, 27% and 10%, respectively.
As of December 31, 2014, Company A, Company B and Company D represented 25%, 32% and 15%, respectively, of the ETG System accounts receivable. Further, as of December 31, 2013, Company A, Company B, and Company C represented 15%, 22% and 10%, respectively, of the ETG System accounts receivable.
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(5) | Property, Plant and Equipment, Net |
Property, plant and equipment, net consisted of the following as of each respective period:
Azure ETG System | ||||||||
Estimated useful life (yrs) | December 31, 2014 | December 31, 2013 | ||||||
Pipelines | 45 | $ | 72,729 | $ | 76,790 | |||
Gas processing and compression facilities | 20 | 18,085 | 13,192 | |||||
Other depreciable assets | 5-15 | — | 18 | |||||
Total property, plant and equipment | 90,814 | 90,000 | ||||||
Accumulated depreciation | (2,908 | ) | (301 | ) | ||||
Total | 87,906 | 89,699 | ||||||
Construction in progress | 15 | 109 | ||||||
Land and other | 618 | — | ||||||
Property, plant and equipment, net | $ | 88,539 | $ | 89,808 | ||||
Depreciation is provided using the straight‑line method based on the estimated useful life of each asset. Depreciation expense recognized by the ETG System for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 was $2.6 million and $0.3 million, respectively.
Long-Lived Asset Impairments
The ETG System had no impairments during the period ended December 31, 2014 or the period from November 15, 2013 to December 31, 2013.
(6) | Long-Term Debt |
Azure Credit Agreement
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (“TLB”) maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (“Revolver” and collectively with the TLB, the “Azure Credit Agreement”) with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement are unconditionally guaranteed, jointly and severally, by all of the Azure Holdings’ subsidiaries, including the ETG System, and are collateralized by first priority liens on substantially all of existing and subsequently acquired assets and equity.
Under the TLB, borrowings bear interest at Azure’s option of either the (i) monthly Eurodollar Rate, which is the British Bankers Association London Inter Bank Offered Rate and cannot be less than 1% per year or (ii) the Alternative Base Rate (“ABR”), which is the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Rate; plus 0.50% or (c) the 30‑day Eurodollar Rate; plus 1.0%; plus the applicable Eurodollar margin or the ABR margin which is 5.5% and 4.5%, respectively. Azure elected the Eurodollar Rate and Eurodollar margin for the TLB for the year ending December 31, 2014 and the period from November 15, 2013 to December 31, 2013. For the Revolver, borrowings bear interest under the same terms as the TLB and the applicable Eurodollar margin and ABR margin vary quarterly based on Azure Holdings’ consolidated leverage ratio. The weighted average interest rate for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013 was 6.50%. Total outstanding borrowings associated with the Azure Credit Agreement were $522.5 million and $550.0 million as of December 31, 2014 and December 31, 2013, respectively, of which $27.5 million is due within one year. As of December 31, 2014 and 2013, all
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outstanding borrowings were associated with the TLB and there were no outstanding borrowings under the Revolver during either period.
In September 2014, Azure Holdings and Azure entered into the first amendment to the Azure Credit Agreement (the “First Amendment”). Among other things, the First Amendment reduced borrowing capacity under the Revolver from $50.0 million to $40.0 million and provided for more favorable financial condition covenants. A loss on the extinguishment of debt in the amount of $0.3 million was recognized by Azure Holdings as a result of the First Amendment, and a portion, $0.1 million, of the loss on the extinguishment of debt has been allocated to the ETG System and is included within interest expense.
ETG System Long-Term Debt and Related Expenses Allocation
The Azure Credit Agreement served as the sole borrowing agreement applicable for the ETG System during the periods presented. In addition, substantially all of Azure Holdings’ subsidiaries, including the ETG System, served as guarantors and pledger's with respect to the Azure Credit Agreement.
The ETG System’s long‑term debt and related expense balances represent an allocation of its proportionate share of the Azure Holdings’ consolidated long‑term debt as of and for all periods presented. Substantially all of the ETG System capital expenditures, including $550 million used to fund a portion of the Acquisition, were financed by the Azure Credit Agreement during these respective periods. As a result, the long‑term debt and related expense balances presented within the ETG System Carve‑out Financial Statements represent the ETG System’s proportionate share using the proportional book value of the ETG System assets as a percentage of total assets financed by the Azure Credit Agreement. The long-term debt allocated to the ETG System as of December 31, 2014 and 2013 was $57.0 million and $60.0 million, respectively.
In connection with entering into the Azure Credit Agreement, Azure incurred financing costs. These deferred financing costs were being amortized to interest expense over the term of the loan. Applying the same allocation methodology as the long‑term debt balances, the ETG System’s deferred finance costs at December 31, 2014 and 2013 were $1.8 million and $2.3 million, respectively. Amortization expense associated with these deferred finance costs was $0.5 million and $0.1 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013.
The estimated remaining principal payments associated with the Azure Credit Agreement that will be allocated to the ETG System are $3.0 million for the fiscal years 2015, 2016 and 2017, and the remaining principal balance due upon maturity in 2018.
The ETG System’s interest expense has also been calculated in a similar allocation methodology as long‑term debt.
(7) | Lease Obligations |
The ETG System leases treating equipment and these leases are accounted for as operating leases. Total rent expense for operating leases, including those with terms of less than one year, was $2.4 million and $0.4 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, respectively.
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The following table is a schedule of future minimum lease payments for leases that had initial or non-cancelable lease terms in excess of one year as of December 31, 2014.
Amount | |||
Year | (in thousands) | ||
2015 | $ | 2,531 | |
2016 | 1,174 | ||
2017 | 139 | ||
2018 | 139 | ||
2019 | 139 | ||
Thereafter | 220 | ||
Total rent payments | $ | 4,342 | |
(8) | Commitments and Contingencies |
Legal Matters
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties, or from other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. Legal costs related to any such contingencies are expensed as incurred. Accruals for estimated losses are adjusted as further information develops or as circumstances change. At December 31, 2014 and December 31, 2013, the ETG System did not have an accrual related to contractual disputes.
During the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, Azure Holdings and its subsidiaries have been a party to litigation arising from events occurring during the normal course of business. While we are unable to estimate the range of exposure, we believe that there is no significant exposure to the ETG System arising out of these matters. As of December 31, 2014 and 2013, the ETG System had no active litigation matters that management believes will have a material adverse impact on its results of operations, financial condition or cash flows.
Regulatory Compliance
In the ordinary course of business, the ETG System is subject to various laws and regulations. In the opinion of management, compliance with current laws and regulations will not have a material effect on our results of operations, cash flows or financial condition.
Commitments
The ETG System and certain related parties were co‑guarantors of the Azure Credit Agreement as of December 31, 2014 and 2013. The amounts outstanding under the Azure Credit Agreement were $522.5 million and $550.0 million as of December 31, 2014 and 2013, respectively.
(9) | Related Party Transactions |
EXCO and BG are considered related parties of the ETG System for financial reporting purposes as a result of their combined 7% ownership interest in Azure Holdings. The ETG System also provides services to an affiliate of Tenaska Capital Management, which is also considered a related party. For the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, the ETG System recorded revenues from these affiliates in the amount of $4.0 million and $0.8 million, respectively. As of December 31, 2013, accounts receivable from these affiliates were $0.4 million, with no outstanding balance as of December 31, 2014.
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Allocated Expenses
Substantially all of the ETG System’s senior management is employed by Azure Holdings, and certain functions critical to the ETG System’s operations are centralized and managed by Azure Holdings. Additionally, the ETG System resides in office space provided by Azure Holdings. As a result, 10.0% of the total consolidated Azure Holdings’ general and administrative expenses have been allocated to the ETG System for the periods presented. The ETG System allocated general and administrative expenses from Azure were $1.4 million and $0.1 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, respectively. The ETG System allocated operating expense labor from Azure were $1.3 million and $0.1 million for the year ended December 31, 2014 and the period from November 15, 2013 to December 31, 2013, respectively.
This allocation represents management’s best estimate of the general and administrative expenses and operating expense labor incurred on behalf of the ETG System and was determined after consideration of multiple operating metrics, including dedicated operating personnel, pipeline mileage and system throughput as a percentage of each total consolidated Azure’s operating metric. Management of the ETG System and Azure believe these allocations reasonably reflect the utilization of services provided and benefits received. The allocated costs are included within general and administrative expense and operating expense of the statements of operations.
See notes 2 and 6 for a discussion of long‑term debt and interest allocated from Azure.
(10) | Supplemental Footnote Information |
Supplemental Cash Flow Information
Year ended December 31, 2014 | Period From November 15, 2013 to December 31, 2013 | |||||
Supplemental schedule of non-cash investing and financing activities: | ||||||
Non-cash capital expenditures included in accounts payable and | ||||||
accrued liabilities | $ | — | $ | 1,655 | ||
Members' equity issued for property and equipment in the Acquisition | $ | — | $ | 90,000 | ||
(11) | Subsequent Events |
On August 6, 2015, the Azure Midstream Partners (the “Partnership”) announced it has acquired 100% of the equity interests of the entity that owns the ETG System for total cash consideration of $83.0 million, subject to customary purchase price adjustments. This acquisition financed with an $80.0 million draw from the Partnership’s credit agreement and the issuance of 255,319 common units representing limited partner interests in the Partnership to the general partner of the Partnership on behalf of Azure. The assets of the ETG System include certain natural gas gathering pipelines located in Nacogdoches and Shelby Counties in Texas. This acquisition was effective as of July 1, 2015 and the Partnership's financial results will retrospectively include the financial results attributable to the acquired gas gathering pipelines for all periods beginning July 1, 2015.
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AZURE ETG SYSTEM
Financial Statements
June 30, 2015 and 2014
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Azure ETG System
Balance Sheets
As of June 30, 2015 and December 31, 2014
(In Thousands)
June 30, 2015 | December 31, 2014 | |||||
Current Assets: | ||||||
Cash and cash equivalents | $ | — | $ | — | ||
Trade accounts receivable | 1,492 | 1,738 | ||||
Other current assets | 617 | 418 | ||||
Total current assets | 2,109 | 2,156 | ||||
Property, plant and equipment, net | 87,594 | 88,539 | ||||
Other non-current assets | 1,823 | 1,771 | ||||
Deferred tax asset | 211 | — | ||||
Total assets | $ | 91,737 | $ | 92,466 | ||
Current Liabilities: | ||||||
Accounts payable and accrued liabilities | $ | 1,877 | $ | 563 | ||
Current portion of long-term debt associated with the Azure Credit | ||||||
Agreement | 3,603 | 3,002 | ||||
Total current liabilities | 5,480 | 3,565 | ||||
Long-term debt associated with the Azure Credit Agreement | 48,660 | 54,040 | ||||
Other long-term liabilities | 11,625 | 5,351 | ||||
Total liabilities | 65,765 | 62,956 | ||||
Parent company net investment | 25,972 | 29,510 | ||||
Total liabilities and parent company net investment | $ | 91,737 | $ | 92,466 | ||
See accompanying notes to the financial statements.
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Azure ETG System
Statement of Operations
For the six month periods ended June 30, 2015 and 2014
(In Thousands)
June 30, 2015 | June 30, 2014 | |||||
Operating Revenues: | ||||||
Natural gas and NGL sales | $ | 1,917 | $ | 2,703 | ||
Natural gas and NGL sales - affiliates | 56 | 2,425 | ||||
Gathering services and other fees | 3,779 | 4,498 | ||||
Gathering services and other fees - affiliates | 8 | 15 | ||||
Total operating revenues | 5,760 | 9,641 | ||||
Operating expenses: | ||||||
Cost of purchased gas and NGLs sold | 1,792 | 4,156 | ||||
Operating expense | 3,808 | 3,465 | ||||
General and administrative | 861 | 704 | ||||
Depreciation and amortization | 1,297 | 1,289 | ||||
Total expenses | 7,758 | 9,614 | ||||
Income (loss) from operations | (1,998 | ) | 27 | |||
Interest expense | 2,349 | 2,222 | ||||
Other expense | 1,680 | 188 | ||||
Net loss before income taxes | (6,027 | ) | (2,383 | ) | ||
Income tax expense | (211 | ) | 25 | |||
Net loss | $ | (5,816 | ) | $ | (2,408 | ) |
See accompanying notes to the financial statements.
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Azure ETG System
Statement of Cash Flows
For the six month periods ended June 30, 2015 and 2014
(In Thousands)
June 30, 2015 | June 30, 2014 | |||||
Operating activities: | ||||||
Net loss | $ | (5,816 | ) | $ | (2,408 | ) |
Adjustments to reconcile net loss to net cash provided by operating | ||||||
activities: | ||||||
Depreciation and amortization | 1,297 | 1,289 | ||||
Amortization of deferred financing costs | 263 | 218 | ||||
Deferred tax benefit | (211 | ) | — | |||
Changes in operating assets and liabilities: | ||||||
Accounts receivable, net | 246 | 1,970 | ||||
Other current assets | (199 | ) | (429 | ) | ||
Accounts payable and other current liabilities | 1,229 | (772 | ) | |||
Other long-term liabilities | 6,275 | 4,282 | ||||
Net cash provided by operating activities | 3,084 | 4,150 | ||||
Investing activities: | ||||||
Capital expenditures | (268 | ) | (2,936 | ) | ||
Net cash used in investing activities | (268 | ) | (2,936 | ) | ||
Financing activities: | ||||||
Repayments under Azure Credit Agreement | (3,741 | ) | (1,501 | ) | ||
Parent company net investment | 925 | 287 | ||||
Net cash provided by (used in) financing activities | (2,816 | ) | (1,214 | ) | ||
Increase (decrease) in cash and cash equivalents | — | — | ||||
Cash and cash equivalents - beginning of period | — | — | ||||
Cash and cash equivalents - end of period | $ | — | $ | — | ||
See accompanying notes to the financial statements.
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Azure ETG System
Statement of Parent Company Net Investment
For the six month period ended June 30, 2015
(In Thousands)
Beginning parent company net investment - December 31, 2014 | $ | 29,510 | |
Net loss for the period | (5,816 | ) | |
Net contribution from parent for the period | 2,278 | ||
Ending parent company net investment - June 30, 2015 | $ | 25,972 | |
See accompanying notes to the financial statements.
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(1) | Organization and Nature of the Business |
Azure ETG System
The Azure ETG System Carve‑out Financial Statements (the “ETG System Carve‑out Financial Statements”) present the historical carve‑out financial position, results of operations, change in parent company net investment and cash flows of Azure ETG, LLC and certain related assets and liabilities of Azure Midstream Holdings, LLC (“Azure Holdings”), collectively the (“ETG System” or “Company”) as of June 30, 2015 and December 31, 2014, and for the six month periods ended June 30, 2015 and 2014. The ETG System Carve‑out Financial Statements have been derived from the accounting records of Azure Holdings, defined further below, on a carve‑out basis.
On November 15, 2013, TPF II East Texas Gathering, LLC (“ETG”), a business managed by Tenaska Capital Management, LLC (“Tenaska Capital Management”), was contributed to Azure Holdings in exchange for an interest in Azure Holdings valued at $90 million (the “ETG Contribution”). The acquisition of the ETG Contribution is referred to as the (“Acquisition”).
Subsequent to the Acquisition, ETG is indirectly owned and operated by Azure Holdings through its wholly owned subsidiary, Azure Midstream Energy, LLC (“Azure”).
Nature of Business
The ETG System is comprised of midstream assets primarily located within San Augustine, Nacogdoches, Sabine, Panola and Shelby counties in East Texas and currently serves multiple formations, including the Haynesville, Bossier and the liquids-rich James Lime formation. These midstream assets currently serve the Deep Bossier formation, Cotton Valley formation, and the Haynesville shale. As of June 30, 2015, the ETG System consisted of approximately 255 miles of high-pressure pipeline. Approximately 98% of the natural gas transported on this system requires treating for carbon dioxide (“CO2”), which we treat for an additional fee. As of June 30, 2015, the system included two amine treating plants with combined capacity of 500 MMcf/d and access to four major interconnect access points that offer our customers superior deliverability. The system also includes our new Fairway processing plant with a processing capacity of 10 MMcf/d, which is designed to extract natural gas liquid (“NGL”) content from natural gas averaging 3.2 gallons per Mcf (“GPM”) from the James Lime formation for liquids processing.
Basis of Presentation
The operating results and the majority of the assets and liabilities of the ETG System have been specifically identified based on the existing divisional organization of Azure Holdings. Certain assets, liabilities and expenses presented in the balance sheets and statements of operations represent allocations and estimates of the costs of services incurred by Azure Holdings. These allocations and estimates were based on methodologies that management believes to be reasonable, and include items such as outstanding debt and related expenses associated with the Azure Credit Agreement (See Note 5) and general and administrative expenses incurred by Azure Holdings on behalf of the ETG System. See the accompanying notes for discussions of the specific allocation methodology applied to debt and related charges and others. Revenues have been identified by contracts that are specifically identifiable to the ETG System. Depreciation and amortization are based upon assets specifically identified to the ETG System. Salaries, benefits and other general and administrative costs have been allocated to the ETG System based on management’s use of a reasonable allocation methodology as such costs were historically not allocated to the ETG System.
Azure Holding’s direct investment in the ETG System is presented as parent company net investment in the ETG System Carve‑out Financial Statements and includes the accumulated net earnings and accumulated
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net contributions from Azure Holdings, including allocated long‑term debt, interest expense and general and administrative expenses.
The ETG System Carve‑out Financial Statements were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). These principles are established by the Financial Accounting Standards Board. The preparation of the ETG System Carve‑out Financial Statements in accordance with GAAP requires that management make estimates and assumptions and use judgment regarding the reported amounts of assets, liabilities, revenues and expenses and disclosures of contingent assets and liabilities for the periods presented herein. The ETG System Carve‑out Financial Statements reflect the application of purchase accounting related to the acquisition of the ETG System, effective as of November 15, 2013.
(2) | Summary of Significant Accounting Policies |
Use of Estimates
The ETG System Carve‑out Financial Statements have been prepared in conformity with GAAP, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the balance sheet dates, the reported amounts of revenue and expense, including fair value measurements, and disclosure of contingencies. Although management believes these estimates are reasonable, actual results could differ from its estimates.
Cash and Cash Equivalents
The ETG System utilizes Azure Holdings’ centralized processes and systems for cash management, payroll, purchasing and expenditures. As a result, cash generated by and cash received by the ETG System were deposited in and commingled with the general corporate funds of the respective period’s owner and is or was not specifically allocated to the ETG System. The net results of these cash transactions between the ETG System and the respective period’s owner are reflected in parent company net investment in the carved‑out balance sheets. Changes in long‑term debt associated with the Azure Credit Agreement is assumed as cash borrowings or repayments in the statements of cash flows.
Trade Accounts Receivable
Trade accounts receivables are specifically identified based on contracts assigned by Azure Holdings to the ETG System and primarily represent receivables for gathering, processing, compression, treating and other services provided to natural gas producers as well as natural gas and NGL sales receivable from third parties.
Allowance for Doubtful Accounts
In evaluating the collectability of accounts receivable, management performs ongoing credit evaluations of the ETG System’s customers and adjusts payment terms based upon payment history and each customer’s current creditworthiness, as determined by management’s review of such customer’s credit information, detailed analysis of the expected collectability of accounts receivable that are past due and the expected collectability of overall receivables. The ETG System did not have an allowance for doubtful accounts as of June 30, 2015 and December 31, 2014.
Concentration of Credit Risk
Financial instruments that potentially subject the ETG System to concentrations of credit risk are primarily trade accounts receivables. The ETG System performs ongoing credit evaluations of its customers’ financial condition. Declines in oil and gas prices have resulted in reductions in capital expenditure budgets of oil and gas exploration and development companies and could impact the financial condition of the ETG System’s customers.
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Property, Plant and Equipment, Net
Property, plant and equipment is specifically identified based on authorization for expenditures for the ETG System and is recorded at its original cost of construction or, upon acquisition, at fair value of the assets acquired. Expenditures for maintenance and repairs that do not add capacity or extend the useful life of an asset are expensed as incurred. Expenditures to extend the useful lives of the assets or enhance their productivity or efficiency from their original design are capitalized over the expected remaining period of use. The carrying value of the assets is based on estimates, assumptions and judgments relative to useful lives and salvage values. Sales or retirements of assets, along with the related accumulated depreciation, are removed from the accounts and any gain or loss on disposition is included in the statement of operations. The ETG System gas gathering asset capital expenditures for the periods presented have been reduced by amounts reimbursed by producers for well connection costs.
Depreciation of property, plant, and equipment is recorded on a straight‑line basis over the estimated useful lives of the assets. These estimates are based on various factors including age (in the case of acquired assets), manufacturing specifications, technological advances and historical data concerning the useful lives of similar assets. In connection with the Acquisition, purchase accounting was applied to the ETG System assets acquired and liabilities assumed and an appropriate estimate for the useful lives of the assets acquired was determined.
Impairment of Long‑Lived Assets
Relevant accounting guidance requires long-lived assets to be reviewed whenever events or changes in circumstances indicate that the carrying value of such assets may not be recoverable. In order to determine whether an impairment has occurred, we compare the net book value of the asset to the estimated undiscounted future net cash flows related to the asset. Our estimate of undiscounted cash flows is based on assumptions regarding the purchase and resale margins on natural gas, volume of gas available to the asset, markets available to the asset, operating expenses, and prices of NGL. The amount of availability of natural gas to an asset is sometimes based on assumptions regarding a producer’s future drilling activity, which may be dependent in part on natural gas prices. Projections of gas volumes and future commodity prices are inherently subjective and contingent upon a number of variable factors. Any significant variance in any of the above assumptions or factors could materially affect our cash flows, which could require us to record an impairment of an asset.
If an impairment has occurred, the amount of the impairment is determined based on the expected future net cash flows discounted using a rate management believes a market participant would assume is reflective of the risk associated with achieving the underlying cash flows.
Deferred Financing Costs
Deferred financing costs are capitalized and amortized as interest expense under the effective interest method over the term of the related debt. The unamortized balance of deferred financing costs is included in other non-current assets on the balance sheets. All deferred financing costs have been allocated from Azure and are associated with the Azure Credit Agreement.
Accounts Payable and Accrued Liabilities
Accounts payable and accrued liabilities primarily represents open invoices as of period end that are specifically identified for the ETG System based on authorization for expenditures using the same information as for property, plant and equipment. Accrued liabilities are allocated to the ETG System based on historical analysis of invoices by authorization for expenditures in the period of services rendered.
Fair Value of Financial Instruments
Accounting guidance requires the disclosure of the fair value of all financial instruments that are not otherwise recorded at fair value in the financial statements. As of June 30, 2015 and December 31, 2014,
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financial instruments recorded at contractual amounts that approximate fair value include accounts receivable, accounts payable and accrued expenses. The fair values of such items are not materially sensitive to shifts in market interest rates because of the short term to maturity of these instruments. The fair value of the debt funded through the Azure Credit Agreement allocated to the ETG System approximates its carrying amount as of June 30, 2015 and December 31, 2014 primarily due to the variable nature of the interest rate of the instrument. The fair value of the debt is considered a Level 2 fair value measurement.
Asset Retirement Obligations
Accounting standards related to asset retirement obligations require us to evaluate whether any future asset retirement obligations exist as of June 30, 2015 and December 31, 2014, and whether the expected retirement date of the related costs of retirement can be estimated. We have concluded that the ETG System natural gas gathering and processing assets, which include pipelines, compression facilities and treating facilities, have an indeterminate life because they are owned and will operate for an indeterminate future period when properly maintained. A liability for these asset retirement obligations will be recorded only if and when a future retirement obligation with a determinable life is identified. The ETG System Carve‑out Financial Statements did not provide any asset retirement obligations as of June 30, 2015 or December 31, 2014 because management of the ETG System did not have sufficient information to reasonably estimate such obligations, and had no intention of discontinuing use of any significant assets.
Gas Imbalances
Quantities of natural gas over delivered or under delivered related to imbalance agreements are recorded monthly as accounts receivable or accounts payable using an estimated price based on current market prices, an index to current market prices or the weighted average prices of natural gas at the plant or system pursuant to imbalance agreements for which settlement prices have yet to be finalized. Dependent on imbalance contract terms within certain volumetric limits, imbalances may be settled by deliveries of natural gas.
Revenue Recognition
Primary revenue producing activities are the sales of natural gas and NGLs purchased from third parties, for which the ETG System takes title. Natural gas revenues arise from transactions that are completed under contracts with limited commodity price exposure, and we elect the normal purchases and normal sales exemption on all such transactions for accounting purposes. The ETG System receives a market price per barrel on our revenue from natural gas condensate liquids. Natural gas and condensate revenues and the associated purchases and expenses are reported on a gross basis within our statement of operations. The cost of natural gas purchased from third parties is reported as a component of operating costs and expenses.
Secondarily, the ETG System earns gathering services and other fee revenues from the transportation, gathering, processing, and treating of natural gas. These gathering services and other fees are generally provided on a fixed fee basis per unit based on the volumes (Mcf) or heating content (MMbtu) of natural gas.
Revenue from all services and activities is recognized when all of the following criteria are met: (i) persuasive evidence of an exchange arrangement exists, (ii) delivery has occurred or services have been rendered, (iii) the price is fixed or determinable, and (iv) collectability is reasonably assured.
The ETG System has a natural gas gathering agreement with a customer that provides for a minimum revenue commitment (“MRC”). Under the MRC, our customer agrees to pay a minimum monetary amount over certain periods during the term of the MRC. The customer must make a deficiency payment to us at the end of the contract year if its actual revenues are less than its MRC for that year. The customer is entitled to utilize the deficiency payments to offset gathering fees in the following periods to the extent that such customer’s revenues in the following periods exceed its MRC for that period. This contract provision ranges for the entire duration of the gas gathering agreement, which is ten years. We record customer billings for obligations under the
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MRC (solely with respect to this natural gas gathering agreement) as deferred revenue when the customer has the right to utilize deficiency payments to offset gathering fees in subsequent periods. We recognize deferred revenue under this arrangement as revenue once all contingencies or potential performance obligations associated with the related revenues have either (i) been satisfied through the gathering of future excess volumes of natural gas, or (ii) expired (or lapsed) through the passage of time pursuant to the terms of the natural gas gathering agreement. We classify deferred revenue as noncurrent where the expiration of the customer’s right to utilize deficiency payments is greater than one year. As of June 30, 2015 and December 31, 2014, deferred revenue under the MRC agreement was $11.6 million and $5.4 million, respectively, and is included within other long term liabilities. No deferred revenue amounts under these arrangements were recognized as revenue during the year ended December 31, 2014.
Income Taxes
No provision for federal or state income taxes is included in the ETG System Carve‑out Financial Statements as such income is taxable directly to the partners owning the ETG System. Each partner is responsible for its share of federal and state income tax. Net earnings for financial statement purposes may differ significantly from taxable income reportable to each partner as a result of differences between the tax basis and financial reporting basis of assets and liabilities.
The ETG System is subject to the Texas gross margin tax. The taxes owed in respect of the ETG System are reflected in the ETG System’s parent’s consolidated Texas franchise tax return. The current tax liability is assessed based on the gross revenue apportioned to Texas. Differences in amounts included in the determination of taxable gross margin for book and tax purposes result in deferred tax assets and liabilities. As of June 30, 2015, the ETG system had an asset of $0.2 million for deferred taxes. There were no deferred tax amounts incurred or recorded as of December 31, 2014.
Uncertain Tax Positions
The tax positions taken or expected to be taken in the course of preparing the financial statements are evaluated to determine whether the tax positions are more likely than not of being sustained by the applicable tax authority. Tax positions deemed not to meet the more likely than not threshold would be recorded as a tax benefit or expense in the current year. Management believes that there are no uncertain tax positions for the ETG System Carve‑out Financial Statements.
Environmental Liabilities
The operations of the ETG System are subject to various federal, state, and local laws and regulations relating to the protection of the environment. Although the Company believes that it is in compliance with applicable environmental regulations, the risk of costs and liabilities are inherent in pipeline ownership and operation, and there can be no assurances that significant costs and liabilities will not be incurred by the Company. Management is not aware of any contingent liabilities that currently exist with respect to environmental matters.
The ETG System’s policy is to accrue for losses associated with environmental remediation obligations when such losses are probable and reasonably estimable. Accruals for estimated losses from environmental remediation obligations generally are recognized no later than completion of the remedial feasibility study. Such accruals are adjusted as further information develops or circumstances change. Costs of future expenditures for environmental remediation obligations are not discounted to their present value. Recoveries of environmental remediation costs from other parties are recorded as assets when their receipt is deemed probable.
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Commitments and Contingencies
The carve‑out financial results of the ETG System may be affected by judgments and estimates related to loss contingencies. Accruals for loss contingencies are recorded when management determines that it is probable that an asset has been impaired or a liability has been incurred and that such economic loss can be reasonably estimated. Such determinations are subject to interpretations of current facts and circumstances, forecasts of future events and estimates of the financial impacts of such events. There are no material commitments and contingencies as of June 30, 2015 and December 31, 2014 associated with the ETG System.
Parent Company Net Investment
Azure Holdings net investment in the operations of the ETG System is presented as parent company net investment in the ETG System Carve‑out Financial Statements. Parent company net investment represents the accumulated net earnings of the operations and the accumulated net contributions from Azure Holdings. Net contributions from Azure Holdings as of June 30, 2015 and December 31, 2014 were primarily comprised of intercompany operations and maintenance expense, cash clearing and other financing activities, and debt and general and administrative costs allocations to the ETG System.
Recent Accounting Pronouncements
Accounting standard‑setting organizations frequently issue new or revised accounting rules and pronouncements. We regularly review new accounting rules and pronouncements to determine their impact, if any, on our financial statements.
In May 2014, the Financial Accounting Standards Board (“FASB”) and International Accounting Standards Board (“IASB”) jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards (“IFRS”). The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods and services. In July 2015, the FASB voted to approve a one-year deferral of the effective date for the new revenue standard, making the requirements of the standard effective for interim and annual periods beginning after December 15, 2017, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The adoption could have a significant impact on the ETG System financial statements, however management of the ETG System is currently unable to quantify the impact.
There are currently no other recent pronouncements that have been issued that the Company believes will materially affect its financial statements.
(3) | Accounts Receivable and Concentration of Credit Risk |
The ETG System primary markets are in the North Louisiana and East Texas natural gas supply basins, and it delivers natural gas to major intrastate and interstate pipelines in these regions. The ETG System has a concentration of revenues and trade accounts receivable due from customers engaged in the production, trading, distribution and marketing of natural gas and condensate. These concentrations may affect overall credit risk in that these customers may be affected similarly by changes in the economic, regulatory, environmental or other factors. The ETG System analyzes its customers’ historical financial and operational information before extending credit.
The ETG System had three customers that individually represented greater than 10% of total operating revenues during the period ended June 30, 2015. Company A, Company B, and Company C, each represented 34%, 27%, and 14% of total operating revenues, respectively. Further, the ETG System had four customers that individually represented greater than 10% of total operating revenues for the six months ended June 30,
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2014. Company A, Company B, Company C and Company D each represented 20%, 24%, 12%, and 25%, respectively.
For the period ended June 30, 2015, Company A, Company B and Company C represented 23%, 32% and 15%, respectively, of the ETG System accounts receivable. Further, as of December 31, 2014, Company A, Company B, and Company C represented 25%, 32%, and 15%, respectively, of the ETG System accounts receivable.
(4) | Property, Plant and Equipment, Net |
Property, plant and equipment, net consisted of the following as of each respective period:
Azure ETG System | ||||||||
Estimated useful life (yrs) | June 30, 2015 | December 31, 2014 | ||||||
Pipelines | 45 | $ | 72,739 | $ | 72,728 | |||
Gas processing and compression facilities | 20 | 18,086 | 18,086 | |||||
Other depreciable assets | 5-15 | 101 | — | |||||
Total property, plant and equipment | 90,926 | 90,814 | ||||||
Accumulated depreciation | (4,205 | ) | (2,908 | ) | ||||
Total | 86,721 | 87,906 | ||||||
Construction in progress | 254 | 14 | ||||||
Land and other | 619 | 619 | ||||||
Property, plant and equipment, net | $ | 87,594 | $ | 88,539 | ||||
Depreciation is provided using the straight‑line method based on the estimated useful life of each asset. Depreciation expense recognized by the ETG System for the six month periods ended June 30, 2015 and June 30, 2014 remained unchanged at $1.3 million.
Long-Lived Asset Impairments
The ETG System had no impairments during the six month periods ended June 30, 2015 and 2014.
(5) | Long-Term Debt |
Azure Credit Agreement
On November 15, 2013, Azure closed on a $550.0 million Senior Secured Term Loan B (“TLB”) maturing November 15, 2018, and a $50.0 million Senior Secured Revolving Credit Facility (“Revolver” and collectively with the TLB, the “Azure Credit Agreement”) with a maturity of November 15, 2017. Borrowings under the Azure Credit Agreement are unconditionally guaranteed, jointly and severally, by all of the Azure Holdings’ subsidiaries, including the ETG System, and are collateralized by first priority liens on substantially all of existing and subsequently acquired assets and equity.
Under the TLB, borrowings bear interest at Azure’s option of either the (i) monthly Eurodollar Rate, which is the British Bankers Association London Inter Bank Offered Rate and cannot be less than 1% per year or (ii) the Alternative Base Rate (“ABR”), which is the greatest of (a) the Prime Rate in effect on such day, (b) the Federal Funds Rate; plus 0.5% or (c) the 30‑day Eurodollar Rate; plus 1.0%; plus the applicable Eurodollar margin or the ABR margin which is 5.5% and 4.5%, respectively. Azure elected the Eurodollar Rate and Eurodollar margin for the TLB for the year ending December 31, 2014 and the period from November 15, 2013 to December 31, 2013. For the Revolver, borrowings bear interest under the same terms as the TLB and
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the applicable Eurodollar margin and ABR margin vary quarterly based on Azure Holdings’ consolidated leverage ratio. The weighted average interest rate for the six months ended June 30, 2015 was 7.2% and the year ended December 31, 2014 was 6.5%. Total outstanding borrowings associated with the Azure Credit Agreement were $399.0 million and $522.5 million as of June 30, 2015 and December 31, 2014, respectively, of which $27.5 million is due within one year. As of June 30, 2015 and December 31 2014, all outstanding borrowings were associated with the TLB and there were no outstanding borrowings under the Revolver during either period.
In September 2014, Azure Holdings and Azure entered into the first amendment to the Azure Credit Agreement (the “First Amendment”). Among other things, the First Amendment reduced borrowing capacity under the Revolver from $50.0 million to $40.0 million and provided for more favorable financial condition covenants. A loss on the extinguishment of debt in the amount of $0.3 million was recognized by Azure Holdings as a result of the First Amendment, and a portion, $0.1 million, of the loss on the extinguishment of debt has been allocated to the ETG System and is included within interest expense.
ETG System Long-Term Debt and Related Expenses Allocation
The Azure Credit Agreement served as the sole borrowing agreement applicable for the ETG System during the periods presented. In addition, substantially all of Azure Holdings’ subsidiaries, including the ETG System, served as guarantors and pledgers with respect to the Azure Credit Agreement.
The ETG System’s long‑term debt and related expense balances represent an allocation of its proportionate share of the Azure Midstream Holdings’ consolidated long‑term debt as of and for all periods presented. Substantially all of the ETG System capital expenditures, including amounts used to fund a portion of the Acquisition, were financed by the Azure Credit Agreement during these respective periods. As a result, the long‑term debt and related expense balances presented within the ETG System Carve‑out Financial Statements represent the ETG System’s proportionate share using the proportional book value of the ETG System assets as a percentage of total assets financed by the Azure Credit Agreement. The debt allocated to the ETG System as of June 30, 2015 and December 31, 2014 was $52.3 million and $57.0 million, respectively.
In connection with entering into the Azure Credit Agreement, Azure incurred financing costs. These deferred financing costs were being amortized to interest expense over the term of the loan. Applying the same allocation methodology as the long‑term debt balances, the ETG System’s deferred finance costs as of June 30, 2015 and December 31, 2014 were $1.8 million for both periods. Amortization expense associated with these deferred finance costs was $0.3 million and $0.2 million for the periods ended June 30, 2015 and June 30, 2014.
Subsequent to February 27, 2015, the allocation of debt, interest and related deferred financing costs increased proportionately as a percentage of remaining collateral due to the sale of Azure Legacy and its related release of collateral by Azure. The increase in the allocation of debt, interest and deferred financing cost has been separately identified as a non-cash impact to the net parent investment in Note 9.
The estimated remaining principal payments associated with the Azure Credit Agreement that will be allocated to the ETG System are $3.0 million for the fiscal years 2015, 2016 and 2017, and the remaining principal balance due upon maturity in 2018.
The ETG System’s interest expense has also been calculated in a similar allocation methodology as long‑term debt.
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(6) | Lease Obligations |
The ETG System leases treating equipment and these leases are accounted for as operating leases. Total rent expense for operating leases, including those with terms of less than one year, was $1.3 million and $1.2 million for six months ended June 30, 2015 and six months ended June 30, 2014, respectively.
The following table is a schedule of future minimum lease payments for leases that had initial or non-cancelable lease terms in excess of one year as of June 30, 2015.
Amount | |||
Year | (in thousands) | ||
2015 | $ | 1,265 | |
2016 | 1,174 | ||
2017 | 139 | ||
2018 | 139 | ||
2019 | 139 | ||
Thereafter | 221 | ||
Total rent payments | $ | 3,077 | |
(7) | Commitments and Contingencies |
Legal Matters
Liabilities for loss contingencies arising from claims, assessments, litigation, fines, penalties, or from other sources are recorded when it is probable that a liability has been incurred and the amount of the assessment can be reasonably estimated. Legal costs related to any such contingencies are expensed as incurred. Accruals for estimated losses are adjusted as further information develops or as circumstances change. As of June 30, 2015 and December 31, 2014, the ETG System did not have an accrual related to contractual disputes.
During the six month periods ended June 30, 2015 and 2014, Azure Holdings and its subsidiaries have been a party to litigation arising from events occurring during the normal course of business. While we are unable to estimate the range of exposure, we believe that there is no significant exposure to the ETG System arising out of these matters. As of June 30, 2015 and December 31, 2014, the ETG System had no active litigation matters that management believes will have a material adverse impact on its results of operations, financial condition or cash flows.
Regulatory Compliance
In the ordinary course of business, the ETG System is subject to various laws and regulations. In the opinion of management, compliance with current laws and regulations will not have a material effect on our results of operations, cash flows or financial condition.
Commitments
The ETG System and certain related parties were co‑guarantors of the Azure Credit Agreement as of June 30, 2015 and December 31, 2014. The amounts outstanding under the Azure Credit Agreement were $399.0 million and $522.5 million as of June 30, 2015 and December 31, 2014, respectively.
31
(8) | Related Party Transactions |
EXCO and BG are considered related parties of the ETG System for financial reporting purposes as a result of their combined 7% ownership interest in Azure Holdings. The ETG System also provides services to an affiliate of Tenaska Capital Management, which is also considered a related party. For the six month periods ended June 30, 2015 and 2014, the ETG System recorded revenues from these affiliates in the amount of $0.1 million and $2.4 million, respectively. For the period ended June 30, 2015, accounts receivable from these affiliates were immaterial, with no outstanding balance as of December 31, 2014.
Allocated Expenses
Substantially all of the ETG System’s senior management is employed by Azure Holdings, and certain functions critical to the ETG System’s operations are centralized and managed by Azure Holdings. Additionally, the ETG System resides in office space provided by Azure Holdings. As a result, 14.8% of the total consolidated Azure Holdings’ general and administrative expenses have been allocated to the ETG System for the periods presented. The ETG System allocated general and administrative expenses from Azure were $0.9 million and $0.7 million for the six month periods ended June 30, 2015 and 2014, respectively. In addition, the ETG System allocated transaction costs, which are included in other expense, were $1.6 million for the six months ended June 30, 2015. The ETG System allocated operating expense labor from Azure were $0.5 million and $0.6 million for the six month periods ended June 30, 2015 and 2014, respectively.
This allocation represents management’s best estimate of the general and administrative expenses and operating expense labor incurred on behalf of the ETG System and was determined after consideration of multiple operating metrics, including dedicated operating personnel, pipeline mileage and system throughput as a percentage of each total consolidated Azure’s operating metric. Management of the ETG System and Azure believe these allocations reasonably reflect the utilization of services provided and benefits received. The allocated costs are included within general and administrative expense and operating expense of the statements of operations.
See notes 2 and 5 for a discussion of long‑term debt and interest allocated from Azure.
(9) Supplemental Footnote Information
Period ended June 30, 2015 | Period ended June 30, 2014 | |||||
Supplemental schedule of non-cash investing and financing activities: | ||||||
Non-cash capital expenditures included in accounts payable and | ||||||
accrued liabilities | $ | 84 | $ | — | ||
Non-cash impact of debt and interest allocation change to net parent investment | $ | 1,353 | $ | — | ||
(10) | Subsequent Events |
On August 6, 2015, the Azure Midstream Partners (the “Partnership”) announced it has acquired 100% of the equity interests of the entity that owns the ETG System for total cash consideration of $83.0 million, subject to customary purchase price adjustments. This acquisition financed with an $80.0 million draw from the Partnership’s credit agreement and the issuance of 255,319 common units representing limited partner interests in the Partnership to the general partner of the Partnership on behalf of Azure. The assets of the ETG System include certain natural gas gathering pipelines located in Nacogdoches and Shelby Counties in Texas. This acquisition was effective as of July 1, 2015 and the Partnership's financial results will retrospectively include the financial results attributable to the acquired gas gathering pipelines for all periods beginning July 1, 2015.
32
33
TPF II EAST TEXAS GATHERING, LLC
Financial Statements
November 14, 2013 and December 31, 2012
(With Independent Auditors’ Report Thereon)
34
Independent Auditors’ Report
The Member
TPF II East Texas Gathering, LLC:
TPF II East Texas Gathering, LLC:
We have audited the accompanying financial statements of TPF II East Texas Gathering, LLC (a Delaware limited liability company) (the Company), which comprise the balance sheets as of November 14, 2013 and December 31, 2012, and the related statements of operations, member’s equity, and cash flows for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, and the related notes to the financial statements.
Management’s Responsibility for the Financial Statements
Management is responsible for the preparation and fair presentation of these financial statements in accordance with U.S. generally accepted accounting principles; this includes the design, implementation, and maintenance of internal control relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.
Auditors’ Responsibility
Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States of America. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.
An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.
We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.
Opinion
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of TPF II East Texas Gathering, LLC as of November 14, 2013 and December 31, 2012, and the results of its operations and its cash flows for the period from January 1, 2013 to November 14, 2013 and the year ended December 31, 2012, in accordance with U.S. generally accepted accounting principles.
Emphasis of Matter
As discussed in note 1 to the financial statements, on November 15, 2013, TPF II East Texas Holdings, LLC, the parent entity to the Company, sold 100% of its ownership in the Company to Azure Midstream Holdings LLC.
Omaha, Nebraska
April 24, 2014
April 24, 2014
35
TPF II EAST TEXAS GATHERING, LLC
Balance Sheets
November 14, 2013 and December 31, 2012
Assets | November 14, 2013 | December 31, 2012 | ||||
Current assets: | ||||||
Cash and cash equivalents | $ | 15,204,269 | $ | 7,898,968 | ||
Accounts receivable | 3,122,778 | 3,374,334 | ||||
Prepaid expenses and other | 450,514 | 456,244 | ||||
Total current assets | 18,777,561 | 11,729,546 | ||||
Property, plant and equipment: | ||||||
Land and right of way | 12,438,371 | 47,346,652 | ||||
Gas gathering system | 72,919,232 | 323,238,061 | ||||
Construction in progress | 4,497,109 | 2,700,191 | ||||
Other | 228,628 | 215,005 | ||||
90,083,340 | 373,499,909 | |||||
Less accumulated depreciation | — | (34,403,984 | ) | |||
Total property, plant and equipment, net | 90,083,340 | 339,095,925 | ||||
Other assets: | ||||||
Contract costs, net | 201,136 | 864,030 | ||||
Deferred finance charges, net | 408,178 | 536,959 | ||||
Other assets | 1,454,486 | 1,573,465 | ||||
Total other assets | 2,063,800 | 2,974,454 | ||||
Total assets | $ | 110,924,701 | $ | 353,799,925 | ||
Liabilities and Member's Equity | ||||||
Current liabilities: | ||||||
Accounts payable and accrued expenses | $ | 5,207,286 | $ | 5,291,246 | ||
Notes payable | 15,000,000 | — | ||||
Other liabilities | 42,365 | 71,400 | ||||
Total current liabilities | 20,249,651 | 5,362,646 | ||||
Long-term liabilities: | ||||||
Notes payable | — | 45,000,000 | ||||
Other liabilities, net of current portion | 411,368 | 411,368 | ||||
Total liabilities | 20,661,019 | 50,774,014 | ||||
Commitments and contingencies (notes 5 and 7) | ||||||
Member's equity | 90,263,682 | 303,025,911 | ||||
Total liabilities and member's equity | $ | 110,924,701 | $ | 353,799,925 | ||
See accompanying notes to financial statements.
36
TPF II EAST TEXAS GATHERING, LLC
Statements of Operations
Period from January 1, 2013 to November 14, 2013 and December 31, 2012
2013 | 2012 | |||||
Revenue: | ||||||
Gathering | $ | 8,570,688 | $ | 16,989,511 | ||
Treating | 5,610,157 | 11,978,945 | ||||
Other | 372,545 | 2,252,468 | ||||
Total revenue | 14,553,390 | 31,220,924 | ||||
Operating expenses: | ||||||
Cost of sales | 253,096 | 1,330,583 | ||||
Operation and maintenance expense | 7,321,551 | 10,134,078 | ||||
Depreciation | 14,923,080 | 16,897,385 | ||||
Impairment of long-lived assets | 237,477,930 | — | ||||
Management fees and expenses | 3,094,873 | 4,441,565 | ||||
Taxes other than income taxes | 2,066,018 | 2,006,608 | ||||
Amortization | 98,157 | 112,700 | ||||
Total operating expenses | 265,234,705 | 34,922,919 | ||||
Net operating loss | (250,681,315 | ) | (3,701,995 | ) | ||
Other income (expense): | ||||||
Interest income | 6,685 | 15,894 | ||||
Interest expense | (961,056 | ) | (1,764,204 | ) | ||
Amortization of deferred finance charges | (128,781 | ) | (150,632 | ) | ||
Other | 2,238 | (440,881 | ) | |||
Total other expense | (1,080,914 | ) | (2,339,823 | ) | ||
Net loss | $ | (251,762,229 | ) | $ | (6,041,818 | ) |
See accompanying notes to financial statements.
37
TPF II EAST TEXAS GATHERING, LLC
Statements of Member's Equity
Period from January 1, 2013 to November 14, 2013 and December 31, 2012
Balance, December 31, 2011 | $ | 309,067,729 | |
Net loss | (6,041,818 | ) | |
Balance, December 31, 2012 | 303,025,911 | ||
Equity contributions | 39,000,000 | ||
Net loss | (251,762,229 | ) | |
Balance, November 14, 2013 | $ | 90,263,682 | |
See accompanying notes to financial statements.
38
TPF II EAST TEXAS GATHERING, LLC
Statements of Cash Flows
Period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012
2013 | 2012 | |||||
Cash flows from operating activities: | ||||||
Net loss | $ | (251,762,229 | ) | $ | (6,041,818 | ) |
Adjustments to reconcile net loss to net cash from operating activities: | ||||||
Depreciation and amortization | 15,021,237 | 17,010,085 | ||||
Amortization of deferred finance charges | 128,781 | 150,632 | ||||
Impairment of long-lived assets | 237,477,930 | — | ||||
Decrease in accounts receivable | 251,556 | 5,240,468 | ||||
Decrease in prepaid expenses and other | 5,730 | 13,299 | ||||
Increase (decrease) in accounts payable and accrued expenses | 1,015,155 | (1,688,918 | ) | |||
Increase (decrease) in other liabilities | (29,035 | ) | 450,835 | |||
Net cash from operating activities | 2,109,125 | 15,134,583 | ||||
Cash flows from investing activities: | ||||||
Capital expenditures | (3,922,803 | ) | (11,678,995 | ) | ||
Other assets | 118,979 | (1,573,465 | ) | |||
Net cash from investing activities | (3,803,824 | ) | (13,252,460 | ) | ||
Cash flows from financing activities: | ||||||
Equity contributions | 39,000,000 | — | ||||
Payments on notes payable | (30,000,000 | ) | (5,000,000 | ) | ||
Net cash from financing activities | 9,000,000 | (5,000,000 | ) | |||
Net increase (decrease) in cash and cash equivalents | 7,305,301 | (3,117,877 | ) | |||
Cash and cash equivalents, beginning of period | 7,898,968 | 11,016,845 | ||||
Cash and cash equivalents, end of period | $ | 15,204,269 | $ | 7,898,968 | ||
Supplemental disclosures of cash and non-cash flow information: | ||||||
Cash paid for interest | $ | 1,101,917 | $ | 1,719,389 | ||
Non-cash additions to property, plant and equipment | $ | 517,946 | $ | 1,617,061 | ||
See accompanying notes to financial statements.
39
TPF II EAST TEXAS GATHERING, LLC
Notes to Financial Statements
November 14, 2013 and December 31, 2012
Summary of Significant Accounting Policies
(a) | Organization |
TPF II East Texas Gathering, LLC (the Company) was formed to construct and own a natural gas gathering system (the Gathering System). The Gathering System was constructed and became operational during the year ended December 31, 2010 and is designed to transport and treat natural gas from Haynesville Shale, Bossier Shale, and James Lime production. The Company is wholly owned by TPF II East Texas Holdings, LLC (Holdings).
On October 16, 2013, Holdings entered into an agreement to sell 100% of its ownership in the Company to Azure Midstream Holdings LLC (Azure). The transaction closed on November 15, 2013. The accompanying financial statements have not been remeasured at fair value under Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 805, Business Combinations, as a result of this transaction.
The Company has no employees and does not anticipate having any employees in the future. Pursuant to an agreement with an affiliate (see note 2), the affiliate will operate and maintain the Gathering System. The direct labor personnel and the operations management for the Gathering System are employees of the affiliate. Management and supervision of the Company’s operations and preparation and maintenance of the financial and other records of the Company are also the responsibility of the affiliate.
(b) | Revenue Recognition |
The Company earns a fee based on volumes of natural gas transported and treated through its Gathering System. The Company also buys natural gas from its gathering customers, transports and treats it, and then sells the natural gas to third parties. Natural gas sales and purchases are recorded net in the accompanying statements of operations. Revenue is recognized in the period gas is delivered and services are provided.
The Company sells natural gas to an affiliate, Tenaska Marketing Ventures (TMV). Gross natural gas sales to TMV were $2,754,316 and $10,335,979 for the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012, respectively. As of November 14, 2013 and December 31, 2012, the Company had a receivable from TMV of $404,175 and $0, respectively.
(c) | Accounts Receivable |
Accounts receivable are recorded at amounts billed to customers. An allowance for doubtful accounts is recorded based on an assessment of the collectibility of billed amounts. As of November 14, 2013 and December 31, 2012, the Company determined that no allowance for doubtful accounts was necessary.
(d) | Prepaid Expenses |
The Company has prepaid for builders risk, property damage, and excess liability policies. These prepayments are being amortized on a straight‑line basis over the term of the contracts or policies.
(e) | Gas Imbalances |
The Company records gas imbalances due to or due from interconnecting pipelines and its customers resulting from the difference between customer nominations and actual gas receipts from, and gas deliveries to, its customers and interconnecting pipelines under various operational balancing agreements. Gas imbalances are either settled in cash or made up in kind. Gas imbalances are recorded
40
TPF II EAST TEXAS GATHERING, LLC
Notes to Financial Statements
November 14, 2013 and December 31, 2012
based on current market prices or their contractually stipulated rate. As of November 14, 2013 and December 31, 2012, the Company’s gas imbalance receivable was $0 and $140,638, respectively, and is recorded in prepaid expenses and other in the accompanying balance sheets. As of November 14, 2013 and December 31, 2012, the Company’s gas imbalance payable was $42,365 and $71,400, respectively, and is recorded in other liabilities in the accompanying balance sheets.
(f) | Property, Plant, and Equipment |
Property, plant, and equipment are recorded at historical cost of construction, net of accumulated depreciation. The costs of maintenance and repairs are expensed when incurred. Expenditures to extend the useful life or expand the capacity of the existing assets are capitalized. During the period from January 1, 2013 to November 14, 2013, the Company recorded an impairment charge of $236,913,193 associated with its property, plant, and equipment (see note 6). Depreciation on plant and equipment is recorded using the straight‑line method over the following useful lives:
Gas gathering system | 15-20 years | |
Other plant and equipment | 3-20 years | |
Natural gas used to maintain pipeline minimum pressures, known as cushion gas, is capitalized and classified as property, plant, and equipment. The Company’s cushion gas is recoverable and as a result, not depreciated as part of the Gathering System.
As of November 14, 2013 and December 31, 2012, the construction in progress consists of costs incurred in the ongoing construction of the Gathering System. Accordingly, no depreciation expense was recorded for these costs.
The Company has various asset retirement obligations to remove or modify certain components of the Gathering System upon its retirement or abandonment. The Company cannot currently reasonably estimate the fair value of these obligations. An asset retirement obligation, if any, will be recognized when sufficient information exists to reasonably estimate the fair value of the obligation.
(g) | Contract Costs |
The Company incurred direct costs associated with entering into contracts to transport and treat natural gas. These costs were capitalized and are being amortized to expense over the terms of the respective contracts using the straight‑line method. As of November 14, 2013 and December 31, 2012, accumulated amortization was $0 and $259,378, respectively. During the period from January 1, 2013 to November 14, 2013, the Company recorded an impairment charge of $564,737 associated with its contract costs (see note 6).
(h) | Income Taxes |
The Company has no liability for federal income taxes. Income is taxed to Holdings based on the Company’s taxable income. Therefore, no provision or liability for federal income taxes has been included in the accompanying financial statements.
The Company recognizes the effect of income tax positions only if these positions are more‑likely than‑not of being sustained. Additionally, for tax positions meeting this more‑likely‑than‑not threshold, the amount of benefit is limited to the largest benefit that has a greater than 50% probability of being realized upon ultimate settlement. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs.
41
TPF II EAST TEXAS GATHERING, LLC
Notes to Financial Statements
November 14, 2013 and December 31, 2012
(i) | Impairment of Long‑Lived Assets |
Long‑lived assets, such as property, plant, and equipment, and contract costs, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long‑lived asset to be tested for impairment, the Company first compares undiscounted cash flows expected to be generated by an asset to the carrying value of the asset. If the carrying value of the long‑lived asset is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. During the period from January 1, 2013 to November 14, 2013, the Company recorded an impairment charge of $237,477,930 associated with its long‑lived assets (see note 6).
(j) | Fair Value Measurements |
In accordance with U.S. generally accepted accounting principles (U.S. GAAP), investments measured and reported at fair value are classified and disclosed in one of the following categories:
Level 1 – Unadjusted quoted prices available in active markets that are accessible at the measurement date for identical unrestricted assets and liabilities. This level primarily consists of financial instruments such as exchange‑traded securities and listed derivatives.
Level 2 – Pricing inputs include quoted prices for identical or similar assets and liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability, and inputs that are derived principally from or corroborated by observable market data by correlation or other means.
Level 3 – Pricing inputs include those that are generally less observable or unobservable and include situations where there is little, if any, market activity for the investment. Fair value for these investments is determined using valuation methodologies that consider a range of factors, including but not limited to the price at which the investment was acquired, the nature of the investment, local markets conditions, and current and projected operating performance. The inputs into the determination of fair value require significant management judgment. Due to the inherent uncertainty of these estimates, these values may differ materially from the values that would have been used had a ready market for these investments existed.
In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, an investment’s level within the fair value hierarchy is based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and the Company considers various factors specific to the investment. A review of the fair value hierarchy classification is conducted at each fiscal year end reporting date.
The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. As of November 14, 2013 and December 31, 2012, the carrying amount approximates fair value for cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, and notes payable. The Company used Level 3 inputs in connection with its long‑lived asset impairment analysis (see note 6).
(k) | Risks and Uncertainties |
The Company is subject to several risks including, but not limited to, risks associated with the nature of and reliance on long‑term contractual obligations with various third parties, the ability to operate
42
TPF II EAST TEXAS GATHERING, LLC
Notes to Financial Statements
November 14, 2013 and December 31, 2012
the Gathering System in order to meet long‑term contractual obligations, regulatory risks, and other uncertainties in the midstream natural gas industry.
(l) | Use of Estimates |
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
(2) | Transactions with Affiliates |
The Company has an agreement with an affiliate, TPF Gas Services, LLC (TPF Gas Services), under which TPF Gas Services provides the day‑to‑day management of the affairs of the Company, services for the operation and maintenance of the Gathering System, and preparation and maintenance of the financial and other records and books of account of the Company. During the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012, billings from TPF Gas Services to the Company were $4,093,334 and $5,852,571, respectively. As of November 14, 2013 and December 31, 2012, the Company had a payable to TPF Gas Services of $319,010 and $25,676, respectively.
The Company had an Operational Services Agreement with an affiliate, TPF Project Services, LLC (Project Services), which terminated effective May 1, 2013. Project Services provided operational and administrative support services to the Company such as engineering and environmental consulting and project management services. During the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012, billings from Project Services to the Company were $111,805 and $447,783, respectively. As of November 14, 2013 and December 31, 2012, the Company had a payable to Project Services of $0 and $133,655, respectively.
(3) | Concentration Risk |
The Company’s customers are comprised of primarily investment grade entities. As of November 14, 2013, four customers accounted for approximately 89% of total accounts receivable, and as of December 31, 2012, three customers accounted for approximately 93% of total accounts receivable. For the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012, three customers accounted for approximately 76% and 83%, respectively, of total gathering and treating revenue.
(4) | Notes Payable |
The Company entered into a credit agreement on August 11, 2011. The credit agreement includes a $50,000,000 commitment for notes payable and letters of credit. As of November 14, 2013 and December 31, 2012, the Company had outstanding notes payable of $15,000,000 and $45,000,000, respectively. The credit agreement terminates on August 11, 2016.
The borrowings have variable interest rates based on a LIBOR loan rate plus an applicable margin. As of November 14, 2013 and December 31, 2012, the weighted average interest rate of the borrowings was 3.23% and 3.30%, respectively. Interest expense for the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012 was $961,056 and $1,764,174, respectively.
The credit agreement contains various restrictive covenants with which the Company must comply, including leverage and interest coverage ratios. As of November 14, 2013 and December 31, 2012, the Company was in compliance with all financial covenants. The credit agreement also provides for a first security interest in substantially all of the assets of the Company.
43
TPF II EAST TEXAS GATHERING, LLC
Notes to Financial Statements
November 14, 2013 and December 31, 2012
(5) | Leases |
The Company has operating leases for treatment and compression plant equipment that expire over the next three years. The leases contain one‑month renewal period provisions. Future minimum lease payments for the leases are as follows:
2013 | $ | 158,540 | |
2014 | 2,505,099 | ||
2015 | 2,391,699 | ||
2016 | 980,950 | ||
$ | 6,036,288 | ||
Rent expense for the period from January 1, 2013 to November 14, 2013 and year ended December 31, 2012 related to these leases was $2,237,887 and $2,643,720, respectively.
(6) | Impairment Charge |
Management reviews long‑lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount of such assets may not be recoverable. On October 16, 2013, Holdings entered into an agreement to sell 100% of its interests in the Company (the Transaction). The Transaction, along with decreases in volume and natural gas prices, triggered the performance of an impairment analysis and an undiscounted cash flow analysis indicated potential impairment. The Company developed a fair value estimate of long‑lived assets and compared the carrying amounts of land, gas gathering system, and contract costs to their estimated fair value. This resulted in an impairment charge of $237,477,930 on the statement of operations for the period from January 1, 2013 to November 14, 2013. The impairment was allocated to long‑lived assets and reduced the gross carrying amount of long‑lived assets and their related accumulated depreciation and amortization. No impairment charges were recorded during the year ended December 31, 2012.
The fair value measurement was primarily based on the value assigned to the Company in the Transaction and was supported by a discounted cash flow analysis that included the following significant inputs: discount rate, terminal multiple, and projections of revenues and expenses. These inputs are considered Level 3 inputs in the fair value hierarchy (see note 1(j)).
(7) | Commitments and Contingencies |
The Company may be involved from time to time in certain regulatory matters, claims, and pending litigation arising in the normal course of business. The Company’s management believes the ultimate resolution of these matters, if applicable, will not have an adverse material effect on the financial condition of the Company.
(8) | Subsequent Events |
On November 15, 2013, Holdings completed the sale of the Company to Azure, repaid the outstanding balance of notes payable, and terminated the credit agreement, and changed its name to Azure ETG LLC.
The Company has performed an evaluation of subsequent events through April 24, 2014, the date the financial statements were available to be issued. Based on the Company’s evaluation, no other material events have occurred requiring disclosure.
44
Exhibit 99.5
Unaudited Pro Forma Consolidated and Combined Financial Statements
The Unaudited Pro Forma Consolidated and Combined Financial Statements, or the pro forma financial statements, combine the carve-out historical financial statements of the Legacy gathering system entities and assets (the "Legacy System") the accounting predecessor of Azure Midstream Partners, LP, formerly Marlin Midstream Partners, LP, (the "Partnership”), the historical consolidated and combined financial statements of the Partnership and the carve-out historical financial statements of the ETG System (as defined below) to illustrate the effect of the transactions described below.
Unless the context requires otherwise, for purposes of this pro forma presentation, all references to "we", "our", or "us" refer to the Partnership and its subsidiaries, including the Legacy System and ETG System, following the transactions described below. The pro forma financial statements were based on, and should be read in conjunction with, the:
• | accompanying notes to the Unaudited Pro Forma Consolidated and Combined Financial Statements; |
• | financial statements of the Azure Legacy System, a carve out of Azure Midstream Holdings LLC, as of and for the year ended December 31, 2014, and the notes relating thereto, included in exhibit 99.2 of the Partnership’s current report on Form 8-K/A dated April 6, 2015; |
• | financial statements of the Azure ETG System, a carve-out of Azure Midstream Holdings LLC (the "ETG System"), as of and for the six months ended June 30, 2015, as of December 31, 2014 and 2013, and for the year ended December 31, 2014, the period from November 15, 2013 to December 31, 2013, and the period from January 1, 2013 to November 14, 2013, and the notes relating thereto, included as Exhibit 99.4 of this Form 8-K/A; and |
• | consolidated financial statements of the Partnership for the six months ended June 30, 2015 and year ended December 31, 2014 and the notes relating thereto, included in the Partnership’s Quarterly Report on Form 10-Q for the six months ended June 30, 2015 and 2014 Annual Report on Form 10-K. |
The historical consolidated financial statements have been adjusted in the pro forma financial statements to give effect to pro forma events that are (a) directly attributable to the transactions described below, (b) factually supportable and (c) with respect to the pro forma statements of operations, expected to have a continuing impact on the combined results. The Unaudited Pro Forma Consolidated and Combined Statements of Operations, or the pro forma statements of operations, for the year ending December 31, 2014 and the six months ended June 30, 2015, give effect to the transactions described below as if they occurred on January 1, 2014. The Unaudited Pro Forma Consolidated and Combined Balance Sheet, or the pro forma balance sheet, as of June 30, 2015, gives effect to the transactions described below as if they occurred on June 30, 2015.
The pro forma financial statements have been prepared under the rules and regulations of the Securities and Exchange Commission. The pro forma financial statements have been presented for informational purposes only and are based upon available information and assumptions that management believes are reasonable under the circumstances. These pro forma financial statements are not necessarily indicative of what the combined entity’s results of operations and financial position would have been had the transactions been completed on the dates indicated. We have incurred and expect to incur additional costs to integrate the Legacy and ETG Systems into the Partnership’s businesses. The pro forma financial statements do not reflect the cost of any integration activities or benefits that may result from synergies that may be derived from any integration activities. In addition, the pro forma financial statements do not purport to project the future results of operations or financial position of the combined entity.
Description of the Transactions
Acquisition of the Legacy System
On February 27, 2015, we consummated certain transactions contemplated by that certain Transaction Agreement (the “Transaction Agreement”) by and among us, Azure Midstream Energy LLC, a Delaware limited liability company that is wholly owned by Azure Midstream Holdings LLC (collectively “Azure”), Azure Midstream Partners GP, LLC formerly Marlin Midstream GP, LLC (the “General Partner”), NuDevco and Marlin IDR Holdings (“IDRH”).
The consummation of the transactions contemplated by the Transaction Agreement resulted in the contribution of the Legacy System to us from Azure and Azure receiving $92.5 million in cash and acquiring 100% of the equity interests in our General Partner and 90% of our IDR Units, as defined below.
1
The Transactions (as defined below) occurred in the following steps:
• | we amended and restated our partnership agreement to (i) reflect the unitization of all of our incentive distribution rights (as unitized, the “IDR Units”), and (ii) recapitalize the incentive distribution rights owned by IDRH into 100 IDR Units. |
• | we redeemed 90 IDR Units held by IDRH in exchange for a payment by us of $63.0 million to IDRH (the “Redemption”). |
• | Azure contributed the Legacy System to us through the contribution of: (i) all of the outstanding general and limited partner interests in Talco Midstream Assets, Ltd., a Texas limited liability company and subsidiary of Azure (“Talco”); and (ii) certain assets (the “TGG Assets”) owned by TGG Pipeline, Ltd., a Texas limited liability company and subsidiary of Azure (“TGG”), in exchange for aggregate consideration of $162.5 million, which was paid to Azure in the form of a cash payment of $99.5 million and the issuance of 90 IDR Units (the foregoing transaction, collectively, the “Contribution”). |
• | Azure purchased from NuDevco: (i) all of the outstanding membership interests in the General Partner for $7.0 million (the “GP Purchase,”); and (ii) an option to acquire up to 20% of each of our common units and subordinated units held by NuDevco as of the execution date of the Transaction Agreement (the “Option,” together with the Redemption, Contribution and GP Purchase, the “Transactions”). |
Contemporaneously with the Transactions, we entered into a new senior secured revolving credit facility (the “Credit Agreement”) with Wells Fargo Bank, National Association, as administrative agent, Wells Fargo Securities, LLC, Merrill Lynch, Pierce, Fenner & Smith Incorporated and SG Americas Securities, LLC (collectively, the “Lenders”). The Credit Agreement has a maturity date of February 27, 2018 and up to $250.0 million in commitments. We immediately borrowed $180.8 million under the Credit Agreement, of which $99.5 million was used in connection with the Contribution, $63.0 million was used in connection with the Redemption, $15.0 million was used to repay the outstanding balance as of February 27, 2015 under our existing senior secured revolving credit facility and $3.3 million was used to pay fees and expenses associated with the Credit Agreement. Associated Energy Services ("AES"), a wholly owned subsidiary of NuDevco and our affiliate, immediately pledged $15.0 million of the $63.0 million received as part of the Redemption as collateral for a letter of credit supporting our logistics segment's transloading services agreements.
As a result of the Transactions, Azure acquired a controlling financial interest in the Partnership through the GP Purchase. Azure is considered the accounting acquirer of the General Partner, and therefore will record its acquisition of the General Partner as a business combination within Azure’s consolidated financial statements. The Legacy System is deemed to be the accounting acquirer of the Partnership because its parent company, Azure, obtained control of the Partnership through the indirect control of the General Partner. Consequently, the Legacy System is the predecessor of the Partnership for financial reporting purposes and the historical consolidated financial statements of the Partnership for the three years ended December 31, 2014 have been recast and now reflect those of the Legacy System, as the accounting acquirer. The Legacy System's assets and liabilities retain their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Legacy System in the business combination have been recorded at their fair values measured as of the acquisition date. The results of the purchase price allocation of the Partnership utilized in these pro forma financial statements are preliminary, and pending completion and review by an external valuation expert within a one year measurement period. Any changes to these preliminary values will be retroactively adjusted using the acquisition method. The excess of the assumed purchase price of the Partnership, which has been determined using acceptable fair value methods and is partially based on the consideration Azure paid for the general partner interests and the IDR Units, over the estimated fair values of the Partnership's net assets acquired will be recorded as goodwill. Goodwill will be subject to annual impairment testing beginning in 2015.
Additionally, because the Legacy System is reflected at Azure’s historical cost, the difference between the $162.5 million in consideration paid by the Partnership and Azure's historical carrying values (net book value) at February 27, 2015 was recorded as an adjustment to partners’ capital.
Legacy System
The Legacy System consists of approximately 658 miles of high-and low-pressure gathering lines and serves approximately 100,000 dedicated acres within Harrison, Panola and Rusk counties in Texas and Caddo parish in Louisiana and currently serves the Cotton Valley formation, the Haynesville shale formation and the shallower producing sands in the Travis Peak formation. The Legacy System has access to seven major downstream markets, three third-party processing plants and the
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Panola County processing plants. The combination of the Partnership's natural gas processing assets and the Legacy System's gathering assets creates a diverse platform of midstream services and establishes the Partnership as one of the largest gathering and processing systems in the Cotton Valley formation in East Texas and North Louisiana.
Contribution of the ETG System
On August 6, 2015, the Partnership, entered into a contribution agreement (the “Contribution Agreement”) with Azure which is the sole member of the General Partner. Pursuant to the Contribution Agreement, Azure contributed 100% of the outstanding membership interests in Azure ETG, LLC ("Azure ETG"), the entity that owns and operates the ETG System, to the Partnership in exchange for the consideration described below. The closing of the transactions contemplated by the Contribution Agreement occurred simultaneously with the execution of the Contribution Agreement. The Contribution Agreement contains customary representations and warranties, indemnification obligations and covenants by the parties, and provides that the Partnership’s acquisition of Azure ETG was effective on July 1, 2015.
The following transactions took place pursuant to the Contribution Agreement:
• | As consideration for the membership interests of Azure ETG, the Partnership paid Azure $80,000,000 in cash and issued 255,319 common units representing limited partner interests in the Partnership to Azure. | ||
• | The Partnership entered into a gas gathering agreement (the “Gas Gathering Agreement”) with TGG as discussed below. | ||
The Partnership financed the cash consideration paid for ETG with an $80,000,000 draw from its credit facility.
Because the acquisition of Azure ETG System is considered to be a transaction amongst entities under common control, the ETG System is reflected at Azure's historical cost and the difference between that historical cost and the purchase price is recorded as an adjustment to partners' capital.
ETG System
The ETG System includes approximately 255 miles of gathering pipelines, three treating plants, 10 MMcf/d of processing capacity and four interconnections with major interstate pipelines providing 1.75 Bcf per day of access to downstream markets. A total of 336,000 gross acres in the Haynesville Shale and Bossier Shale formations are dedicated to the ETG System under 23 long-term producer contracts.
Gas Gathering Agreement
Pursuant to the terms of the Gas Gathering Agreement, the Partnership agreed to provide gathering services to TGG on a priority basis for quantities of gas designated by TGG as set forth therein. Azure has guaranteed TGG’s obligations under the Gas Gathering Agreement.
Sale of Limited Partner Units
On June 17, 2015, and July 17, 2015 the Partnership sold 3,590,000 limited partner units in a public offering. The net proceeds of the offering, including the proportionate capital contribution by the General Partner to maintain its 1.95% general partner interest was approximately $49.5 million.
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Azure Midstream Partners, LP
Unaudited Pro Forma Consolidated and Combined Statement of Operations
For the Year Ended December 31, 2014
(in thousands, except per unit amounts)
Legacy System | Azure Midstream Partners, LP | ETG System | Pro Forma | Pro Forma | |||||||||||||||
Historical | Historical | Historical | Adjustments | Combined | |||||||||||||||
Operating Revenues: | |||||||||||||||||||
Natural gas, NGLs and condensate revenue | $ | 42,854 | $ | 13,569 | $ | 8,630 | $ | — | $ | 65,053 | |||||||||
Gathering, processing, transloading and other fee revenue | 14,253 | 23,635 | 8,984 | — | 46,872 | ||||||||||||||
Gathering, processing, transloading and other fee revenue - affiliates | — | 38,024 | — | — | 38,024 | ||||||||||||||
Total operating revenues | 57,107 | 75,228 | 17,614 | — | 149,949 | ||||||||||||||
Operating Expenses: | |||||||||||||||||||
Cost of natural gas and NGLs | 30,642 | 4,790 | 7,400 | — | 42,832 | ||||||||||||||
Cost of natural gas and NGLs - affiliates | — | 12,558 | — | — | 12,558 | ||||||||||||||
Operation and maintenance | 5,912 | 8,899 | 6,854 | (2,392 | ) | (a) | 19,273 | ||||||||||||
Operation and maintenance - affiliates | — | 6,668 | — | — | 6,668 | ||||||||||||||
General and administrative | — | 3,602 | — | — | 3,602 | ||||||||||||||
General and administrative - affiliates | 4,444 | 5,067 | 1,368 | (620 | ) | (b) | 10,339 | ||||||||||||
80 | (b) | ||||||||||||||||||
Property tax expense | 919 | 1,316 | — | — | 2,235 | ||||||||||||||
Depreciation and amortization expense | 5,354 | 8,817 | 2,607 | 7,010 | (c) | 23,788 | |||||||||||||
Loss (gain) on disposal of equipment | (13 | ) | 60 | — | — | 47 | |||||||||||||
Asset impairments | 228 | — | — | — | 228 | ||||||||||||||
Total operating expenses | 47,486 | 51,777 | 18,229 | 4,078 | 121,570 | ||||||||||||||
Operating income (loss) | 9,621 | 23,451 | (615 | ) | (4,078 | ) | 28,379 | ||||||||||||
Interest expense | 10,648 | 766 | 4,501 | (15,149 | ) | (d) | 9,601 | ||||||||||||
7,551 | (d) | ||||||||||||||||||
1,284 | (d) | ||||||||||||||||||
Other expense | — | — | 464 | — | 464 | ||||||||||||||
Net income (loss) before tax expense | (1,027 | ) | 22,685 | (5,580 | ) | 2,236 | 18,314 | ||||||||||||
Income tax expense | 163 | 553 | 50 | — | 766 | ||||||||||||||
Net income (loss) | $ | (1,190 | ) | $ | 22,132 | $ | (5,630 | ) | $ | 2,236 | $ | 17,548 | |||||||
Net income per unit: | |||||||||||||||||||
Net Income | $ | 22,132 | $ | 17,548 | |||||||||||||||
Less: | |||||||||||||||||||
Allocation of East Texas New Mexico Dropdown net income prior to acquisition | 160 | 160 | |||||||||||||||||
General partner interest in net income | 435 | 345 | |||||||||||||||||
Limited partner interest in net income | $ | 21,537 | $ | 17,043 | |||||||||||||||
Net Income per limited partner common and subordinated unit - basic | $ | 1.22 | $ | 0.79 | |||||||||||||||
Net Income per limited partner common and subordinated unit - diluted | $ | 1.21 | $ | 0.79 | |||||||||||||||
Weighted average limited partner common and subordinated units outstanding - basic | 17,626,840 | 4,041,427 | (e) | 21,668,267 | |||||||||||||||
Weighted average limited partner common and subordinated units outstanding - diluted | 17,751,279 | 4,041,427 | (e) | 21,792,706 | |||||||||||||||
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Azure Midstream Partners, LP
Unaudited Pro Forma Consolidated and Combined Balance Sheet
As of June 30, 2015
(in thousands, except number of units)
Azure Midstream Partners, LP | ETG System | Pro Forma | Pro Forma | |||||||||||||
Historical | Historical | Adjustments | Combined | |||||||||||||
Assets | ||||||||||||||||
Current Assets: | ||||||||||||||||
Cash and cash equivalents | $ | 5,179 | $ | — | $ | 84,000 | (f) | $ | 9,179 | |||||||
(80,000 | ) | (g) | ||||||||||||||
Accounts receivable, net | 12,091 | 1,492 | — | 13,583 | ||||||||||||
Other current assets | 628 | 617 | (605 | ) | (h) | 640 | ||||||||||
Total current assets | 17,898 | 2,109 | 3,395 | 23,402 | ||||||||||||
Property, plant and equipment, net | 404,020 | 87,594 | — | 491,614 | ||||||||||||
Intangible assets, net | 62,833 | — | — | 62,833 | ||||||||||||
Goodwill | 215,758 | — | — | 215,758 | ||||||||||||
Deferred tax asset | — | 211 | — | 211 | ||||||||||||
Other non-current assets | 3,437 | 1,823 | (1,823 | ) | (i) | 3,437 | ||||||||||
Total Assets | $ | 703,946 | $ | 91,737 | $ | 1,572 | $ | 797,255 | ||||||||
Liabilities, Partners' Capital and Parent Company Net Investment | ||||||||||||||||
Current Liabilities: | ||||||||||||||||
Accounts payable and accrued liabilities | $ | 8,409 | $ | 1,877 | $ | (1,086 | ) | (i) | $ | 9,840 | ||||||
640 | (i) | |||||||||||||||
Current portion of long-term debt allocated from the Azure Credit Agreement | — | 3,603 | (3,603 | ) | (j) | — | ||||||||||
Total current liabilities | 8,409 | 5,480 | (4,049 | ) | 9,840 | |||||||||||
Long-Term Liabilities: | ||||||||||||||||
Long-term debt | 142,951 | 48,660 | 84,000 | (f) | 226,951 | |||||||||||
(48,660 | ) | (j) | ||||||||||||||
Deferred income taxes | 1,037 | — | 1,037 | |||||||||||||
Other long-term liabilities | — | 11,625 | — | 11,625 | ||||||||||||
Total liabilities | 152,397 | 65,765 | 31,291 | 249,453 | ||||||||||||
Partners' Capital and Parent Company Net Investment | ||||||||||||||||
Common Units (12,950,675 issued and outstanding at June 30, 2015) | 266,330 | — | (943 | ) | (k) | 265,387 | ||||||||||
Subordinated units (8,724,545 issued and outstanding at June 30, 2015) | 207,265 | — | (2,670 | ) | (k) | 204,595 | ||||||||||
General partner units (357,935 issued and outstanding at June 30, 2015) | 7,954 | — | (134 | ) | (k) | 7,820 | ||||||||||
Incentive distribution rights (100 issued and outstanding as of June 30, 2015) | 70,000 | — | — | 70,000 | ||||||||||||
Parent company net investment | — | 25,972 | (25,972 | ) | (l) | — | ||||||||||
Total Partners' Capital and Parent Company Net Investment | 551,549 | 25,972 | (29,719 | ) | 547,802 | |||||||||||
Total Liabilities, Partners' Capital and Parent Company Net Investment | $ | 703,946 | $ | 91,737 | $ | 1,572 | $ | 797,255 | ||||||||
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Azure Midstream Partners, LP
Unaudited Pro Forma Consolidated and Combined Statement of Operations
For the Six Months Ended June 30, 2015
(in thousands, except per unit amounts)
Azure Midstream Partners, LP | Azure System Predecessor | ETG System | Pro Forma | Pro Forma | ||||||||||||||||
Historical | Historical (1) | Historical | Adjustments | Combined | ||||||||||||||||
Operating Revenues: | ||||||||||||||||||||
Natural gas, NGLs and condensate revenue | $ | 10,053 | $ | 549 | $ | 1,973 | $ | — | $ | 12,575 | ||||||||||
Gathering, processing, transloading and other fee revenue | 24,239 | 9,312 | 3,787 | — | 37,338 | |||||||||||||||
Total operating revenues | 34,292 | 9,861 | 5,760 | — | 49,913 | |||||||||||||||
Operating Expenses: | ||||||||||||||||||||
Cost of natural gas and NGLs | 8,005 | 1,179 | 1,792 | — | 10,976 | |||||||||||||||
Operation and maintenance | 6,627 | 3,523 | 3,808 | (1,196 | ) | (h) | 12,762 | |||||||||||||
General and administrative | 6,387 | 11,548 | 861 | 640 | (i) | 19,436 | ||||||||||||||
Depreciation and amortization expense | 7,781 | 1,490 | 1,297 | 1,148 | (m) | 11,716 | ||||||||||||||
Total operating expense | 28,800 | 17,740 | 7,758 | 592 | 54,890 | |||||||||||||||
Operating Income | 5,492 | (7,879 | ) | (1,998 | ) | (592 | ) | (4,977 | ) | |||||||||||
Interest expense | 4,349 | 109 | 2,349 | (2,458 | ) | (n) | 4,558 | |||||||||||||
209 | (n) | |||||||||||||||||||
Other expense, net | — | — | 1,680 | — | 1,680 | |||||||||||||||
Net income (loss) before income tax expense | 1,143 | (7,988 | ) | (6,027 | ) | 1,657 | (11,215 | ) | ||||||||||||
Income tax expense (benefit) | 710 | 39 | (211 | ) | — | 538 | ||||||||||||||
Net income (loss) | $ | 433 | $ | (8,027 | ) | $ | (5,816 | ) | $ | 1,657 | $ | (11,753 | ) | |||||||
Net income per unit: | ||||||||||||||||||||
Net Income | $ | 433 | $ | (11,753 | ) | |||||||||||||||
Less: | ||||||||||||||||||||
Net loss attributable to to Azure System Predecessor for the period January 1, 2015 to February 28, 2015 | (1,666 | ) | (3,543 | ) | ||||||||||||||||
General partner interest in net income (loss) | 41 | (160 | ) | |||||||||||||||||
Limited partner interest in net income (loss) | $ | 2,058 | $ | (8,050 | ) | |||||||||||||||
Net income (loss) per limited partner common and subordinated units - basic and diluted | $ | 0.11 | $ | (0.37 | ) | |||||||||||||||
Weighted average limited partner common and subordinated units outstanding - basic and diluted | 18,178,098 | 3,886,731 | (o) | 22,064,829 | ||||||||||||||||
(1) Azure System Predecessor historical results of operations reflect the period from January 1, 2015 to February 28, 2015. | ||||||||||||||||||||
6
Notes to the Unaudited Pro Forma Consolidated and Combined Financial Statements of
Azure Midstream Partners, LP
(1) Basis of Presentation
The Unaudited Pro Forma Consolidated and Combined Financial Statements are based upon the historical carve-out financial statements of the Legacy System (as Predecessor), the historical carve-out financial statements of the ETG System and the historical financial statements of the Partnership. The unaudited pro forma consolidated and combined financial statements, at and for the twelve months ended December 31, 2014, present the effect of the Transactions and the Contribution Agreement, described above, on the Legacy System's historical results of operations and financial position, as if the Transactions and Contribution Agreement occurred on January 1, 2014 and December 31, 2014, as applicable. The Unaudited Pro Forma Consolidated and Combined Statements of Operations, or the pro forma statements of operations, for the year ending December 31, 2014 and the six months ended June 30, 2015, give effect to the transactions described below as if they occurred on January 1, 2014. The Unaudited Pro Forma Consolidated and Combined Balance Sheet, or the pro forma balance sheet, as of June 30, 2015, gives effect to the transactions described below as if they occurred on June 30, 2015.
(2) Pro Forma Adjustments
The following adjustments have been made to the unaudited pro forma consolidated and combined financial statements at and for the year ended December 31, 2014:
a. | To eliminate rent expense of $2.4 million associated with three leased amine treating units. Per the terms of the Contribution Agreement, the lease agreements for the three amine treating units were terminated and paid in full by Azure and not contributed to the Partnership. |
b. | To reflect the adjustment for: (i) a decrease of $0.6 million in general and administrative expense to remove the portion of the Legacy System transaction costs that were previously expensed during the year ended December 31, 2014; and (ii) an increase of $0.1 million of transaction costs consisting of advisory and other transaction-related costs related to the ETG System to reflect transaction costs incurred to date. The Partnership estimates that it will incur $2.1 million in total transaction related expenses, and these transaction expenses are excluded from the pro forma statement of operations because they reflect non-recurring charges that are not expected to have a continuing impact on the combined results. |
c. | Adjustments to depreciation and amortization expense resulting from the effects of purchase accounting adjustments related to the acquisition of the Legacy System and the effects of adjusting the useful lives used to calculate depreciation and amortization. The adjusted estimated useful lives correspond to the expected lives used to determine the fair value of the property, plant and equipment and related identifiable intangible assets. Expected useful lives and amortization periods related to depreciation and amortization in the pro forma adjustments are as follows: |
Useful Lives | ||
Tangible Assets: | ||
Gathering pipelines and related equipment | 45 | |
Gas processing plants | 20 | |
Buildings | 30 | |
Other depreciable assets | 5 - 15 | |
The pro forma adjustments increased historical depreciation and amortization expense by $7.0 million for the year ended December 31, 2014, of which $6.5 million is associated with the customer relationship intangible assets that resulted from the purchase accounting adjustments described above and $0.5 million is associated with the adjustment to the tangible assets.
d. | To reflect the net adjustment to interest expense for changes in outstanding debt, interest rates, deferred financing cost amortization and commitment fees associated with the Partnership's $250.0 million senior secured revolving credit facility (the "Credit Agreement") and Azure's $550.0 million senior secured term loan B and $50.0 million senior secured revolving credit facility, collectively (the "Azure Credit Agreement") related to: (i) reverse interest |
7
expense related to the Azure Credit Agreement of $10.6 million allocated to the Legacy system and $4.5 million allocated to the ETG System as these amounts were not contributed to the Partnership; (ii) increase in interest expense related to the Credit Agreement of $6.3 million related to the Legacy System determined utilizing an interest rate of approximately 3.50% on the outstanding borrowings of $180.8 million during the period plus estimated deferred financing cost amortization of $1.1 million plus estimated commitment fees of $0.2 million; and (iii) increase in interest expense related to the Credit Agreement of $1.3 million related to the ETG System determined utilizing an interest rate of approximately 3.50% on the net outstanding borrowings of $36.7 million during the period. The net outstanding borrowing represent borrowings of $80.0 million to fund the Contribution Agreement and $4.0 million for general operating and administrative expenses, offset by a payment of $47.3 million from proceeds of our public offering of 3,500,000 common units, which closed in June of 2015.
e. | To reflect 255,319 common units issued in connection with the Contribution Agreement, the effect of 3,590,000 common units sold in the public offering and 196,108 common units related to the long-term incentive plan which automatically vested upon the consummation of the transactions contemplated by the Transaction Agreement on February 27, 2015. |
The following adjustments have been made to the unaudited pro forma consolidated and combined financial statements at and for the six months ended June 30, 2015:
f. To reflect borrowing of $84.0 million on the Credit Agreement for: (i) $80.0 million to fund the Contribution Agreement; and (ii) $4.0 million for general operating and administrative expenses, including costs related to the transactions contemplated by the Contribution Agreement.
g. To reflect the payment of $80.0 million to Azure as consideration pursuant to the Contribution Agreement.
h. To eliminate prepaid rent expense of $0.6 million and rent expense of $1.2 million associated with three leased amine treating units. Per the terms of the Contribution Agreement, the lease agreements for the three amine treating units were terminated and paid in full by Azure and not contributed to the Partnership.
i To reflect the adjustments for: (i) write-off of the ETG System's deferred financing costs of $1.8 million and accrued liabilities of $1.1 million as these assets were not contributed to the Partnership and have been removed as pro forma adjustments to partners' capital; and (ii) increase of $0.6 million of accrued transaction costs consisting of advisory and other transaction-related costs related to the ETG System.
j. To eliminate the $3.6 million of current portion of long-term debt and $48.7 million of long-term debt allocated to the ETG System related to the Azure Credit Agreement as it was not contributed to the Partnership and thus has been removed as a pro forma adjustment to partners' capital.
k. To reflect the adjustments for the decrease to partners' capital due to the consideration paid for the ETG System being in excess of the net book value of Azure's historical cost of the ETG System's net assets acquired and liabilities assumed.
l. To reflect the net adjustment to the parent company net investment of the ETG System as this amount is eliminated in connection with the transactions contemplated by the Contribution Agreement.
m. Adjustments to depreciation and amortization expense resulting from the effects of purchase accounting adjustments related to the acquisition of the Legacy System and the effects of adjusting the useful lives used to calculate depreciation and amortization. The pro forma adjustments increased historical depreciation and amortization expense by $1.1 million for the six months ended June 30, 2015, primarily associated with the customer relationship intangible assets that resulted from the purchase accounting adjustments described above.
n. To reflect the adjustments to reverse interest expense and amortization of deferred financing costs of $2.3 million for the six months ended June 30, 2015 allocated to the ETG System not contributed to the Partnership and reverse interest expense of $0.1 million allocated to the Azure System Predecessor not contributed to the Partnership. This decrease was partially offset by a net increase in interest expense of $0.2 million comprised of: (i) increase to interest expense of $3.1 million related to the Legacy System determined utilizing an interest rate of approximately 3.50% on the outstanding borrowings of $180.8 million during the period plus estimated deferred financing cost amortization of $0.5 million plus estimated commitment fees of $0.1 million; and (ii) increase to interest expense of $0.8 million related to the ETG System determined utilizing an interest rate of approximately 3.50% on net
8
outstanding borrowings of $36.7 million during the period. The net outstanding borrowing represent borrowings of $80.0 million to fund the transactions contemplated by the Contribution Agreement and $4.0 million for general operating and administrative expenses, offset by a payment of $47.3 million from proceeds of our public offering of 3,500,000 common units, which closed in June of 2015; these increases were partially offset by (iii) $4.3 million of interest expense previously recorded during the period by the Partnership.
o. To reflect 255,319 common units issued in connection with the transactions contemplated by the Contribution Agreement, the effect of 3,590,000 common units sold in the public offering, partially offset by 154,696 common units included in the weighted average calculation of common units at the Partnership at June 30, 2015 and 196,108 common units related to the long-term incentive plan which automatically vested upon the consummation of the transactions contemplated by the Transaction Agreement on February 27, 2015.
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