Form 10-Q AZURE MIDSTREAM PARTNERS For: Sep 30

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

Form 10-Q



☑QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

Or

◻TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from           to

 

 

Azure Midstream Partners, LP

(Exact Name of Registrant as Specified in its Charter)

 

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes  ☑    No  ◻

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files.)  Yes  ☑     No   ◻

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in rule 12b-2 of the Exchange Act.

 

 

Indicate by a check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange

Act).  Yes  ◻   No  ☑

 

The registrant had the following number of units outstanding as of November 2, 2016:

 

 

 

 

 

 

AZURE MIDSTREAM PARTNERS, LP

INDEX TO QUARTERLY REPORT ON FORM 10-Q

For the Quarter Ended September 30, 2016

 

 

 

 

 

 

 

 

GLOSSARY OF TERMS

 

The following are definitions of certain terms used in this Quarterly Report on Form 10-Q (“Quarterly Report”):

 

Bbls: One stock tank barrel, or 42 U.S. gallons liquid volume, used in reference to oil or other liquid hydrocarbons.

 

Bbls/d: Stock tank barrel per day.

 

Bbls/hr: Stock tank barrel per hour.

 

Condensate: A natural gas liquid with a low vapor pressure, mainly composed of propane, butane, pentane and heavier hydrocarbon fractions.

 

Crude oil: A mixture of hydrocarbons that exists in liquid phase in underground reservoirs.

 

Dry gas: A natural gas primarily composed of methane and ethane where heavy hydrocarbons and water either do not exist or have been removed through processing.

 

End-user markets: The ultimate users and consumers of transported energy products.

 

EUR: Estimated ultimate recovery.

 

GPM: Gallons per Mcf.

 

Mcf: One thousand cubic feet.

 

MMBtu: One million British Thermal Units.

 

MMcf: One million cubic feet.

 

MMcf/d: One million cubic feet per day.

 

Natural gas liquids, or NGLs: The combination of ethane, propane, normal butane, isobutane and natural gasolines that when removed from natural gas become liquid under various levels of higher pressure and lower temperature.

 

Residue gas: The dry gas remaining after being processed or treated.

 

Tailgate: Refers to the point at which processed natural gas and natural gas liquids leave a processing facility for end-user markets.

 

Throughput: The volume of natural gas transported or passing through a pipeline, plant, terminal or other facility during a particular period.

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

We have made in this Quarterly Report and may from time to time otherwise make in other public filings, press releases and discussions by management, forward-looking statements concerning our operations, economic performance and financial condition. These statements can be identified by the use of forward-looking terminology including “may,” “will,” “believe,” “expect,” “anticipate,” “estimate,” “continue,” or other similar words. These statements discuss future expectations, contain projections of results of operations or financial condition or include other “forward-looking” information. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will be realized. These forward-looking statements involve risks and uncertainties. Important factors that could cause actual results to differ materially from our expectations include, but are not limited to, the following risks and uncertainties:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

The risk factors and other factors noted throughout or incorporated by reference in this report could cause our actual results to differ materially from those contained in any forward-looking statement.  Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

PART I. FINANCIAL INFORMATION

Item 1.  Financial Statements.

 

AZURE MIDSTREAM PARTNERS, LP

CONDENSED CONSOLIDATED BALANCE SHEETS

(in thousands, except number of units)

 

 

See the accompanying notes to the condensed consolidated financial statements.

 

AZURE MIDSTREAM PARTNERS, LP

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except unit and per unit data)

(unaudited)

 

See the accompanying notes to the condensed consolidated financial statements.

AZURE MIDSTREAM PARTNERS, LP

CONDENSED CONSOLIDATED STATEMENT OF PARTNERS’ CAPITAL

(in thousands)

(unaudited)

 

 

 

 

See the accompanying notes to the condensed consolidated financial statements.

 

 

AZURE MIDSTREAM PARTNERS, LP

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

 

 

See the accompanying notes to the condensed consolidated financial statements.

 

 

AZURE MIDSTREAM PARTNERS, LP

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

 

1. ORGANIZATION AND DESCRIPTION OF BUSINESS

 

General

 

In this Quarterly Report, the terms “Partnership”, “our”, “we”, “us” and “its” refer to Azure Midstream Partners, LP itself or Azure Midstream Partners, LP together with its consolidated subsidiaries, which includes the Azure System, as defined below, for all periods presented.

 

In this Quarterly Report the term “Legacy System” refers to the Legacy gathering system entities and assets, which has been deemed to be the predecessor of the Partnership for accounting and financial reporting purposes. The closing of the transactions described below under “Sale of General Partner Interests and Contribution of the Legacy System” (the “Transactions”) occurred on February 27, 2015, and was reflected in the condensed consolidated financial statements of the Partnership using, for accounting purposes, a date of convenience of February 28, 2015 (the “Transaction Date”). The effect of recording the Transactions as of the Transaction Date was not material to the information presented.

 

In this Quarterly 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 (“Azure ETG”) 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 (“AME”), a Delaware limited liability company that is wholly owned by Azure Midstream Holdings LLC a Delaware limited liability company, (collectively “Azure”), acquired 100% of the equity interests in the entities that own the Legacy System and the ETG System up to the Transaction Date.  Azure contributed the ETG System to the Partnership on August 6, 2015, effective as of July 1, 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 all periods presented.

 

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 natural gas gathering, compression, dehydration, treating, processing, and hydrocarbon dew-point control and transportation services to producers, marketers and third-party pipeline companies.

 

As of September 30, 2016, Azure owned and controlled 100% of our general partner, Azure Midstream Partners GP, LLC, a Delaware limited liability company, (the "General Partner"), through its ownership of: (i) 429,365 general partner units representing 3.7% general partner interest; (ii) 255,319 common units, representing 2.3% of our outstanding limited partner interests; and (iii) 100% of our outstanding IDR Units, as defined below.  As of September 30, 2016, the public owned 11,029,022 of our common units, representing 97.7% of our outstanding limited partner interest. Azure, through its ownership of our General Partner, controls us and is responsible for managing our business and operations.

 

 

 

 

 

Recent Developments

 

Disposition of Assets

 

On August 4, 2016, our wholly-owned subsidiary Marlin Midstream, LLC (“Marlin Midstream”) entered into an Asset Purchase and Sale Agreement (the “Sale Agreement”) with a subsidiary of Align Midstream Partners, LP (“Align”).  Pursuant to the Sale Agreement, we sold our 100 MMcf/d Panola I processing plant and our Murvaul pipeline to Align.  The Murvaul pipeline consists of approximately 51.1 miles of 4.5” to 12.75” OD steel pipelines, related compression and gathering facilities and associated tracts of real property, surface leases, easements and rights-of-way located in Panola and Rusk Counties, Texas.  The purchase price was $44.9 million in cash, less certain agreed-upon adjustments in respect of ad valorem taxes on the assets sold. We recorded a gain of $4.8 million on the sale of these assets, which is classified within gain on sale of assets in the condensed consolidated statements of operations. Proceeds of $41.0 million from the Sale Agreement were used to pay down debt under our senior secured revolving credit facility (the "Credit Agreement"). The Sale Agreement contained customary representations, warranties and indemnification provisions.

 

In connection with the Sale Agreement, Marlin Midstream and Align entered into certain agreements relating to the facilities sold, including a gas gathering agreement and reciprocal gas processing agreements.  We also entered into an agreement with Align by which we guaranteed Marlin Midstream’s obligations under the Sale Agreement.

 

The Partnership continues to own and operate the 125 MMcf/d Panola II processing plant located in East Texas.

 

Going Concern Uncertainty

 

The decline in commodity prices throughout 2015 and continuing into 2016 has adversely affected the Partnership’s liquidity outlook. The decline in commodity prices has affected a number of companies in the oil and natural gas industries, including our customers.  Lower commodity prices have caused a significant reduction in drilling, completing and connecting new wells, which has caused a reduction in our forecasted volumes.  These lower volumes have negatively impacted our operating cash flows.  The downturn in the market has also affected the Partnership’s ability to access the capital markets, which may have allowed the Partnership to facilitate growth or reduce debt.

 

As a result of these and other factors the Partnership’s inability to comply with financial covenants and ratios in its Credit Agreement has adversely impacted the Partnership’s ability to continue as a going concern. Absent a waiver or amendment, failure to meet these covenants and ratios would have resulted in a default and, to the extent Wells Fargo Bank, National Association, as administrative agent and other lenders (collectively “the Lenders”) so elect, an acceleration of the existing indebtedness, causing such debt of approximately $173.5 million to be immediately due and payable. Based upon our current estimates and expectations for commodity prices in 2016, we do not expect to remain in compliance with all of the restrictive covenants contained in our Credit Agreement throughout 2016 unless those requirements are waived or amended. The Partnership does not currently have adequate liquidity to repay all of its outstanding debt in full if such debt were accelerated.

 

The report of the Partnership’s independent registered public accounting firm that accompanies its 2015 audited consolidated financial statements contains an explanatory paragraph regarding the substantial doubt about the Partnership’s ability to continue as a going concern. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of the going concern uncertainty. The Partnership’s Credit Agreement contains the requirement to deliver audited consolidated financial statements without a going concern or like qualification or exception. Consequently, the Partnership would have been in default under the Credit Agreement. Had we been unable to obtain a waiver or other suitable relief from the Lenders under the Credit Agreement prior to the expiration of the 30 day grace period, an Event of Default (as defined in the Credit Agreement) could have resulted in the acceleration of the outstanding indebtedness, which would have made it immediately due and payable. On March 29, 2016, the Partnership entered into the third amendment to the Credit Agreement (“Third Amendment”), which waived the event of default described above and certain other events of default until June 30, 2016. Subsequently, the

Partnership has entered into other amendments to the Credit Agreement (as described below), which extended the waiver of certain other events of default. See Note 3 for further information regarding our ability to continue as a going concern.

 

Amendments to Credit Agreement

 

Since June 30, 2016, the Partnership has entered into four limited duration waiver agreements and two amendments to the Credit Agreement which have, among other things, i) waived certain covenants of default for specific periods of time; (ii) reduced the borrowing capacity under the Credit Agreement to $173.7 million; (iii) required that future repayments or reductions to the outstanding balance on the Credit Agreement will reduce the borrowing capacity by an equal amount of the repayment or reduction; (iv) restricted the amount of capital expenditures the Partnership may make; and (v) required the Partnership to submit plans to sell assets of the Partnership and plans to raise capital.  Fees associated with the limited duration waiver agreements and amendments to the Credit Agreement for the three and nine months ended September 30, 2016 were $0.7 million and $1.5 million and are included within general and administrative expense in the condensed consolidated statements of operations.

 

On October 28, 2016, the Partnership entered into a limited duration waiver agreement to the Credit Agreement   extending the waiver of certain covenant defaults until November 30, 2016.

 

Based upon our current estimates and expectations for commodity prices in 2016, we do not expect to remain in compliance with all of the restrictive covenants contained in the Credit Agreement throughout 2016 unless those requirements are waived or amended. The Partnership does not currently have adequate liquidity to repay all of its outstanding debt in full if such debt were accelerated.

 

Associated Energy Services, LP (“AES”) Contract Terminations

 

During the first quarter of 2016, AES was delinquent in paying amounts invoiced under its gathering and processing contracts, as well as its logistics contracts, with subsidiaries of the Partnership.  The contracts had provisions requiring AES to make payments based on minimum volume commitments (“MVCs”). AES caused its bank to issue a $15.0 million letter of credit to the administrative agent under the Credit Agreement to secure the amount of its obligations under its logistics contracts. On March 31, 2016, the Partnership’s General Partner executed a settlement agreement with AES and its parent, NuDevco, (the “AES Agreement”) to resolve these issues under the gathering and processing agreements and the logistics contracts.  The execution of the AES Agreement resulted in the following: (i) on April 1, 2016, AES instructed our administrative agent to draw down the full $15.0 million amount of the letter of credit, the proceeds of which were applied to pay down debt under our Credit Agreement; (ii) effective as of January 1, 2016, the gathering and processing agreement and the logistics contracts were terminated; (iii) effective April 1, 2016, NuDevco surrendered to the Partnership 8,724,545 subordinated units, 1,939,265 common units and 10 IDR Units of the Partnership held by NuDevco or its subsidiary; (iv) the parties released each other from other claims in respect of the terminated contracts; and (v) AES assigned all of its rights and interests in third-party contracts to Azure. The AES Agreement was subject to final approval from the Lenders under the Credit Agreement, which was obtained.  

 

Delisting of Common Units and Trading of Common Units on the OTCQB Market

 

On June 6, 2016, the Partnership was formally notified by the New York Stock Exchange (“NYSE”) that the NYSE delisted the Partnership’s common units from the NYSE. The delisting results from the Partnership’s failure to comply with the continued listing standard set forth in Section 802.01B of the NYSE Listed Company Manual. This standard required the Partnership to maintain an average global market capitalization over a consecutive 30-day trading period of at least $15.0 million for the Partnership’s common units.  The NYSE suspended the trading of the Partnership’s common units at the close of trading on June 3, 2016.

 

On June 6, 2016, the Partnership’s common units began trading on the OTCQB Market under the same ticker symbol used previously on the NYSE “AZUR”. The Partnership will remain subject to the public reporting requirements of the SEC following the trading of its common units on the OTCQB Market.

 

Suspension of Distribution

 

As a result of covenant restrictions contained in our Credit Agreement, the board of directors of the General Partner of the Partnership and management have continued the suspension of the distributions for the quarterly period ended September 30, 2016. The board of directors will continue to evaluate the Partnership’s ability to reinstate the distribution, although reinstatement of distributions is not expected in the near term absent substantial improvement in our operating performance and compliance with the terms of our Credit Agreement.

 

Sale of General Partner Interest and Contribution of the Legacy System

 

On February 27, 2015, we consummated a transaction agreement, dated January 14, 2015 (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 Legacy System 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:

 

 

 

 

 

The Legacy System consists of approximately 666 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 Legacy System has access to seven major downstream markets, three third-party processing plants and our Panola County processing plant.

 

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 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:

 

 

 

The ETG System includes approximately 255 miles of gathering pipelines, two treating plants, 5 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 portion of the ETG Contribution with an $80.0 million draw from its credit facility.

 

2.  SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

Azure Midstream Partners, LP

 

The condensed consolidated financial statements give effect to the business combination, accounted for in accordance with the applicable reverse merger accounting guidance, the Transactions under the acquisition method of accounting and the Contribution Agreement, which was determined to be a transaction between entities under common control.

 

Azure acquired a controlling financial interest in us through the acquisition of our General Partner. As a result, the Legacy System was 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 Legacy System was 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 Legacy System 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 condensed consolidated financial statements of the Partnership as of the Transaction Date. The recording of the Transactions as of the Transaction Date did not have a material effect to the condensed consolidated financial statements.

 

The Legacy System's assets and liabilities retained their historical carrying values. Additionally, the Partnership's assets acquired and liabilities assumed by the Legacy System in the business combination were recorded at their fair values measured as of the Transaction 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 Legacy System 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 Transaction Date was recorded as an increase to partners’ capital in the amount of $51.7 million. The purchase price and fair values were prepared with the assistance of the Partnership's external fair value specialists and represent management's best estimate of the enterprise value and fair values of the Partnership.    

 

The ETG Contribution on August 6, 2015, effective July 1, 2015, was determined to be a transaction between entities under common control for financial reporting purposes. Because the ETG Contribution 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 was recorded as an adjustment to partners' capital in the amount of $6.8 million.  In addition, we have recast the financial results of the Partnership to include the financial results of the ETG System for all periods presented.

 

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 nine months periods ended September 30, 2016 and 2015 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.

 

Azure System

 

The operating results and the majority of the assets and liabilities of the Azure System 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 contributions of the Legacy System and ETG System 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 Azure's credit agreement and general and administrative expenses incurred by Azure on behalf of the Azure System.

 

Revenues were identified by contracts that are specifically identifiable to the Azure System. Depreciation and amortization are based upon assets specifically identified to the Azure System. Salaries, benefits and other general and administrative costs were 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. Prior to the execution of the Transactions and the Contribution Agreement, Azure’s direct investment in the Azure System was presented as parent company net investment in the condensed consolidated balance sheets and included 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

 

The following serves to update our significant accounting policies and to provide our significant accounting policies effective before and after the Transaction 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.

 

Accounts Receivable

 

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Trade accounts receivable arise from our natural gas sales, natural gas gathering, compression, dehydration, treating, processing, and hydrocarbon dew-point control and transportation services. Amounts collected on trade accounts receivable are included in net cash provided by operating activities in the condensed consolidated statements of cash flows. We had no allowance for doubtful accounts as of September 30, 2016 and December 31, 2015.

 

Concentration of Credit Risk

 

Financial instruments that potentially subject us to concentrations of credit risk are primarily accounts receivable. As of September 30, 2016, three customers accounted for more than 10% of our accounts receivable, BP plc, which accounted for 17.9%, Anadarko Petroleum Corporation, which accounted for 13.0% and, Texla Energy Management Inc., which accounted for 12.8%.  

 

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 during the three and nine months periods ended September 30, 2016 and 2015. 

 

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

 

We evaluate our long-lived assets for impairment when events or circumstances indicate that their carrying values may not be recoverable. These events include, but are not limited to, market declines that are believed to be other than temporary, changes in the manner in which we intend to use a long-lived asset, decisions to sell an asset and adverse changes in the legal or business environment such as adverse actions by regulators. If an event occurs, we evaluate the recoverability of our carrying value based on the long-lived asset's ability to generate future cash flows on an undiscounted basis. If the undiscounted cash flows are not sufficient to recover the long-lived asset's carrying value, or if we decide to sell a long-lived asset or group of assets, we adjust the carrying values of the asset downward, if necessary,

to their estimated fair value. Our fair value estimates are generally based on assumptions market participants would use, including market data obtained through the sales process or an analysis of expected discounted cash flows. See Note 7.

 

Intangible Assets

 

We evaluate intangible assets for impairment upon a significant change in the operating environment or whenever circumstances indicate that the carrying value may not be recoverable. If an evaluation of the undiscounted cash flows indicates impairment, the asset is written down to its estimated fair value, which is generally based on discounted future cash flows.

 

As part of the AES Agreement executed on March 31, 2016, the gathering and processing agreement and the logistics contracts were terminated effective January 1, 2016.  Accordingly, the intangible assets which represented the existing customer relationship with AES were impaired.  The intangible assets were identified as part of the purchase price allocation to the Partnership's assets acquired by the Azure System.  The remaining balance of the intangible asset was eliminated in the second quarter of 2016 as part of the assignment of common and subordinated units and IDR Units from NuDevco to the Partnership. See Note 7.

 

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 at September 30, 2016 is included within current portion of long-term debt within the condensed consolidated balance sheets. The unamortized balance of deferred financing costs at December 31, 2015 is included within long-term debt, net of deferred borrowing costs within the condensed consolidated balance sheets. The Partnership had net deferred loan costs of $1.6 million and $3.3 million as of September 30, 2016 and December 31, 2015. These deferred loan costs will be amortized over the maturity period of the Credit Agreement. All deferred financing costs included within the Azure System’s condensed consolidated balance sheets, up to the Transaction Date, are associated with the Azure Credit Agreement. See Note 8.

 

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 operating segments. The Partnership has two operating segments, gathering and processing and logistics, for financial reporting purposes.

 

At the time of the execution of the AES agreement, on April 1, 2016, AES was the sole customer of the crude oil logistics business.  We currently have one customer for our crude oil logistics business.  The Partnership is pursuing other customer contracts and currently has no plans to sell the assets of the logistics business. Accordingly, the assets of the logistics business are classified as held for use and the logistics segment does not meet the criteria to be classified as a discontinued operation.  

 

Revenues and Cost of Natural Gas and NGLs

 

The Partnership’s revenues are derived primarily from natural gas processing and fees earned from its gathering and processing operations. Revenues from all services and activities 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; (iii) the buyer’s price is fixed or determinable; and (iv) collection is reasonably assured. Utilizing these criteria, revenues are recognized when the commodity is delivered or services are rendered. Similarly, cost of natural gas and NGLs 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: (i) natural gas gathering; (ii) compression; (iii) dehydration; (iv) treating; (v) processing and hydrocarbon dew-point control; and (vi) 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 services in the month such services are performed. Substantially all of these fee-based agreements contain MVCs 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 natural gas and NGLs 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 retains 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 natural gas and NGLs.

 

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 and NGLs. The keep-whole contracts convey 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 natural gas and NGLs sold directly identified with gathering, processing and other revenue.

 

Other revenue producing activities are the sale of natural gas and NGLs purchased from third parties, for which the Partnership takes title, and the sale of condensate liquids. Natural gas revenues are derived from transactions that are completed under contracts with limited commodity price exposure, and the Partnership has elected the normal purchases and normal sales exemption on all such transactions for accounting purposes. The Partnership receives a market price per barrel on our revenue from natural gas condensate liquids.  We recognize 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.

 

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; (ii) expired, or lapsed through the passage of time pursuant to the terms of the natural gas gathering agreement; or (iii) upon determination that the likelihood the customer will be able to generate revenues in excess of its future MRC as an offset to future gathering fees is remote.

 

During the third quarter of 2016, based on facts known, it was determined that all of the revenue recognition criteria related to the revenues which had been previously deferred under this contract had been met.  Accordingly, we recognized the entire previously deferred balance of $18.5 million as revenue in the accompanying condensed consolidated statements of operations upon the determination that based on current facts the likelihood that our customer would be able to generate revenues in excess of its future MRC as an offset to future gathering fees is remote. As of December 31, 2015, deferred revenue under the MRC agreement was $11.6 million and is included within other long-term liabilities in the condensed consolidated balance sheet.

.  

 

Accounts Payable and Accrued Liabilities

 

The Partnership's accounts payable and accrued liabilities as of September 30, 2016 and December 31, 2015, consist of obligations arising during the normal course of the Partnership's business operations which are expected to be settled within a period of twelve months.

 

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 September 30, 2016 and December 31, 2015 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 closing of the Transactions, we terminated our omnibus agreement, dated July 31, 2013, by and between NuDevco, the General Partner and us, and entered into an omnibus agreement, the “New Omnibus Agreement” with the General Partner and Azure, pursuant to which, among other things, Azure has agreed to 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.  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.

 

Asset Retirement Obligations

 

Applicable accounting guidance requires us to evaluate whether any future asset retirement obligations exist as of September 30, 2016 and December 31, 2015, 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 has not recognized any asset retirement obligations as of September 30, 2016 and December 31, 2015 because we have no current intention of discontinuing use of any significant assets in the long-term.

 

Environmental Expenditures

 

Our operations 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 we will not incur significant costs and liabilities.

 

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.

 

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 its consolidated subsidiaries 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. The Partnership is 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. The Partnership does not do business in any other state where a similar tax is applied. As of September 30, 2016 and December 31, 2015, the Partnership had a non-current liability of $0.9 million and $1.1 million for deferred taxes.

 

Net Income (Loss) Per Unit

 

Net income (loss) per unit is presented for the three and nine months periods ended September 30, 2016, the three months ended September 30, 2015 and the period from March 1, 2015 to September 30, 2015 as this is the period in which the Partnership's results of operations are included within net loss. The Azure System from the period January 1, 2015 up to the Transaction Date had no units and therefore net loss per unit is not presented for periods in which net loss consists only of the Azure System.

 

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 August 2016, the Financial Accounting Standards Board (“FASB”) issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments, which amends ASC Topic 230, Statement of Cash Flows (“ASU 2016-15”). The amendments in ASU 2016-15 provide guidance on the following eight specific cash flow issues: (i) debt prepayment or debt extinguishment costs; (ii) settlement of zero-coupon bonds; (iii) contingent consideration payments made after a

business combination; (iv) proceeds from the settlement of insurance claims; (v) proceeds from the settlement of corporate-owned life insurance policies, including bank-owned life insurance policies; (vi) distributions received from equity method investees; (vii) beneficial interests in securitization transactions; and (viii) separately identifiable cash flows and application of the predominance principal. ASU 2016-15 is effective for public business entities for annual and interim periods beginning after December 17, 2017. Early adoption is permitted.

 

In March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, which amends ASC Topic 718, Compensation – Stock Compensation (“ASU 2016-09”). The new standard will require the following: (i) all of the tax effects related to share-based payments at settlement (or expiration) to be recorded through the income statement, and is required to be applied prospectively; (ii) the new standard also allows entities to withhold taxes of an amount up to the employees’ maximum individual tax rate in the relevant jurisdiction without resulting in liability classification of the award, and is required to be adopted using a modified retrospective approach; and (iii) forfeitures can be estimated, as currently required, or recognized when they occur. If elected, the change to recognize forfeitures when they occur must be adopted using a modified retrospective approach. ASU 2016-09 is effective for annual reporting periods beginning after December 15, 2016 including interim periods within those annual periods. Early adoption is permitted. This standard became effective for us July 1, 2016.

 

In April 2015, the FASB issued a pronouncement that specifies how to calculate historical earnings per unit for a master limited partnership with retrospectively adjusted financial statements subsequent to a drop-down acquisition. The amendments specify that for purposes of calculating historical earnings per unit under the two-class method, the earnings or losses of a transferred business before the date of a drop-down acquisition are to be allocated entirely to the general partner. In that circumstance, the previously reported earnings per unit of the limited partners would not change as a result of the dropdown acquisition. Qualitative disclosures about how the rights to the earnings or losses differ before and after the drop-down acquisition occurs for purposes of computing earnings per unit under the two-class method are also required. This standard became effective beginning in 2016; however, we have elected to early adopt this standard in this report and have retrospectively adjusted our prior period balances related to this standard in this report. See Note 5.

 

In February 2015, the FASB issued a new accounting pronouncement to respond to stakeholders’ concerns about the current accounting for consolidation of certain legal entities. The update provides additional guidance to reporting entities in evaluating whether certain legal entities, such as limited partnerships, limited liability corporations and securitization structures, should be consolidated. The update is considered to be an improvement on current accounting requirements as it reduces the number of existing consolidation models. The update was implemented by us on January 1, 2016, and had no effect on our condensed consolidated financial statements or related disclosures.

 

 

In February 2016, the FASB issued a pronouncement amending disclosure and presentation requirements for lessees and lessors to better reflect the recognition of assets and liabilities that arise from leases. The pronouncement states that a lessee should recognize a liability to make lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term on the face of the balance sheet. When measuring assets and liabilities arising from a lease, a lessee (and a lessor) should include payments to be made in optional periods only if the lessee is reasonably certain to exercise an option to extend the lease or not to exercise an option to terminate the lease. Similarly, optional payments to purchase the underlying asset should be included in the measurement of lease assets and lease liabilities only if the lessee is reasonably certain to exercise that purchase option. In addition, also consistent with the previous leases guidance, a lessee (and a lessor) should exclude most variable lease payments in measuring lease assets and lease liabilities, other than those that depend on an index or a rate or are in substance fixed payments. This standard will become effective beginning in 2019.

 

In September 2015, the FASB issued a new accounting standard, which eliminates the requirement for an acquirer to retrospectively adjust the financial statements for measurement-period adjustments that occur in periods after a business combination is consummated. The standard is effective for public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2015. The update was implemented on January 1, 2016.

 

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 adopted the guidance effective January 1, 2016. The standard only affected the presentation of the Partnership's condensed consolidated balance sheet and does not affect any of the Partnership's other financial statements.

 

In August 2014, the FASB issued ASU 2014-15, "Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern (Subtopic 205-40)".  The guidance will require management to evaluate whether there are conditions and events that raise substantial doubt about the company's ability to continue as a going concern within one year after the financial statements are issued on both an interim and annual basis. Additionally, management will be required to provide certain footnote disclosures if it concludes that substantial doubt exists or when it plans to alleviate substantial doubt about the company's ability to continue as a going concern. ASU 2014-15 is effective for annual periods ending after December 15, 2016, and for annual and interim periods thereafter.

 

In May 2014, the FASB and International Accounting Standards Board jointly issued a comprehensive new revenue recognition standard that will supersede nearly all existing revenue recognition guidance under GAAP and International Financial Reporting Standards. 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. This standard will become effective beginning in the first quarter of 2018. The adoption could have a significant impact on the condensed consolidated financial statements, however management is currently unable to quantify the impact.

 

There are currently no other recent accounting pronouncements that have been issued that we believe will materially affect our condensed consolidated financial statements.

 

3. GOING CONCERN

 

The precipitous decline in oil and natural gas prices during 2015 and into 2016 has had a significant adverse impact on our business, and has impacted the Partnership’s ability to comply with financial covenants and ratios in its Credit Agreement.  Based upon our current estimates and expectations for commodity prices in 2016, we do not expect to remain in compliance with all of the restrictive covenants contained in the Credit Agreement throughout 2016 unless those requirements are waived or amended. Absent a waiver or amendment, failure to meet these covenants and ratios would result in a default and, to the extent the applicable Lenders so elect, an acceleration of the existing indebtedness, causing such debt of approximately $173.5 million to be immediately due and payable.  The Partnership does not currently have adequate liquidity to repay all of its outstanding debt in full if such debt were accelerated.

 

The Credit Agreement requires us to deliver audited, consolidated financial statements without a “going concern” or like qualification or exception. On March 29, 2016, the Partnership entered into the Third Amendment. Pursuant to the Third Amendment, we received an agreement from the Lenders that the default resulting from non-compliance with our financial covenants and ratios had been waived as it relates to the 2015 consolidated financial statements.

 

Pursuant to the Third Amendment to the Credit Agreement, certain other events of default were waived until June 30, 2016. Subsequently, the Partnership has entered into other amendments to the Credit Agreement, which extended the waiver of certain covenant defaults until November 30, 2016. Notwithstanding the effects of these waivers, it is unlikely that we can comply with the leverage covenant currently contained in the Credit Agreement during the next twelve months. If we cannot obtain from the Lenders a waiver of such potential breach or an amendment of the leverage covenant, our breach would constitute an event of default that could result in an acceleration of substantially all of our outstanding indebtedness. We would not have sufficient capital to satisfy these obligations.

 

While these amendments offer a temporary solution to the defaults under the Credit Agreement, the Partnership still seeks a long-term solution to enhance the Partnership’s liquidity and address concerns surrounding its ability to remain in compliance with the financial covenants under its Credit Agreement.

 

The significant risks and uncertainties described above raise substantial doubt about the Company’s ability to continue as a going concern. The condensed consolidated financial statements have been prepared on a going concern basis of accounting, which contemplates continuity of operations, realization of assets, and satisfaction of liabilities and commitments in the normal course of business. The condensed consolidated financial statements do not include any adjustments that might result from the outcome of the going concern uncertainty.

 

The Partnership is currently in discussions with various stakeholders and is pursuing or considering a number of actions including: (i) obtaining additional sources of capital from asset sales, private issuances of equity or equity-linked securities, debt for equity swaps, or any combination thereof; (ii) obtaining waivers or amendments from the Lenders; and (iii) continuing to minimize its capital expenditures, reduce costs and maximize cash flows from operations. There can be no assurance that sufficient liquidity can be obtained from one or more of these actions or that these actions can be consummated within the period needed.

 

4.  PARTNERSHIP EQUITY AND DISTRIBUTIONS

 

Outstanding Units

 

As of September 30, 2016, Azure owned 100% of our general partner interests consisting of 429,365 general partner units representing a 3.7% general partner interest, 255,319 common units representing a 2.3% limited partner interest and 100% of our outstanding IDR Units. As of September 30, 2016, the Partnership had common units outstanding of 11,284,341 of which, the public owned 11,029,022 units, representing a 97.7% 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 and its affiliates.

 

On February 1, 2016, the Partnership announced a temporary suspension of the distributions for the quarterly period ended December 31, 2015. In addition, we have also suspended the distributions for the quarterly periods ended March 31, 2016, June 30, 2016 and September 30, 2016, primarily due to liquidity constraints contained in the amendments to our Credit Agreement. Should the distributions be reinstated, the common unitholders will be entitled to receive the minimum quarterly distribution of $0.35 per unit in arrears for each quarter as to which the distributions were suspended.  Payment of any such amount in arrears will be subject to board of director’s approval and compliance with the terms of our Partnership Agreement and the agreements governing our indebtedness. Our ability to pay distributions also is reliant on our ability to comply with restrictions contained in the agreements governing our debt. However, there is no guarantee that we will pay the minimum quarterly distribution on our units in any quarter.

 

The Partnership declared the following cash distributions to its unitholders of record for the periods presented:

 

 

General Partner Interest

 

As of September 30, 2016, 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 September 30, 2016, the general partner interest was the equivalent of 3.7%. This general partner interest increased from 1.9% as of March 31, 2016 as  a result of: (i) NuDevco surrendering to the Partnership 8,724,545 subordinated units and 1,939,265 common units as a result of the AES Agreement; partially offset by (ii) our General Partner electing not to make a contribution in connection with the previous issuances of common units related to the vesting of awards under the Marlin Midstream Partners, LP 2013 Long-Term Incentive Plan (“LTIP”) (See Note 12); and (iii) our General Partner electing not to make a contribution in connection with the issuance of 255,319 common units to Azure in connection with the contribution of Azure ETG.

 

Incentive Distribution Rights

 

As of September 30, 2016, Azure owned all of our outstanding 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 or Azure 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.

 

As previously disclosed, the Partnership temporarily suspended distributions for the first three quarters of 2016 and fourth quarter of 2015.  Should the distributions be reinstated, the common unitholders will be entitled to receive the minimum quarterly distribution of $0.35 per unit in arrears for each quarter as to which the distributions were suspended prior to distributions being made in respect of IDR Units or any junior securities. Payment of any such amount in arrears will be subject to the approval of the board of directors of the General Partner of the Partnership and compliance with the terms of our Partnership Agreement and the agreements governing our indebtedness.

 

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 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.

 

All subordinated units were surrendered to the Partnership effective April 1, 2016 per the terms of the AES Agreement.

 

5. NET INCOME (LOSS) PER UNIT

 

The Partnership's condensed consolidated statements of operations were recast to reflect the Azure System for periods prior to March 1, 2015 in accordance with applicable accounting and financial reporting guidance. The Azure System had no units outstanding prior to the Transaction Date. Therefore, net loss per unit for the nine months ended September 30, 2015 is presented for the period March 1, 2015 to September 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 (loss) for the three and nine months periods ended September 30, 2016, the three months ended September 30, 2015 and the period March 1, 2015 to September 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 System's net losses of $5.8 million have been allocated to the General Partner for the period January 1, 2015 to June 30, 2015 as this period preceded the contribution date of August 6, 2015. Basic and diluted net income (loss) per unit is calculated by dividing the partner’s interest in net income (loss) by the weighted average number of units outstanding during the period. There were no units or awards issued or outstanding during the three and nine months periods ended September 30, 2016, the three months ended September 30, 2015 and the period March 1, 2015 to September 30, 2015 that would be considered dilutive to the net income (loss) per unit calculation, and, therefore, basic and diluted net income (loss) per unit are the same for the periods presented.

 

For the three and nine months periods ended September 30, 2016 and 2015, net income (loss) was allocated to the unvested phantom unit awards granted to our executive officers and certain employees for the earnings (loss) per unit calculation. Relevant accounting guidance requires that unvested unit-based payments that entitle employees to receive non-forfeitable distributions are considered participating securities for earnings per unit calculations.  

 

The following table illustrates the Partnership’s calculation of net income (loss) per unit for common and subordinated units for the periods presented:

 

 

 

6. ACQUISITIONS

 

Effective as of the Transaction Date, Azure contributed the Legacy System 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 Credit Agreement (see Note 8).  

 

The Legacy System 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 Legacy System’s assets and liabilities retained their historical carrying values. The Partnership's assets acquired and liabilities assumed by the Legacy System have been recorded at their fair values measured as of the Transaction 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 Transaction Date and the consideration paid by Azure for the general partner interest and IDR Units. The purchase price allocation has been prepared based on a valuation report prepared with the assistance of the Partnership’s fair value specialists and represents management’s best estimate of the enterprise and fair values of the Partnership.

 

The property, plant and equipment of the Legacy System has been reflected at its 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 was reflected as an increase to partners' capital. Additionally, the Partnership did not assume certain liabilities of the Legacy System as part of the Transactions, 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 Transaction Date as a result of the Transactions. These transaction related expenses were recognized by the Partnership when incurred in the periods

prior to the Transaction Date, and therefore are not included within the results of operations presented within the condensed consolidated financial statements for the nine months ended September 30, 2015.

 

The following tables summarize the assumed purchase price, fair value and the allocation to the assets acquired and liabilities assumed as of February 28, 2015 (in thousands):

 

 

The allocation of the assumed purchase price is as follows (in thousands):

 

 

Goodwill recognized from the business combination primarily related to the value attributed to additional growth opportunities, synergies and operating leverage within the Partnership's areas of operation. Goodwill was allocated to our gathering and processing segment and our logistics segment. Goodwill was fully impaired in September 2015. The assumed purchase price and fair values 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.

 

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. 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 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.

 

The assets acquired and liabilities assumed of the ETG System have been reflected at their historical net carrying value, which is less than the consideration paid for the business. The excess of the consideration paid over the historical carrying value was $6.8 million and was reflected as a decrease to partners' capital. Additionally, the Partnership did not assume certain liabilities of the ETG System as part of the Contribution Agreement and, as a result, the amount of such liabilities not assumed is considered a deemed contribution within the condensed consolidated statement of partners' capital.  

 

The Partnership incurred $0.7 million in transaction related expenses associated with the contribution of the ETG System for the year ended December 31, 2015.