|NUVERRA ENVIRONMENTAL SOLUTIONS, INC. filed this Form 10-K on 03/18/2013|
|NUVERRA ENVIRONMENTAL SOLUTIONS, INC. filed this Form 10-K on 03/18/2013|
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
For the fiscal year ended: December 31, 2012
For the transition period from to
Commission File Number: 001-33816
(A Delaware Corporation)
I.R.S. Employer Identification No. 26-0287117
14646 N. Kierland, Suite 260, Scottsdale, Arizona 85254
Telephone: (602) 903-7828
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
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 x No ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the Company is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of large accelerated filer, accelerated filer, and smaller reporting company in Rule 12b-2 of the Exchange Act. (Check one):
Indicate by check mark whether the Company is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x
As of June 30, 2012, the last business day of the registrants most recently completed second fiscal quarter, the aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant was $632,552,451 based on the closing sale price on such date as reported on the New York Stock Exchange. Shares held by executive officers, directors and persons owning directly or indirectly more than 10% of the outstanding common stock have been excluded from the preceding number because such persons may be deemed to be affiliates of the registrant. This determination of affiliate status is not necessarily a conclusive determination for any other purposes.
The number of shares outstanding of the registrants common stock as of March 12, 2013 was 266,169,474.
Documents Incorporated by Reference
Portions of the registrants Proxy Statement for the 2012 Annual Meeting of Stockholders to be held on May 8, 2013, are incorporated by reference into Part III, Items 10-14 of this Annual Report on Form 10-K.
In addition to historical information, this Annual Report contains forward-looking statements within the meaning of Section 27A of the United States Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the United States Securities Exchange Act of 1934, as amended, or the Exchange Act. These statements relate to our expectations for future events and time periods. All statements other than statements of historical fact are statements that could be deemed to be forward-looking statements, including, but not limited to, statements regarding:
You can identify these and other forward-looking statements by the use of words such as anticipates, expects, intends, plans, predicts, believes, seeks, estimates, may, will, should, would, could, potential, future, continue, ongoing, forecast, project, target similar expressions, and variations or negatives of these words.
These forward-looking statements are based on information available to us as of the date of this Annual Report and our current expectations, forecasts and assumptions, and involve a number of risks and uncertainties. Accordingly, forward-looking statements should not be relied upon as representing our views as of any subsequent date. Future performance cannot be ensured, and actual results may differ materially from those in the forward-looking statements. Some factors that could cause actual results to differ include:
You are cautioned not to place undue reliance on any forward-looking statements, which speak only as of the date of this Annual Report. Except as required by law, we do not undertake any obligation to update or release any revisions to these forward-looking statements to reflect any events or circumstances, whether as a result of new information, future events, changes in assumptions or otherwise, after the date hereof.
When used in this Annual Report, the terms Heckmann, the Company, we, our, and us refer to Heckmann Corporation and its consolidated subsidiaries, unless otherwise specified.
Heckmann Corporation is an environmental solutions company. The Company is one of the largest companies in the United States dedicated to providing comprehensive and full-cycle environmental solutions to our customers in energy and industrial end-markets. The Company focuses on the delivery, collection, treatment, recycling, and disposal of restricted solids, water, waste water, used motor oil, spent antifreeze, waste fluids and hydrocarbons. Heckmann continues to expand its suite of environmentally compliant and sustainable solutions to customers that demand environmental compliance and accountability from their service providers.
The following chart describes our strategic focus on providing comprehensive environmental solutions to our customers in industrial and energy end-markets, and the assets we currently possess that allow us to execute on our strategy:
Since the closing of the Thermo Fluids Inc. (TFI) acquisition on April 10, 2012, we have operated through two business segments: our Fluids Management Division (formerly Heckmann Water Resources or HWR); and our Recycling Division (formerly Heckmann Environmental Services or HES), which includes TFI. Fluids Management addresses the pervasive demand for diverse water solutions required for the production of oil and gas in an integrated and efficient manner through various service and product offerings. Fluid Managements services include water delivery and disposal, trucking, fluids handling, treatment, permanent pipeline facilities, water infrastructure services and equipment rental services for oil and gas exploration and production companies. Fluids Management also transports fresh water for drilling and completion activities and provides services for water pit excavations, site preparation and remediation.
Fluids Management operates in the United States in the Haynesville, Eagle Ford, Marcellus/Utica, Tuscaloosa Marine, Barnett, Mississipian Lime and Permian Basin Shale areas and since the completion of the merger with Badlands Power Fuels, LLC (Power Fuels) on November 30, 2012 with and into a wholly-owned subsidiary, the Bakken Shale area. Fluids Management serves customers seeking fresh water acquisition, temporary water transmission and storage, transportation, treatment or disposal of fresh water and complex water flows, such as flowback and produced brine water, in connection with shale oil and gas hydraulic fracturing drilling, or hydrofracturing, operations. Fluids Management also includes our majority investment in Appalachian Water Services, LLC (AWS), which owns and operates a state-of-the-art wastewater treatment facility specifically designed to treat and recycle water involved in the hydraulic fracturing process in the Marcellus Shale area.
Recycling provides route-based environmental services and waste recycling solutions that focus on the collection and recycling of used motor oil (UMO) and is the largest seller of reprocessed fuel oil (RFO) from recovered UMO in the Western United States. Historically, Recycling has supplied a large percentage of its RFO for use in the production of asphalt, and consequently experiences some seasonality in its business.
During 2013, the Company intends to commence an internal reorganization with the intention of managing the Companys operations by end-markets served, which currently include energy and industrial markets. The Company expects
that its business operations will consist of three operating segments: one of which (Industrial Recycling Solutions) will focus primarily on industrial end-markets, and the other two of which (Oil Shale Solutions and Gas Shale Solutions, and collectively Shale Segments) will focus on the shale energy end-markets. In each of these proposed operating segments, our focus will be dedicated to achieving our strategic objective of providing comprehensive environmental solutions to our customers centering on the delivery, collection, treatment, recycling, and disposal of restricted products.
In the operating segments focused on energy end-markets, we provide environmental solutions for exploration and production (E&P) companies focused on the extraction of oil and natural gas resources from shale or unconventional basins. Pro forma for the operations of Power Fuels, which we merged with in the fourth quarter of 2012, approximately 70% of our shale-related revenues are derived from areas where oil or liquids drive activity, with the remaining 30% from natural-gas focused areas. We currently operate in the following shale basins: Bakken, Eagle Ford, Marcellus, Utica, Haynesville, Barnett, Tuscaloosa Marine, and Mississippian Lime Shale areas and the Permian Basin shale area.
We also provide environmental solutions for industrial end-markets, including the collection, treatment, and recycling of waste products including used motor oil, or UMO, wastewater, spent antifreeze, used oil filters, and parts washers. We collected approximately 53 million gallons of used oil in 2012, making us the largest used oil collection and recycling company in the Western U.S. We also are a leading seller of reprocessed fuel oil (RFO), and provide other complementary collection, treatment, recycling, and disposal services to industrial customers.
During 2013, we expect our operating segments to consist of:
We believe our business possesses the following competitive strengths which position us to serve our customers and grow our revenue and cash flow:
Our strategy is to continue to expand our solutions-based relationships with our customers and provide a comprehensive, full-cycle environmental solution including delivery, collection, treatment, recycling, and disposal of environmental waste products. The principal elements of our business strategy are to:
Leverage Our Transportation Network to Expand Treatment, Recycling, and Disposal Solutions. We intend to leverage our advanced transportation and logistics system to continue to expand our treatment, recycling, and disposal environmental solutions. We believe we have a leading network providing for delivery and collection solutions, and as the market in the unconventional shales evolves, customers will put an increasing focus on treatment and recycling solutions, particularly around solid waste products. Our current transportation and logistics footprint gives us an opportunity to continue to expand our customer touch-points and provide end-to-end solutions, from delivery through disposal.
Pursue Growth and Consolidation Opportunities in Our Industrial Recycling Solutions Division. We believe there are a number of avenues to grow our Industrial Recycling Solutions division, including through regional acquisition opportunities to grow our share in existing markets and expand our operations in geographic adjacencies. The UMO market is highly fragmented, and we believe we are one of only three multi-regional players and the largest UMO collector in the western U.S. The majority of competition in our current market areas comes from smaller local or regional players, and as such we believe we can pursue acquisition opportunities to continue to grow this division.
Focus on Consistent and Analytical Operational Improvement. We intend to aggressively integrate and implement best practices across our business. Our customers require high levels of regulatory and environmental compliance, which we emphasize through employee training, maintenance of our asset base and ongoing analysis of our operating performance. In addition, we believe that there are best-practices in certain of our current shale geographies that can be expanded to other areas of operations to drive revenues and cash flow. We also intend to aggressively pursue the implementation of new accounting, invoicing, and fleet management systems to reduce costs and paperwork, improve data collection and increase operating efficiency.
Over the past several years, E&P companies have focused on utilizing the vast resource potential available across many of North Americas unconventional resource areas through the application of horizontal drilling and completion technologies, including multi-stage hydraulic fracturing technologies. We believe long-term capital for the continued development in new and existing basins will be provided in part by the large, well-capitalized domestic and international oil and natural gas companies that have made and continue to make significant capital commitments through joint ventures and direct investments in North Americas unconventional basins. We believe these companies are highly focused on environmental responsibility, compliance, and regulatory issues and prefer to work with large, highly qualified national solutions providers.
Advances in drilling technology and the development of unconventional North American hydrocarbon plays allow previously inaccessible or non-economical formations in the earths crust to be exploited by utilizing high pressure methods from millions of gallons of freshwater (or the process known as hydraulic fracturing, or fracking) combined with proppant fluids (containing sand grains or microscopic ceramic beads) to crack open new perforation depths and fissures to extract large quantities of natural gas, oil, and other hydrocarbon condensates. Significant amounts of water are required to be delivered to the well for hydraulic fracturing operations, and subsequently, complex water flows, in the forms of flowback and produced water, represent a waste stream from these methods of hydrocarbon exploration and production. Produced water volumes, which represent water from the formation produced alongside hydrocarbons over the life of the well, are generally driven by marginal costs of production and frequently create a multi-year demand for our services once the well has been drilled. In addition to the liquid product stream involved in the hydraulic fracturing process, there are also significant environmental solid waste streams that are generated during the drilling and completion of a well. During the drilling process, a combination of the cut rock, or cuttings, mixed with the liquid used to drill the well, is returned to the surface and must be handled in accordance with environmental and other regulations. Historically, much of this solid waste byproduct was buried at the wellsite. We believe that customers will increasingly be focused on the treatment and offsite disposal of the solid waste byproduct as regulations increase the financial and operational burdens.
We primarily operate in the Bakken, Eagle Ford, Marcellus, Utica, Haynesville, Mississippian Lime, Tuscaloosa Marine and Barnett Shale areas.
The Companys industrial end-market is comprised of companies that provide routine collection of used oil (and other related wastes) from a broad range of commercial and industrial businesses. As a result of environmental regulations that prohibit the disposal of UMO into sewers or landfills, generators of UMO must arrange to have their waste picked up periodically in order to avoid their storage tanks getting full. Following collection, the UMO is reprocessed into RFO, a commercial-grade fuel product, and sold as (i) an alternative to traditional energy (i.e., natural gas, virgin oil and diesel fuel) or (ii) feedstock for re-refining into base lube oil.
An estimated 1.4 billion gallons of UMO are generated annually in the U.S., of which 1.0 billion gallons are collected. Approximately two-thirds of the overall market volume is generated by automotive service providers as a result of performing oil changes on passenger cars and trucks with the remaining one-third coming from industrial plants.
Once collected, the UMO is reprocessed into RFO and sold into the following markets:
In 2012, we completed two major expansions of our business. On November 30, 2012, we consummated the merger of Power Fuels, an environmental services company with extensive operations in the Bakken Shale area. On April 10, 2012, we established our Recycling Division with the acquisition of TFI which provides route-based environmental services and waste recycling solutions, including the collection and reprocessing of UMO.
Energy End-Market Operations
We address the pervasive demand for diverse environmental solutions required for unconventional oil and gas production. We focus on providing one-stop total environmental solutions centering around the delivery, collection, treatment, recycling, and disposal of liquid and solid environmental products used in oil and gas drilling and production activities.
Our assets focused on serving energy end-markets include a 50-mile underground pipeline network in the Haynesville Shale area for the efficient delivery of fresh water and removal of produced water. We also have approximately 200 miles of portable poly and aluminum pipe and associated pumps and other equipment that are used above ground for pumping and transporting water, which can generally be moved to meet customer demand and market conditions. With the addition of the Power Fuels assets acquired in the merger, we now own and operate a fleet of more than 1,200 trucks for delivery and collection, including 104 low-emission LNG trucks, and approximately 4,200 frac tanks, 1,900 upright and other tanks, and we own or lease 46 operating salt water disposal or underground injection wells in the Bakken, Marcellus/Utica, Haynesville, Eagle Ford, and Tuscaloosa Shale areas. We continually assess our equipment mix and, as needs and demand require, will invest in additional equipment or improvements to our existing equipment.
Industrial End-Market Operations
Our Recycling Division (formerly referred to as Heckmann Environmental Services or HES) was initiated with our acquisition of TFIs operations and assets in April 2012. The Recycling Division provides route-based environmental services and waste recycling solutions, offering customers a reliable, high-quality and environmentally responsible solution through our one-stop shop of collection and recycling services for waste products including UMO, oily water, spent antifreeze, used oil filters and parts washers. Our Recycling Division collects UMO and reprocesses it to be sold in the form of RFO to (i) re-refiners as a critical feedstock for the production of base lubricants and (ii) industrial customers as a lower cost, higher British Thermal Units (BTU) alternative to diesel fuel. We collected more than approximately 53 million gallons of used oil in 2012, making us the largest used oil collection and recycling company in the western U.S.
Our assets focused on serving industrial end-markets include 34 processing facilities, 385 tanker trucks, vacuum trucks and trailers, and over 200 railcars as of December 31, 2012. With a presence in 19 states stretching from Washington to Texas, we provide a suite of essential services to more than 20,000 commercial and industrial customers that collectively generate high volumes of regulated non-hazardous waste on a daily basis.
Our UMO volume is sourced from participants within the automotive service industry (e.g., quick lube shops, auto dealerships, retail automotive service providers, etc.) and a diverse array of commercial and industrial operations across the trucking, railroad, manufacturing and mining industries. We have established relationships with more than 250 RFO customers located throughout the United States, typically consisting of re-refiners and energy-intensive industries that require the use of a boiler or furnace, such as the asphalt, pulp, paper and bunker fuel markets.
In our energy end-markets, our customers include major United States and international oil and gas companies, foreign national oil and gas companies and independent oil and natural gas production companies that are active in our core areas of operations. In Recycling, we have established relationships with more than 20,000 mostly small-to medium-sized UMO-generating facilities and more than 250 RFO customers located throughout the western United States. In the year ended December 31, 2012, Chesapeake Energy Corp., Royal Dutch Shell plc (Shell) and Omega Holdings Company, LLC represented 15%, 15% and 9%, respectively, of our total consolidated revenues. In Recycling, Omega Holdings Company, LLC accounted for approximately 34% of our sales of RFO for the year ended December 31, 2012, while no single generator accounted for more than 5% of UMO volume in 2012. In our energy end-markets segments, in addition to Chesapeake Energy Corp. and Shell, we expect Hess Corporation and Whiting Oil & Gas Corporation, which accounted for approximately 33% and 25%, respectively, of the 2012 revenues of Power Fuels, which we merged with in the fourth quarter of 2012, to become increasingly important to our business.
In our energy end-markets segments, there are a limited number of competitors who approach the market similarly to Heckmann. Some competitors are focused primarily on treatment, recycling, and disposal operations, preferring to avoid the logistical components of delivery and collection, and include Tervita Corporation, R360 Environmental Solutions (now part of Waste Connections, Inc.), and Clean Harbors, Inc.. We believe that offering a comprehensive environmental solution to our customers, which includes certainty of control of environmental products from generation through disposal, is an important value proposition and will only increase in importance over time. We believe the logistical network we have built to provide delivery and collection is a significant competitive advantage relative to these competitors.
Other competitors offer certain environmental services as ancillary offerings to their core businesses, which are focused largely on the downhole aspects of oil and natural gas operations. Unlike us, many of these competitors also conduct hydraulic fracturing operations, examples of which would include Schlumberger Limited, Baker-Hughes, Inc., Key Energy Services, Inc. and Basic Energy Services, Inc. However, none of these companies focus entirely on the surface environmental aspects of unconventional oil and natural gas operations, a key aspect of our strategy. Other competitors focus primarily or exclusively on the fluids handling aspects of hydraulic fracturing and include numerous small, regional enterprises.
The UMO collection and recycling industry is highly fragmented, with a significant number of companies competing for the environmental services needs of commercial and industrial customers nationwide. These competitors include national companies such as Safety-Kleen (now part of Clean Harbors) and FCC Environmental, LLC, regional players such as Midstate Environmental Services, LP and Emerald Oil, Inc., and various local collectors. Companies operating in the industry typically utilize one of the following business models:
As a result, the markets in which we operate are highly competitive and certain of our competitors in both our energy end-markets segments and our Industrial Recycling Solutions segment have longer industry tenure and greater resources than us. Competition is influenced by such factors as price, capacity, availability of work crews and equipment, HS&E programs, legal compliance, technology, reputation and experience. We believe we can compete effectively in the environmental solutions sector as a result of our extensive industry experience, depth and breadth of transport, treatment and disposal assets, focus on HS&E and commitment to customer service.
Health, Safety & Environment
We are committed to excellence in HS&E in our operations, which we believe is a critical characteristic for our business. Our customers in the unconventional shale basins, including many of the large integrated and international oil and gas companies, require us, as a service provider, to meet high standards on HS&E matters. As a result, we believe that being a large environmental solutions company with a national presence and a dedicated focus on environmental solutions with a track record on HS&E in our operations and in the services we provide our customers is a competitive advantage relative to smaller regional companies as well as companies that provide certain environmental services as an ancillary offering.
Our business segments are impacted by seasonal factors. Generally, our business is negatively impacted during the winter months due to inclement weather, fewer daylight hours and holidays. During periods of heavy snow, ice or rain, we may not be able to move our trucks and equipment between locations, thereby reducing our ability to provide services and generate revenues. In addition, these conditions may impact our customers operations, and, as our customers drilling activities are curtailed, our services may also be reduced. During the fourth quarter, we historically have experienced slowdown during the Thanksgiving and Christmas holiday seasons and demand sometimes slows during this period as our customers exhaust their annual capital spending budgets.
Historically, Recycling has supplied a large percentage of its RFO for use in the production of asphalt, and consequently experiences some seasonality in its business. Demand for asphalt and asphalt products is generally higher during the summer months due to increases in highway traffic and road construction work.
We operate under numerous trade names and own several trademarks, the most important of which are Heckmann, HWR, and Heckmann Water Resources. We also have access, through certain exclusive and business relationships, to various water treatment technologies which, based on our experience, we utilize to create unique, cost-effective and proprietary total water treatment solutions for our customers.
Our operations are subject to hazards inherent in our industry, including accidents and fires that could cause personal injury or loss of life, damage to or destruction of property, equipment and the environment, and suspension of operations. Because our business involves the transportation of materials, we may also experience traffic accidents or pipeline breaks which may result in spills, property damage and personal injury. We have implemented a comprehensive HS&E program designed to minimize accidents in the workplace, enhance our safety programs, maintain environmental compliance and improve the efficiency of our operations.
Governmental Regulation, including Environmental Regulation and Climate Change
Our operations are subject to stringent United States federal, state and local laws and regulations regulating the discharge of materials into the environment or otherwise relating to health and safety or the protection of the environment. Additional laws and regulations, or changes in the interpretations of existing laws and regulations, that affect our business and operations may be adopted, which may in turn impact our financial condition. The following is a summary of the more significant existing health, safety and environmental laws and regulations to which our operations are subject.
Hazardous Substances and Waste. The United States Comprehensive Environmental Response, Compensation, and Liability Act, as amended, referred to as CERCLA or the Superfund law, and comparable state laws, impose liability without regard to fault or the legality of the original conduct on certain defined persons, including current and prior owners or operators of a site where a release of hazardous substances occurred and entities that disposed or arranged for the disposal of the hazardous substances found at the site. Under CERCLA, these responsible persons may be liable for the costs of cleaning up the hazardous substances, for damages to natural resources and for the costs of certain health studies.
In the course of our operations, we occasionally generate materials that are considered hazardous substances and, as a result, may incur CERCLA liability for cleanup costs. Also, claims may be filed for personal injury and property damage allegedly caused by the release of hazardous substances or other pollutants. We also generate solid wastes that are subject to the requirements of the United States Resource Conservation and Recovery Act, as amended, or RCRA, and comparable state statutes. In particular, RCRA standards require our Recycling Division to track all shipments of UMO and RFO destined for market and verification that the materials marketed by us meet the definition of on-specification used oil, which results in less stringent pollution controls, if any. If our products are deemed to be off-specification, potentially new emission standards could be imposed on our customers facilities that burn on-specification used oil (e.g. asphalt plants).
Although we use operating and disposal practices that are standard in the industry, hydrocarbons or other wastes may have been released at properties owned or leased by us now or in the past, or at other locations where these hydrocarbons and wastes were taken for treatment or disposal. Under CERCLA, RCRA and analogous state laws, we could be required to clean up contaminated property (including contaminated groundwater), or to perform remedial activities to prevent future contamination.
Air Emissions. The Clean Air Act, as amended, or CAA, and similar state laws and regulations restrict the emission of air pollutants and also impose various monitoring and reporting requirements. These laws and regulations may require us to obtain approvals or permits for construction, modification or operation of certain projects or facilities and may require use of emission controls.
Global Warming and Climate Change. While we do not believe our operations raise climate change issues different from those generally raised by the commercial use of fossil fuels, legislation or regulatory programs that restrict greenhouse gas emissions in areas where we conduct business or that would require reducing emissions from our truck fleet could increase our costs.
Water Discharges. We operate facilities that are subject to requirements of the United States Clean Water Act, as amended, or CWA, and analogous state laws for regulating discharges of pollutants into the waters of the United States and regulating quality standards for surface waters. Among other things these laws impose restrictions and controls on the discharge of pollutants, including into navigable waters as well as protecting drinking water sources. Spill prevention, control and counter-measure requirements under the CWA require implementation of measures to help prevent the contamination of navigable waters in the event of a hydrocarbon spill. Other requirements for the prevention of spills are established under the United States Oil Pollution Act of 1990, as amended, or OPA, which amended the CWA and applies to owners and operators of vessels, including barges, offshore platforms and certain onshore facilities. Under OPA, regulated parties are strictly liable for oil spills and must establish and maintain evidence of financial responsibility sufficient to cover liabilities related to an oil spill for which such parties could be statutorily responsible.
Oil Pollution Act. The United States Oil Pollution Act, as amended, or OPA, governs any facility that has the capacity to store more than 1,320 gallons of oil and/or petroleum products and has the potential to discharge to a navigable water of the United States. All our Recycling facilities are subject to this regulation, which requires that each facility develop and maintain a Spill Prevention Control and Countermeasures Plan, or SPCC. The SPCC requires certain planning and training to minimize the potential for oil and/or other petroleum products to be released into a navigable waterway.
National Pollutant Discharge Elimination System. Our Recycling Divisions storm water discharges and waste water discharges are regulated by the National Pollutant Discharge Elimination System, or NPDES, permit program. Many of Recyclings facilities are required to manage their storm water runoff according to a Multi Sector General Permit issued by the EPA or by a particular state, if the state has been delegated authority to administer the program. Under NPDES, our regulated facilities must maintain a Storm Water Pollution Prevention Plan that identifies certain best management practices to minimize the off-site impact of any pollutants that may be carried off-site by precipitation. Very few of Recyclings locations require specific waste water discharge permits from industrial processes.
State Environmental Regulations. Our operations involve the storage, handling, transport and disposal of bulk waste materials, some of which contain oil, contaminants and other regulated substances. Various environmental laws and regulations require prevention, and where necessary, cleanup of spills and leaks of such materials and some of our operations must obtain permits that limit the discharge of materials. Failure to comply with such environmental requirements or permits may result in fines and penalties, remediation orders and revocation of permits. In Texas, we are subject to rules and regulations promulgated by the Texas Railroad Commission and the Texas Commission on Environmental Quality, including those designed to protect the environment and monitor compliance with water quality. In Louisiana, we are subject to rules and regulations promulgated by the Louisiana Department of Environmental Quality and the Louisiana Department of Natural Resources as to environmental and water quality issues, and the Louisiana Public Service Commission as to allocation of intrastate routes and territories for waste water transportation. In Pennsylvania, we are subject to the rules and regulations of the Pennsylvania Department of Environmental Protection and the Pennsylvania Public Service Commission. In Ohio, we are subject to the rules and regulations of the Ohio Department of Natural Resources and the Ohio Environmental Protection Agency. In North Dakota, are subject to the rules and regulations of the North Dakota Department of Health, the North Dakota Industrial Commission, Oil and Gas Division, and the North Dakota State Water Commission. In Montana, we are subject to the rules and regulations of the Montana Department of Environmental Quality and the Montana Board of Oil and Gas.
In addition, Recyclings operations involve the storage, handling, transport and disposal of bulk waste materials, some of which contain oil, contaminants and other regulated substances. Various state environmental laws and regulations require prevention, and where necessary, cleanup of spills and leaks of such materials and some of our operations must obtain permits that limit the discharge of materials. Failure to comply with such environmental requirements or permits may result in fines and penalties, remediation orders and revocation of permits. For example, in California, Recycling is subject to the Department of Toxic Substances Control, or DTSC, controls on the shipment and management of used oil. Recycling has worked with the California DTSC to develop a testing and reporting agreement with the to assist transporters of used motor oil to meet the states standard.
Occupational Safety and Health Act. We are subject to the requirements of the United States Occupational Safety and Health Act, as amended, or OSHA, and comparable state laws that regulate the protection of employee health and safety. OSHAs hazard communication standard requires that information about hazardous materials used or produced in our operations be maintained and provided to employees, state and local government authorities and citizens.
Saltwater Disposal Wells. We operate salt water disposal wells that are subject to the CWA, the Safe Drinking Water Act, or SWDA, and state and local laws and regulations, including those established by the Underground Injection Control Program of the United States Environmental Protection Agency, or EPA, which establishes the minimum program requirements including for permitting, testing, monitoring, record keeping and reporting of injection well activities. All of our salt water disposal wells are located in Ohio, Mississippi, Texas, North Dakota and Montana. Regulations in Texas, Louisiana and Ohio, North Dakota and Montana require us to
obtain a permit to operate each of our salt water disposal wells in those states. These regulatory agencies have the general authority to suspend or modify one or more of these permits if continued operation of one of our underground injection wells is likely to result in pollution of freshwater, substantial violation of permit conditions or applicable rules, or leaks to the environment. Any leakage from the subsurface portions of the injection wells could cause degradation of fresh groundwater resources, potentially resulting in cancellation of operations of a well, issuance of fines and penalties from governmental agencies, incurrence of expenditures for remediation of the affected resource and imposition of liability by third parties for property damages and personal injuries.
Transportation regulations. We conduct interstate motor carrier (trucking) operations that are subject to federal regulation by the Federal Motor Carrier Safety Administration, or FMCSA, a unit within the United States Department of Transportation, or USDOT. The FMCSA publishes and enforces comprehensive trucking safety regulations, including rules on commercial driver licensing, controlled substance testing, medical and other qualifications for drivers, equipment maintenance, and drivers hours of service, referred to as HOS. The agency also performs certain functions relating to such matters as motor carrier registration (licensing), insurance, and extension of credit to motor carriers customers. Another unit within USDOT publishes and enforces regulations regarding the transportation of hazardous materials, or hazmat, but the waste water and other water flows we transport by truck are not normally regulated as hazmat at this time.
In December 2010, the FMCSA launched a program called Compliance, Safety, Accountability, or CSA, in an effort to improve commercial truck and bus safety. A component of CSA is the Safety Measurement System, or SMS, which will continuously analyze all safety violations recorded by the federal and state law enforcement personnel to determine a carriers safety performance. The SMS is intended to allow the FMCSA to identify carriers with safety issues and intervene to address those problems. Although our trucking operations currently hold a Satisfactory safety rating from FMCSA (the best rating available), the agency has announced a future intention to revise its safety rating system by making greater use of SMS data in lieu of on-site compliance audits of carriers. We cannot predict the effect of such a revision on our safety rating.
Our intrastate trucking operations are also subject to the state environmental and waste water transportation regulations discussed under Environmental Regulations above. Federal law also allows states to impose insurance and safety requirements on motor carriers conducting intrastate business within their borders, and to collect a variety of taxes and fees on an apportioned basis reflecting miles actually operated within that state.
The HOS regulations establish the maximum number of hours that a commercial truck driver may work. A new FMCSA rule reducing the number of hours a commercial truck driver may work each day became effective in February 2012 and the compliance date of selected provisions is July 1, 2013. The new rule, which is intended to reduce the risk of fatigue and fatigue-related crashes and harm to driver health in several ways, among other things prohibits a driver from driving if more than eight hours have passed since the drivers last off-duty or sleeper berth break of at least 30 minutes and limits the use of the restart to once a week, which, on average, will cut the maximum work week from 82 to 70 hours. The effect of reduced driver hours may raise operating costs for many if not most truck fleets.
In addition, the USDOTs Pipeline and Hazardous Materials Safety Administration regulates the transportation of materials deemed by to be hazardous while in transport. A small portion of the materials that Recycling transports are subject to these regulations, which require certain training and communication rules to ensure the safe transport of hazardous materials.
Hydraulic Fracturing. Although we do not directly engage in hydraulic fracturing activities, certain of our customers, particularly our Fluids Management customers, perform hydraulic fracturing operations. While we believe that the adoption of new federal and/or state laws or regulations imposing increased regulatory burdens on hydraulic fracturing could increase demand for our services, it is possible that it could harm our business by making it more difficult to complete, or potentially suspending or prohibiting, crude oil and natural gas wells in shale formations, increasing our and our customers costs of compliance and adversely affecting the hydraulic fracturing services that we provide for our customers.
Due at least in part to public concerns that have been raised regarding the potential impact of hydraulic fracturing on drinking water, the EPA has commenced a comprehensive study, at the order of the United States Congress, of the potential environmental and health impacts of hydraulic fracturing activities. A final draft report is expected to be issued by the EPA for public comment in 2014. On October 15, 2012, a new rule promulgated by the EPA that established new air emission controls for crude oil and natural gas production and natural gas processing operations became effective. The rule includes New Source Performance Standards, or NSPS, to address emissions of sulfur dioxide and volatile organic compounds, or VOCs, and a separate set of emission standards to address hazardous air pollutants associated with oil and natural gas production and processing activities. EPAs final rule requires the reduction of VOC emissions from crude oil and natural gas production facilities by mandating the use of green completions for hydraulic fracturing, which requires the operator to recover rather than vent the gas and natural gas liquids that come to the surface during completion of the fracturing process.
Legislation, including bills known collectively as the Fracturing Responsibility and Awareness of Chemicals Act, or FRAC Act, has been introduced before both houses of Congress in the last few sessions to remove the exemption of hydraulic fracturing under the SDWA and to require disclosure to a regulatory agency of chemicals used in the fracturing process and otherwise restrict hydraulic fracturing. To date, this legislation has not been passed by either house.
Various state, regional and local governments have implemented, or are considering, increased regulatory oversight of hydraulic fracturing through additional permit requirements, operational restrictions, disclosure requirements, and temporary or permanent bans on hydraulic fracturing in certain environmentally sensitive areas such as certain watersheds. The North Dakota Industrial Commission, Oil and Gas Division recently proposed regulations requiring owners, operators, and service companies to post the composition of the hydraulic fracturing fluid used during certain hydraulic fracturing stimulations on the FracFocus Chemical Disclosure Registry. The availability of information regarding the constituents of hydraulic fracturing fluids could potentially make it easier for third parties opposing the hydraulic fracturing process to initiate legal proceedings based on allegations that specific chemicals used in the fracturing process could adversely affect groundwater. In addition, North Dakota recently proposed regulations prohibiting the discharge of fluids, wastes, and debris other than drill cuttings into open pits.
As of December 31, 2012, we had 2,698 full time employees, of whom 342 were executive, managerial, sales, general, administrative, and accounting staff, and 2,356 were truck drivers, service providers and field workers. In addition, as of December 31, 2012, we contracted with approximately 65 independent contractor truck drivers to supplement our trucking capacity in the Bakken Shale area on an as-needed basis. None of our employees are under collective bargaining agreements. We believe that we maintain a satisfactory working relationship with our employees and we have not experienced any significant labor disputes.
Information that we file with or furnish to the SEC, including our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to or exhibits included in these reports, are available free of charge on our website at www.heckmanncorp.com soon after such reports are filed with or furnished to the SEC. From time to time, we also post announcements, updates, events, investor information and presentations on our website in addition to copies of all recent press releases. Our reports, including any exhibits included in such reports, that are filed with or furnished to the SEC are also available on the SECs website at www.sec.gov. You may also read and copy any materials we file with or furnish to the SEC at the SECs Public Reference Room at 100 F Street, NE, Room 1580, Washington, D.C. 20549; information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. You may request copies of these documents from the SEC, upon payment of a duplicating fee, by writing to the SEC at its principal office at 100 F Street, NE, Room 1580, and Washington, D.C. 20549.
Neither the contents of our website nor that maintained by the SEC are incorporated into or otherwise a part of this filing. Further, references to the URLs for these websites are intended to be inactive textual references only.
You should carefully consider the risks described below. If any of the risks and uncertainties described in the cautionary factors described below actually occurs, our business, financial condition and results of operations could be materially and adversely affected. The risks and factors listed below, however, are not exhaustive. Other sections of this Annual Report on 10-K include additional factors that could materially and adversely impact our business, financial condition and results of operations. Moreover, we operate in a rapidly changing environment. In addition, we are subject to legal and regulatory changes. New factors emerge from time to time and it is not possible to predict the impact of all these factors on our business, financial condition or results of operations.
Risks Related to Our Company
We may not be able to grow successfully through future acquisitions or successfully manage future growth, and we may not be able to effectively integrate the businesses we do acquire.
Our business strategy includes growth through the acquisitions of other businesses in both our Fluids Management and Recycling Divisions. We may not be able to continue to identify attractive acquisition opportunities or successfully acquire those opportunities identified. In order to complete acquisitions, we would expect to require additional debt and/or equity financing, which could increase our interest expense, leverage and shares outstanding. In addition, we may not be successful in integrating current or future acquisitions into our existing operations, which may result in unforeseen operational difficulties or diminished financial performance or require a disproportionate amount of our managements attention.
Even if we are successful in integrating our current or future acquisitions into our existing operations, we may not derive the benefits, such as operational or administrative synergies or earnings gains`, that we expected from such acquisitions, which may result in the commitment of our capital resources without the expected returns on such capital. Also, competition for acquisition opportunities may escalate, increasing our cost of making further acquisitions or causing us to refrain from making additional acquisitions.
Additional risks related to our acquisition strategy include, but are not limited to:
We may not be able to successfully integrate or realize the anticipated benefits of our merger with Power Fuels or acquisition of TFI and may not be able to maintain or achieve profitability of the acquired businesses or overall.
Although we have completed a number of smaller acquisitions since mid-2010, Power Fuels and TFI represent, by far, the largest additions to our business. The integration and consolidation of Power Fuels and TFI has and will continue to require substantial management, financial and logistical and other resources. While we believe that we have sufficient resources to integrate these businesses successfully, such integration involves a number of significant risks, including diversion of managements attention and resources. Moreover, there can be no assurance as to the extent to which the anticipated benefits of these transactions will be realized, if at all, or that significant time and cost beyond that anticipated will not be required in connection with the integration of TFI and the continuing operation of the Power Fuels and TFI businesses. If we are unable to integrate and manage TFI successfully, or to achieve a substantial portion of the anticipated benefits of these acquisitions within the time frames anticipated by management and within budget, it could have a material adverse effect on our business, financial condition or results of operations.
The merger with Power Fuels and our acquisition of TFI makes evaluating our operating results difficult given the significance of these transactions, and historical and unaudited pro forma financial information may not give you an accurate indication of how we will perform in the future.
Our acquisition activities, in particular the Power Fuels merger and the acquisition of TFI, may make it more difficult for us to evaluate and predict our future operating performance. Neither our historical results of operations, nor the separate pre-acquisition financial information of Power Fuels or TFI, give effect to those transactions; accordingly, such historical financial information does not necessarily reflect what our, Power Fuels or TFIs financial position, operating results and cash flows will be in the future on a consolidated basis following consummation of those transactions. Unaudited pro forma financial information giving effect to the Power Fuels merger and the TFI acquisition does not represent, and should not be relied upon as reflecting, what our financial position, results of operations or cash flows actually would have been if the transactions referred to therein had been consummated on the dates or for the periods indicated, or what such results will be for any future date or any future period.
We are vulnerable to the potential difficulties associated with rapid growth.
We believe that our future success depends on our ability to manage the rapid growth that we have experienced, and the continued growth that we expect to experience organically and through acquisitions. Our growth places additional demands and responsibilities our management to, among other things, maintain existing customers and attract new customers, recruit, retain and effectively manage employees, as well as expand operations and integrate customer support and financial control systems. The following factors could present difficulties to us: lack of sufficient executive-level personnel, increased administrative burden, long lead times associated with acquiring additional equipment; availability of suitable acquisition candidates and of additional capacity of trucks, saltwater disposal and underground injection wells, frac tanks, rail cars, processing facilities and pipeline right-of-way; and the ability to provide focused service attention to our customers in the areas of fracking, oil collection, tank storage, antifreeze collection,
antifreeze re-manufacturing, industrial waste management and oil and water filtration, among others. In addition, the planned expansion of our LNG truck fleet, and the anticipated cost savings, are dependent on available infrastructure for LNG refueling, which is currently limited to Haynesville, and the lack of available infrastructure may significantly restrict this planned expansion and the expected benefits of this growth.
Future charges due to possible impairments of assets may have a material adverse effect on our financial condition and results of operations, and stock price.
A portion of our assets is comprised of goodwill and other intangible assets, which may be subject to future impairment that would result in financial statement write-offs. Goodwill and other intangible assets represent approximately 51.1% of our total assets as of December 31, 2012, the majority of which relates to the Power Fuels merger and TFI acquisition. If there is a material change in our business operations or prospects, the value of our intangible assets, or those we may acquire in the future, could decrease significantly.
Accounting Standards Codification 350 (ASC 350 Intangibles Goodwill and Other) provides specific guidance for testing goodwill and other non-amortized intangible assets for impairment. The testing of goodwill and other intangible assets for impairment requires us to make significant estimates about our future performance and cash flows, as well as other assumptions. These estimates can be affected by numerous factors, including changes in the definition of a business segment in which we operate; changes in economic, industry or market conditions; changes in business operations; changes in competition; or potential changes in the share price of our common stock and market capitalization. Changes in these factors, or changes in actual performance compared with estimates of our future performance, could affect the fair value of goodwill or other intangible assets, which may result in an impairment charge. Should the value of our goodwill or other intangible assets become impaired, it could have a material adverse effect on our consolidated results of operations and could result in our incurring net losses in future periods.
On an ongoing basis and at least annually, we evaluate whether the carrying value of our intangible assets may no longer be recoverable, in which case a charge to earnings may be necessary. We cannot accurately predict the amount or timing of any impairment of assets. Any future determination requiring the write-off of a significant portion of unamortized intangible assets, although not requiring any additional cash outlay, could have a material adverse effect on our financial condition, results of operations and stock price.
We depend on our senior management.
Our success is largely dependent on the skills, experience and efforts of our people. In particular, the continued services of Mr. Heckmann, our Executive Chairman, and Mr. Johnsrud, our Chief Executive Officer and Vice Chairman. The loss of the services of Mr. Heckmann or Mr. Johnsrud, or of other members of our senior management could have a negative effect on our business, financial condition and results of operations and future growth if we were unable to replace them.
Mr. Johnsrud has not previously been the chief executive officer of a publicly traded company and has no prior experience managing a publicly traded company and complying with federal securities laws, including compliance with disclosure requirements on a timely basis. Our management may be required for a period of time to divert its attention from operational matters to compliance and reporting requirements, which could harm our business.
We have had, and may have in the future, material weaknesses in our internal control over financial reporting that could cause investors to lose confidence in our reported financial information and thereby cause a decline in our stock price.
As of December 31, 2012, our management concluded that our internal control over financial reporting was effective to provide reasonable assurance that the information required to be disclosed in our reports filed with the SEC under the Exchange Act are recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms, and are accumulated and communicated to our management, including our Chief Executive Officer, as appropriate to allow timely decisions regarding required disclosure. However, we have had in the past and may have in the future material weaknesses in our internal control over financial reporting.
If we are unable to address any material weaknesses in our internal control over financial reporting, we may have errors in our financial statements that could result in a restatement of our financial statements, cause us to fail to meet our reporting deadlines, and cause investors to lose confidence in our reported financial information, leading to a decline in our stock price.
We are engaged in litigation and subject to an SEC inquiry relating to China Water and Drinks Inc., our former China water bottling business which was disposed of in 2011, and a negative outcome in any of these proceedings could materially adversely affect us.
As described in greater detail in Note 11, Commitments and Contingencies, of the Notes to our 2012 Consolidated Financial Statements herein, we and certain of our directors and officers are involved in litigation arising from or relating to our acquisition of China Water and Drinks, Inc., or China Water, in October 2008, including a purported class action and a derivative action. In addition, on June 10, 2011, we received a subpoena from the Denver Regional Office of the SEC seeking information and documents concerning China Water. We are cooperating and intend to continue to cooperate fully with the SEC with respect to its requests. A negative outcome of the SEC inquiry could result in the SEC imposing fines or penalties on us, or requiring us to satisfy other remedies including modifications to business practices and implementing compliance programs.
The litigation and the SEC inquiry are also causing us to incur substantial legal fees and expenses as well as requiring management time and involvement. The outcome of the litigation and the SEC inquiry are uncertain and, if adversely decided or settled against us or any of our officers or directors, could have a material adverse impact on our business, financial condition, results of operations and cash flows.
Changes to the fair market or carrying value of our investments in UGSI could result in a write down.
As of December 31, 2012, we own approximately 7% of Underground Solutions, Inc., or UGSI, a supplier of water infrastructure pipeline products, which we acquired in 2009 for a total investment of $7.2 million. There is no or limited liquidity in the stock of UGSI. Changes to the fair market or carrying value of our investments in UGSI could result in a write down of this investment.
Significant capital expenditures are required to conduct our business.
The development of our business and services, excluding acquisition activities, requires substantial capital expenditures, particularly in our Fluids Management Division. During the year ended December 31, 2012, we made capital expenditures of approximately $45.6 million, including an expansion of our fleet of trucks and trailers, additional salt water disposal wells and completion of the construction of a pipeline in the Haynesville Shale area. We fund our capital expenditures through a combination of cash flows from operations and borrowings under our bank credit facilities and, to the extent those sources are not sufficient, we may fund capital expenditures from the proceeds of debt and equity issuances. Future cash flows from operations are subject to a number of risks and variables, such as the level of drilling activity and oil and natural gas production of our customers, prices of natural gas and oil, ability to source UMO, demand for RFO, and the other risk factors discussed herein. Our ability to obtain capital from other sources, such as the capital markets, is dependent upon many of those same factors as well as the orderly functioning of credit and capital markets. To the extent we fail to have adequate funds, we could be required to reduce our capital spending, or pursue other funding alternatives, which in turn could adversely affect our business and results of operations.
Increases in costs relating to our large fleet of trucks, including driver compensation or difficulty in attracting and retaining qualified drivers as well as increases in fuel costs, could adversely affect our profitability.
During 2012, we increased the number of truck drivers we employ to approximately 1,630 as of December 31, 2012, compared to approximately 670 as of December 31, 2011, including approximately 125 additional drivers added through the TFI acquisition and over 600 drivers added through the Power Fuels merger. Maintaining a staff of qualified truck drivers is critical to the success of our operations. We have in the past experienced difficulty in attracting and retaining sufficient numbers of qualified drivers in some of the markets in which we operate, which difficulty is due in part to our high standards for retention of drivers. A shortage of qualified drivers and intense competition for drivers from other companies may create difficulties in some regions.
The compensation we offer our drivers is subject to market conditions, and we may find it necessary to increase driver compensation and/or modify the benefits provided to our employees in future periods.
In Fluids Management, we and other companies in the oil and gas industry suffer from a high turnover rate of drivers. The high turnover rate requires us to continually recruit a substantial number of drivers in order to operate existing equipment. If we are unable to continue to attract and retain a sufficient number of qualified drivers, we could be forced to, among other things, adjust our compensation packages, increase the number of our trucks without drivers, or operate with fewer trucks and face difficulty meeting customer demands, any of which could adversely affect our growth and profitability. Additionally, in anticipation of or in response to geographical and market-related fluctuations in the demand for our services, we strategically relocate our equipment and personnel from one area to another, which results in operating inefficiencies, increased labor, fuel and other operating costs and could adversely affect our growth and profitability. As a result, our driver and employee training and orientation costs could be negatively impacted.
Increases in oil, natural gas and diesel prices have a significant impact on our operating expenses. The price and supply of oil and fuel is unpredictable and fluctuates based on events beyond our control, including geopolitical developments, supply and demand for oil, natural gas and LNG, actions by the Organization of Petroleum Exporting Countries, or OPEC, and other oil and gas producers, war and unrest in oil producing countries, regional production patterns and environmental concerns. Continued increases in/high prices of diesel costs throughout 2012 reduced profit margins in Fluids Management. Fuel prices may continue to increase significantly in 2013 and beyond, which could adversely affect our operating results, particularly in Fluids Management.
In addition, the supply of critical infrastructure assets, in particular employee housing, in the Bakken Shale area has not kept pace with the rapid growth in the region caused by the boom in the energy and environmental services industry. As a result, there is a shortage of fixed housing in the region, making it difficult for energy services operators and other businesses to attract quality, long-term personnel. Through an entity he controls, but which was not included in the Merger, Mr. Johnsrud owns fixed-housing units in the Bakken Shale area. Prior to the merger, Power Fuels employees had priority access to rent the housing owned by this entity, however there is no formal arrangement with Mr. Johnsrud to ensure that our employees have continued access to rent this housing following the merger. There can be no assurance that there will be sufficient housing available for all of our employees in the Bakken Shale area, which could adversely affect our ability to provide services and our operating results.
We depend on certain key customers for a significant portion of our revenues. The loss of any of these key customers or the loss of any contracted volumes could result in a decline in our business.
We rely on a limited number of customers for a significant portion of our revenues. Chesapeake Energy Corp., Shell Swepi, LLC, and Omega Holdings Company, LLC represented 15%, 14% and 9% of our total consolidated revenues for the year ended December 31, 2012, respectively. Additionally, Omega Holdings Company, LLC accounted for approximately 34% of our sales of RFO for the year ended December 31, 2012, and in Fluids Management, Chesapeake Energy Corp., Shell Swepi, LLC, and Chevron Corp. accounted for approximately 21%, 20% and 11%, respectively, of Fluids Management revenues. The loss of all, or even a portion of, the revenues from these customers, as a result of competition, market conditions or otherwise, could have a material adverse effect on our business, results of operations, financial condition, and cash flows. For example, our 2012 results of operations were adversely affected by Chesapeake Energys reduced natural gas drilling activity.
The loss of key contracts could adversely impact our financial condition and results of operations.
Contracts with customers of our environmental solutions business generally have initial terms of one to three years, with renewal options and early termination clauses. Although we have experienced growth in the number of companies using our services during 2012, the loss or material reduction of business could adversely affect our financial condition and results of operations. We cannot assure you that our existing contracts will continue or be extended or renewed, that existing customers will continue to use our services at current levels or that we will be successful in obtaining new contracts.
Our ability to utilize net operating loss carryforwards in the future may be subject to substantial limitations.
The company believes that its ability to use its U.S. federal net operating loss carryforwards and other tax attributes may be limited. Internal Revenue Code Sections 382 and 383 provide annual limitations with respect to the ability of a corporation to utilize its net operating loss (as well as certain built-in losses) and tax credit carryforwards, respectively (Tax Attributes), against future U.S. taxable income, if the corporation experiences an ownership change. In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percentage points over a three-year period. The company regularly monitors ownership changes (as calculated for purposes of Section 382). Based on currently available information, the company believes that an ownership change may have occurred during 2012, for purposes of the rules described above. Moreover, any future transaction or transactions and the timing of such transaction or transactions could trigger additional ownership changes under Section 382. In the event of an ownership change, utilization of the companys Tax Attributes will be subject to an overall annual limitation determined in part by multiplying the total adjusted aggregate market value of the companys common stock immediately preceding the ownership change by the applicable long-term tax-exempt rate, possibly subject to increase based on the built-in gain, if any, in the companys assets at the time of the ownership change. Any unused annual limitation may be carried over to later years. Future U.S. taxable income may not be fully offset by existing Tax Attributes, if such income exceeds the companys annual limitation.
We operate in competitive markets, and there can be no certainty that we will maintain our current customers or attract new customers or that our operating margins will not be impacted by competition.
The industries in which our Fluids Management and Recycling businesses operate are highly competitive. We compete with numerous local and regional companies of varying sizes and financial resources. We expect competition to intensify in the future. Furthermore, numerous well-established companies are focusing significant resources on providing similar services to those that we provide that will compete with our services. We cannot assure you that we will be able to effectively compete with these other companies or that competitive pressures, including possible downward pressure on the prices we charge for our products and services, will not arise. In the event that we cannot effectively compete on a continuing basis, or competitive pressures arise, such inability to compete or competitive pressures could have a material adverse effect on our business, results of operations and financial condition.
Our Fluids Management business depends on spending by the oil and natural gas industry in the United States, and this spending and our business has been, and may continue to be, adversely affected by industry and financial market conditions that are beyond our control.
We depend on our customers willingness to make operating and capital expenditures to explore, develop and produce oil and natural gas in the United States. Declines in these expenditures, due to the low natural gas price environment or other factors, could result in project modification, delays or cancellations, general business disruptions, and delays in, or nonpayment of, amounts owed to us. Customers expectations for lower market prices for oil and natural gas, as well as the availability of capital for operating and capital expenditures, may also cause our customers to curtail spending, thereby reducing demand for our services.
Industry conditions are influenced by numerous factors over which we have no control, including:
The volatility of the oil and natural gas industry and the impact on exploration and production activity could adversely impact the level of drilling activity by some of our customers or in some of the regions in which we operate. For example, natural gas spot prices have fallen significantly since late 2011 and the number of active drilling rigs operating in the Haynesville, Barnett and Marcellus Shale areas has declined with many of these rigs moving to other oil- and liquids-rich shale areas such as the Utica, Eagle Ford, Bakken and Permian Basin. This transition in exploration and production activity has caused and may continue to cause a decline in the demand for our services in affected regions where we operate and has adversely affected and may continue to affect the price of our services and the financial results of our operations. In addition, reduced discovery rates of new oil and natural gas reserves in our market areas also may have a negative long-term impact on our business, even in an environment of stronger oil and natural gas prices, due to reduced fracking activity and reduced produced water from existing producing wells to the extent existing production is not replaced and the number of producing wells for us to service declines.
Recent declines in natural gas prices have caused many oil and natural gas producers to announce reductions in capital budgets for future periods. Limitations on the availability of capital, or higher costs of capital, for financing expenditures may cause these and other oil and natural gas producers to make additional reductions to capital budgets in the future even if commodity prices increase from current levels. These cuts in spending have curtailed drilling programs as well as discretionary spending on well services, which have also adversely affected and may continue to affect the demand for our services, the rates we can charge and our utilization. In addition, certain of our customers could become unable to pay their vendors and service providers, including us, and we increased our bad debt reserve in 2011 and 2012 to reflect this development. Any of these conditions or events could adversely affect our operating results and cash flows.
Any interruption in our Fluids Management services due to pipeline ruptures or spills or necessary maintenance could impair our financial performance and negatively affect our brand.
Our fixed water transport pipelines are susceptible to ruptures and spills, particularly during start up and initial operation, and require ongoing inspection and maintenance. For example, in 2010 and 2011, we had breaks in our 50-mile underground pipeline network in the Haynesville Shale area that resulted in delays in transporting our customers water and resulted in significant repair and remediation costs. We may experience further difficulties in maintaining the operation of our pipelines, which may cause downtime and delays. Any interruption in our services due to pipeline breakdowns or necessary maintenance could reduce sales revenues and earnings and result in remediation costs. Transportation interruptions at our pipelines, even if only temporary, could severely harm our business and reputation.
Our operations are subject to risks inherent in the oil and natural gas industry, some of which are beyond our control. These risks may not be fully covered under our insurance policies.
Our operations are subject to operational hazards, including accidents or equipment issues that can cause pollution and other damage to the environment. For example, produced water from our pipelines has leaked into private property on several occasions. As required pursuant to applicable law, we remediated the environmental impact, including related to site investigation and soil, groundwater and surface water cleanup.
In addition, hazards inherent in the oil and natural gas industry, such as, but not limited to, accidents, blowouts, explosions, pollution and other damage to the environment, fires and hydrocarbon spills, may delay or halt operations at extraction sites which we service. These conditions can cause:
The occurrence of a significant event or a series of events that together are significant, or adverse claims in excess of the insurance coverage that we maintain or that are not covered by insurance, could have a material adverse effect on our financial condition and results of operations. In addition, claims for loss of oil and natural gas production and damage to formations can occur in the well services industry. Litigation arising from a catastrophic occurrence at a location where our equipment and services are being used may result in our being named as a defendant in lawsuits asserting large claims.
The Companys maintains insurance coverage that we believe to be customary in the industry against these hazards. We may not be able to maintain adequate insurance in the future at rates we consider reasonable. In addition, insurance may not be available to cover any or all of the risks to which we are subject, or, even if available, it may be inadequate, or insurance premiums or other costs could make such insurance prohibitively expensive. It is likely that, in our insurance renewals, our premiums and deductibles will be higher, and certain insurance coverage either will be unavailable or considerably more expensive than it has been in the recent past. In addition, our insurance is subject to coverage limits, and some policies exclude coverage for damages resulting from environmental contamination.
Improvements in or new discoveries of alternative energy technologies or fracking methodologies could have a material adverse effect on our financial condition and results of operations.
Because our Fluids Management segment depends on the level of activity in the oil and natural gas industry, any improvement in or new discoveries of alternative energy technologies (such as wind, solar, geothermal, fuel cells and biofuels) that increase the use of alternative forms of energy and reduce the demand for oil and natural gas could have a material adverse impact on our business, financial condition and results of operations. In addition, technological changes could decrease the quantities of water required for fracking operations or otherwise affect demand for our services.
Seasonal weather conditions and natural disasters could severely disrupt normal operations and harm our business.
We operate in the southern, mid-western, western and eastern United States. These areas are adversely affected by seasonal weather conditions, primarily in the winter and spring. During periods of heavy snow, ice or rain, our customers may curtail their operations or we may be unable to move our trucks between locations or provide other services, thereby reducing demand for, or our ability to provide services and generate revenues. For example, many municipalities impose weight restrictions on the paved roads that lead to our customers jobsites in the spring due to the muddy conditions caused by spring thaws, limiting our access and our ability to provide service in these areas. In February 2011, portions of Texas had record snowfalls. In September 2011 and October 2012, portions of Pennsylvania and other areas in the eastern United States had record rainfall and flooding. During those periods, we and our customers had to significantly reduce or halt operations, resulting in a loss of revenue. In addition, the regions in which we operate have in the past been, and may in the future be, affected by natural disasters such as hurricanes, windstorms, floods and tornadoes; in 2005 and 2008, for example, tropical hurricanes and related storm activity caused extensive damage in portions of Texas and Louisiana, causing disruptions in our, and our customers, operations. Future natural disasters or inclement weather conditions could severely disrupt the normal operation of our, or our customers, business and have a material adverse effect on our financial condition and results of operations.
Our operating margins and profitability may be negatively impacted by changes in fuel and energy costs, in part due to the fixed cost structure of our business.
Our Recycling business is dependent on the widespread availability of certain crude oil products such as UMO and both our Recycling and Fluids Management business are depending on the availability of fuel for operating our fleet of trucks. Changes and volatility in the price of crude can adversely impact the prices for these products and therefore affect our operating results. The price and supply of fuel is unpredictable and fluctuates based on events beyond our control, including geopolitical developments, supply and demand for oil and gas, actions by OPEC and other oil and gas producers, war and unrest in oil producing countries, regional production patterns, and environmental concerns.
In addition, the price at which we sell our RFO can be affected by changes in certain oil indices. If the relevant oil index rises, we can typically increase prices for our RFO. If the relevant oil index declines, we must typically reduce prices for our RFO. However, the cost to collect UMO, including the amounts we must pay to obtain UMO and the fuel costs of our oil collection fleet,
generally also increases or decreases when the relevant index increases or decreases. Even though the prices we can charge for our RFO and the costs to collect and process UMO generally increase and decrease together, we cannot assure you that when our costs to collect and process UMO increase we can increase the prices we charge for our RFO to cover such increased costs or that the costs to collect and process UMO will decline when the prices we can charge for processed oil declines, which could adversely affect our profit margins. If the prices we charge for our RFO and the costs to collect and process UMO do not move together or in similar magnitudes, it could adversely affect our profit margins, financial condition and results of operations. In addition, falling oil and diesel prices could make diesel more cost competitive with RFO, which could adversely affect our Recycling Division segment operating results.
Furthermore, our facilities, fleet and personnel subject us to fixed costs, which make our margins and earnings sensitive to changes in revenues. In periods of declining demand, our fixed cost structure may limit our ability to cut costs, which may put us at a competitive disadvantage to firms with lower cost structures, or may result in reduced operating margins and/or operating losses.
Consolidation and/or declines in the United States automotive repair and manufacturing industries could cause us to experience lower sales volumes, which could materially affect our growth and financial performance.
Our Recycling Division relies on continued demand for oil collection, environmental and waste management services in the United States automotive repair and manufacturing industries, which may suffer from declining market size and number of locations, due in part to the uncertainty of economic conditions, international competition, and consolidation. Industry trends affecting our customers have caused our customers businesses to contract. Additional decline could reduce the demand for our parts cleaning and other services and products and have a material adverse impact on our business. As a result, we may not be able to continue to grow our business by increasing penetration into the industries which we serve, and our ability to retain our market share and base of sales could become more difficult.
The price we receive for our RFO depends on numerous factors beyond our control, such as the supply and demand of asphalt, paper and pulp.
The price of RFO and other refined products depends on numerous factors beyond our control, including the supply and demand of asphalt, paper and pulp and other industrial products, in general. Our Recycling Division supplies a large percentage of its RFO for use in the production of asphalt and paper and pulp. Changes in the supply and demands for these products may, in turn, drive the price of RFO down, which could have an adverse effect on the results of our Recycling Division. The supply and demand of asphalt, for example, is affected by, among other things, local economic conditions, federal, state and local spending on infrastructure development, housing starts, federal highway trust funds, and seasonality, with demand for asphalt and asphalt products generally being higher during the summer months, due to increases in highway traffic and road construction work. Likewise, the supply and demand of paper and pulp is affected by, among other things, costs of wood, logging and transportation of timber, price of market pulp, cyclical changes in the global economy, industry capacity, foreign exchange rates, levels of economic growth and climate change, as well as social and government responses to climate change.
The inability of our Recycling Division to source adequate volumes of UMO to generate profits or contributions from the sale of RFO could have a material adverse effect on our financial condition and results of operations.
Our Recycling Division is dependent on the availability of UMO. If our Recycling Division is not able to source adequate volumes of UMO from generators or other third parties at acceptable prices to generate profits or contributions from the subsequent sale of RFO, we could experience a material adverse effect on our financial condition and results of operations.
Nonconforming or contaminated materials that we may receive from our Recycling customers may expose us to earnings impairments.
Our Recycling Division relies, in part, on materials, particularly UMO, provided by our customers. From time to time, customers tender nonconforming materials that could be contaminated with toxins (e.g. polychlorinated biphenyls and other non-value added waste streams). It is possible that the costs associated with remediation and business interruption due to this contamination and any associated regulatory fines could be in excess of our insurance coverage limits, thus exposing us to earnings impairments.
Litigation related to personal injury from the operation of our Recycling business may result in significant liabilities and limit our profitability.
The hazards and risks associated with the use, transport, storage, and handling and disposal of our customers waste (such as fires, natural disasters, explosions and accidents) may expose us to personal injury claims, property damage claims and/or products liability claims from our customers or third parties. As protection against such claims and operating hazards, we maintain insurance coverage against some, but not all, potential losses. However, we may sustain losses for uninsurable or uninsured risks, or in amounts in excess of existing insurance coverage. Due to the unpredictable nature of personal injury litigation, it is not possible to predict the ultimate outcome of these claims and lawsuits, and we may be held liable for significant personal injury or damage to property or third parties, or other losses, that are not fully covered by our insurance, which could have a material adverse effect on our business.
Our Recycling Division is dependent on third parties to supply us with the necessary components and materials to service our customers as well as on third party transport, recycling and disposal contractors.
If we are unable to obtain adequate supplies and components in a timely and cost-effective manner, we may be unable to adequately provide sufficient quantities of our services and products to our customers, which could have a material adverse effect on our financial condition and results of operations. We, and our third party transporters, ship used oil and containerized waste collected from our customers to a number of third party recycling and disposal facilities, including incinerators, landfill operators and waste-to-energy facilities. We generally do not have long-term fixed price contracts with our third party contractors, and if we are forced to seek alternative vendors to handle our third party recycling and disposal activities, we may not be able to find alternatives without significant additional expenses, or at all, which could result in a material adverse effect on our financial performance. In addition, we could be subject to significant environmental liabilities from claims relating to the transport, storage, processing, recycling and disposal of our customers waste by our third party contractors and their subcontractors.
We are subject to potential indemnification and warranty and product liability claims relating to our services and products.
Generally, our contracts with our customers provide that in certain circumstances we will be responsible for expenses resulting from, among other things, a spill that occurs while we are transporting, processing or disposing of customers oil, used solvent and other waste, or any other damage to property, death or harm to any person, contamination of or adverse effects to the environment, or violation of governmental laws or rules. Accordingly, in that situation we may be required to indemnify our customers for liability under CERCLA or other environmental, employment, health and safety laws and regulations, as a result of our own willful misconduct or negligence. We may also be exposed to warranty or product liability claims by our customers, users of our parts cleaning antifreeze sales, oily water collection, oil filter collection and processing and products or third parties claiming damages stemming from the mechanical failure of parts cleaned with solvents and/or equipment provided by us. Although we maintain product liability insurance coverage, if our insurance coverage proves inadequate or adequate insurance becomes unreasonably costly or otherwise unavailable, future claims may not be fully insured. An uninsured or partially insured successful claim against us could have a material adverse effect on our business, financial condition and results of operations.
Security breaches and other disruptions could compromise our information and expose us to liability, which would cause our business and reputation to suffer.
In the ordinary course of business, we collect and store sensitive data, including intellectual property, our proprietary business information and that of our customers, suppliers and business partners, and personally identifiable information of our customers and employees, in our data centers and on our networks. The secure processing, maintenance and transmission of this information is critical to our operations and business strategy. Despite our security measures, our information technology and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. Any such breach could compromise our networks and the information stored there could be accessed, publicly disclosed, lost or stolen. Any such access, disclosure or other loss of information could result in legal claims or proceedings, liability under laws that protect the privacy of personal information, and regulatory penalties, disrupt our operations and the services we provide to customers, and damage our reputation, and cause a loss of confidence in our products and services, which could adversely affect our business/operating margins, revenues and competitive position.
Risks Related to Our Indebtedness
Our substantial level of indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our indebtedness.
As of December 31, 2012, we had approximately $566.1 million of indebtedness, net of premiums and discounts, outstanding on a consolidated basis, of which approximately $167.0 million was secured, including $147.0 million outstanding under our $325.0 million senior secured revolving credit facility, which we refer to as the Amended Revolving Credit Facility and $20.0 million of capital leases for new trucks acquired in 2012 and other vehicle financings. Borrowings under our Amended Revolving Credit Facility effectively rank senior to our unsecured indebtedness, including our $400.0 million aggregate principal amount of 9.875% Senior Notes due 2018, or the 2018 Notes, to the extent of the value of the assets securing such debt. We have approximately $177.0 million of additional availability (less approximately $1.0 million used for letters of credit) under our Amended Revolving Credit Facility. Our substantial level of indebtedness increases the risk that we may be unable to generate cash sufficient to pay amounts due in respect of our indebtedness. Our substantial level of indebtedness could have other important consequences. For example, our level of indebtedness and the terms of our debt agreements may:
Each of these factors may have a material and adverse effect on our financial condition and viability. Our ability to make payments with respect to the 2018 Notes and to satisfy our other debt obligations will depend on our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors affecting our Company and industry, many of which are beyond our control. In addition, the indenture governing the 2018 Notes and the Amended Revolving Credit Facility contain financial and other restrictive covenants that will affect our ability to engage in activities that may be in our long-term best interests. Our failure to comply with those covenants could result in an event of default that, if not cured or waived, could result in the acceleration of all of our debt.
Borrowings under our Amended Credit Facility bear interest at variable rates. If we were to borrow funds and these rates were to increase significantly, our ability to borrow additional funds may be reduced and the risks related to our substantial indebtedness would intensify. While we may enter into agreements limiting our exposure to higher interest rates, any such agreements may not offer complete protection for this risk.
Despite existing debt levels, we may still be able to incur substantially more debt, which would increase the risks associated with our leverage.
Even with our existing debt levels, we and our subsidiaries may be able to incur substantial amounts of additional debt in the future, some or all of which may be secured. As of December 31, 2012 we had approximately $177.0 million of borrowing availability (less approximately $1.0 million used for letters of credit) under our Amended Credit Facility. In addition, the indenture governing the 2018 Notes and the Amended Credit Facility allow us to issue additional debt, including additional notes, under certain circumstances, which may be guaranteed by our subsidiaries. Although the terms of the Amended Credit Facility and the indenture governing the 2018 Notes limit our ability to incur additional debt, these terms do not and will not prohibit us from incurring substantial amounts of additional debt for specific purposes or under certain circumstances, some or all of which may be secured. If new debt is added to our and our subsidiaries current debt levels, the related risks that we and they now face could intensify and could further exacerbate the risks associated with our leverage.
We may not be able to generate sufficient cash flow to meet our debt service, lease payments and other obligations due to events beyond our control.
We expect our interest expense related to the 2018 Notes, the borrowings under our Amended Credit Facility as of December 31, 2012, and our other indebtedness, including indebtedness assumed in connection with the Merger, to increase to approximately $47.7 million per year, and we will have higher lease expenses and other obligations after consummation of the Merger. Our ability to generate cash flows from operations, to make scheduled payments on or refinance our indebtedness and to fund working capital needs and planned capital expenditures will depend on our future financial performance and our ability to generate cash in the future. Our future financial performance will be affected by a range of economic, financial, competitive, business and other factors that we cannot control, such as general economic, legislative, regulatory and financial conditions in our industry, the economy generally or other risks described in our reports filed with the SEC. A significant reduction in operating cash flows resulting from changes in economic, legislative or regulatory conditions, increased competition or other events beyond our control could increase the need for additional or alternative sources of liquidity and could have a material adverse effect on our business, financial condition, results of operations, prospects and our ability to service our debt and other obligations. If we are unable to service our indebtedness or to fund our other liquidity needs, we may be forced to adopt an alternative strategy that may include actions such as reducing or delaying capital expenditures, selling assets, restructuring or refinancing our indebtedness, seeking additional capital, or any combination of the
foregoing. If we raise additional debt, it would increase our interest expense, leverage and our operating and financial costs. We cannot assure you that any of these alternative strategies could be effected on satisfactory terms, if at all, or that they would yield sufficient funds to make required payments on our indebtedness or to fund our other liquidity needs. Reducing or delaying capital expenditures or selling assets could delay future cash flows. In addition, the terms of existing or future debt agreements may restrict us from adopting any of these alternatives. We cannot assure you that our business will generate sufficient cash flows from operations or that future borrowings will be available in an amount sufficient to enable us to pay our indebtedness or to fund our other liquidity needs.
If for any reason we are unable to meet our debt service and repayment obligations, we would be in default under the terms of the agreements governing our indebtedness, which would allow our creditors at that time to declare all outstanding indebtedness to be due and payable. This would likely in turn trigger cross-acceleration or cross-default rights between our applicable debt agreements. Under these circumstances, our lenders could compel us to apply all of our available cash to repay our borrowings or they could prevent us from making payments on the 2018 Notes or our other indebtedness. In addition, the lenders under our Amended Credit Facility or other secured indebtedness could seek to foreclose on our assets that are their collateral. If the amounts outstanding under our indebtedness were to be accelerated, or were the subject of foreclosure actions, we cannot assure you that our assets would be sufficient to repay in full the money owed to the lenders or to our other debt holders.
The Amended Credit Facility and the indenture governing the 2018 Notes impose significant operating and financial restrictions on us and our subsidiaries that may prevent us from pursuing certain business opportunities and restrict our ability to operate our business.
The Amended Credit Facility and the indenture governing the 2018 Notes contain covenants that restrict our and our restricted subsidiaries ability to take various actions, such as:
In addition, our Amended Credit Facility requires, and any future credit facilities will likely require, us to maintain minimum cash balances and operating performance levels and comply with specified financial ratios, including regarding net leverage, debt to capitalization, fixed charge coverage or similar ratios. A breach of any of the foregoing covenants under the indenture governing the Notes or the Amended Credit Facility, as applicable, could result in a default. In addition, any debt agreements we enter into in the future may further limit our ability to enter into certain types of transactions.
We may also be prevented from taking advantage of business opportunities that arise if we fail to meet certain ratios or because of the limitations imposed on us by such restrictive covenants. These restrictions may also limit our ability to plan for or react to market conditions, meet capital needs or otherwise restrict our activities or business plans and adversely affect our ability to finance our operations, enter into acquisitions, execute our business strategy, effectively compete with companies that are not similarly restricted or engage in other business activities that would be in our interest. In the future, we may also incur debt obligations that
might subject us to additional and different restrictive covenants that could affect our financial and operational flexibility. We cannot assure you that we will be granted waivers or amendments to the indenture governing the 2018 Notes, the Amended Credit Facility or such other debt obligations if for any reason we are unable to comply with our obligations thereunder or that we will be able to refinance our debt on acceptable terms or at all should we seek to do so.
The covenants described above are subject to important exceptions and qualifications. Our ability to comply with these covenants will likely be affected by events beyond our control, and we cannot assure you that we will satisfy those requirements. A breach of any of these provisions could result in a default under such indenture, Amended Credit Facility or other debt obligation, or any future credit facilities we may enter into, which could allow all amounts outstanding thereunder to be declared immediately due and payable, subject to the terms and conditions of the documents governing such indebtedness. If we were unable to repay the accelerated amounts, our secured lenders could proceed against the collateral granted to them to secure such indebtedness. This would likely in turn trigger cross-acceleration and cross-default rights under any other credit facilities and indentures. If the amounts outstanding under the 2018 Notes or any other indebtedness outstanding at such time were to be accelerated or were the subject of foreclosure actions, we cannot assure you that our assets would be sufficient to repay in full the money owed to the lenders or to our other debt holders.
Our borrowings under our Amended Credit Facility expose us to interest rate risk.
Our earnings are exposed to interest rate risk associated with borrowings under our Amended Credit Facility. Our Amended Credit Facility carries a floating interest rate; therefore, as interest rates increase, so will our interest costs, which may have a material adverse effect on our results of operations and financial condition. We have not yet decided whether or not we will engage in hedging activity with respect to our Amended Credit Facility.
Risks Related to Our Common Stock
We may issue a substantial number of shares of our common stock in the future and stockholders may be adversely affected by the issuance of those shares.
We may raise additional capital by issuing shares of common stock, which will increase the number of common shares outstanding and may result in dilution in the equity interest of our current stockholders and may adversely affect the market price of our common stock. We have filed a registration statement on Form S-4 with the SEC which allows us, in connection with acquisitions, to issue up to 15.0 million shares of common stock that are freely tradable upon issuance. As of December 31, 2012, we had issued approximately 7.0 million shares of our common stock under this registration statement and had approximately 8.0 million shares remaining available for future issuance. We have also filed a shelf registration statement on Form S-3 with the SEC which allows us to issue up to $400.0 million in debt, equity and hybrid securities. As of December 31, 2012, we had issued 18,200,000 shares of common stock at total price of $80.08 million, under this registration statement and could issue up to an additional $319.92 million of debt, equity or hybrid securities. In addition, we have issued shares of our common stock pursuant to private placement exemptions from Securities Act registration requirements, including 95.0 million shares issued in connection with the Power Fuels merger, and may do so in the future. The issuance, and the resale or potential resale, of shares of our common stock in connection with acquisitions or otherwise could adversely affect the market price of our common stock, and could be dilutive to our stockholders depending on the performance of the acquired business and other factors.
Our stock price may be volatile, which could result in substantial losses for investors in our securities.
The stock markets have experienced extreme volatility that has often been unrelated to the operating performance of particular companies. These broad market fluctuations may adversely affect the trading price of our common stock.
The market price of our common stock may also fluctuate significantly in response to the following factors, some of which are beyond our control:
The trading price of our common stock on the New York Stock Exchange, or NYSE, since our initial public offering has ranged from a high of $10.74 on September 3, 2008 to a low of $2.60 on August 7, 2012. The last reported price of our common stock on the NYSE on March 14, 2013 was $4.32 per share.
We currently do not intend to pay any dividends on our common stock.
We currently do not intend to pay any dividends on our common stock, and restrictions and covenants in our commercial credit facilities may prohibit us from paying dividends now or in the future. While we may declare dividends at some point in the future, subject to compliance with such restrictions and covenants, we cannot assure you that you will ever receive cash dividends as a result of ownership of our common stock and any gains from investment in our common stock may only come from increases in our stock prices, if any.
We are subject to anti-takeover effects of certain charter and bylaw provisions and Delaware law, as well as of our substantial insider ownership.
Provisions of our certificate of incorporation and bylaws, each as amended and restated, and Delaware law may discourage, delay or prevent a merger or acquisition that stockholders may consider favorable, including transactions in which you might otherwise receive a premium for your shares. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove our management and board of directors. These provisions include:
We are also subject to provisions of the Delaware corporation law that, in general, prohibit any business combination with a beneficial owner of 15% or more of our common stock for three years following the date the beneficial owner acquired at least 15% of our stock, unless various conditions are met, such as approval of the transaction by our board of directors. Together, these charter and statutory provisions could make the removal of management more difficult and may discourage transactions that otherwise could involve payment of a premium over prevailing market prices for our common stock.
The existence of the foregoing provisions and anti-takeover measures, as well as the significant common stock beneficially owned by our Chief Executive Officer and Vice Chairman, Mr. Johnsrud, could limit the price that investors might be willing to pay in the future for shares of our common stock. They could also deter potential acquirers of our company, thereby reducing the likelihood that you could receive a premium for your common stock in an acquisition.
Risks Related to Environmental and Other Governmental Regulation
We are subject to United States federal, state and local laws and regulations relating to health, safety, transportation, and protection of natural resources and the environment. Under these laws and regulations, we may become liable for significant penalties, damages or costs of remediation. Any changes in laws and regulations could increase our costs of doing business.
Our operations, and those of our customers, are subject to United States federal, state and local laws and regulations relating to health, safety, transportation and protection of natural resources and the environment and worker safety, including those relating to waste management and transportation and disposal of produced water and other materials. For example, we are subject to environmental regulation relating to disposal into injection wells, which can pose some risks of environmental liability, including leakage from the wells to surface or subsurface soils, surface water or groundwater. Liability under these laws and regulations could result in cancellation of well operations, fines and penalties, expenditures for remediation, and liability for property damage and personal injuries.
Our businesses, in particular our Recycling business, involve the use, handling, storage, and contracting for recycling or disposal of environmentally sensitive materials, such as motor oil, waste motor oil and filters, solvents, transmission fluid, antifreeze, lubricants, degreasing agents, gasoline, and diesel fuels. Accordingly, we are subject to regulation by federal, state, and local authorities establishing investigation and health and environmental quality standards, and liability related thereto, and providing penalties for violations of those standards. We also are subject to laws, ordinances, and regulations governing investigation and
remediation of contamination at facilities we operate or to which we send hazardous or toxic substances or wastes for treatment, recycling, or disposal. In particular, CERCLA imposes joint, strict, and several liability on owners or operators of facilities at, from, or to which a release of hazardous substances has occurred; parties that generated hazardous substances that were released at such facilities; and parties that transported or arranged for the transportation of hazardous substances to such facilities. A majority of states have adopted statutes comparable to and, in some cases, more stringent than CERCLA. If we were to be found to be a responsible party under CERCLA or a similar state statute, we could be held liable for all investigative and remedial costs associated with addressing such contamination. In addition, claims alleging personal injury or property damage may be brought against us as a result of alleged exposure to hazardous substances resulting from our operations.
Failure to comply with these laws and regulations could result in the assessment of significant administrative, civil or criminal penalties, imposition of cleanup and site restoration costs and liens, revocation of permits, and orders to limit or cease certain operations. In addition, certain environmental laws impose strict and/or joint and several liability, which could cause us to become liable for the conduct of others or for consequences of our own actions that were in compliance with all applicable laws at the time of those actions. For example, if a landfill or disposal operator mismanages our wastes in a way that creates an environmental hazard, we and all others who sent materials could become liable for cleanup costs, fines and other expenses many years after the disposal or recycling was completed. Future events, such as the discovery of currently unknown matters, spills caused by future pipeline ruptures, changes in existing environmental laws and regulations or their interpretation, and more vigorous enforcement policies by regulatory agencies, may give rise to additional expenditures or liabilities, which could impair our operations and adversely affect our business and results of operations.
Although we believe that we are in substantial compliance with all applicable laws and regulations, legal requirements are changing frequently and are subject to interpretation. New laws, regulations and changing interpretations by regulatory authorities, together with uncertainty regarding adequate testing and sampling procedures, new pollution control technology and cost benefit analysis based on market conditions are all factors that may increase our future capital expenditures to comply with environmental requirements. Accordingly, we are unable to predict the ultimate cost of future compliance with these requirements or their effect on our operations.
Increased regulation of hydraulic fracturing, including regulation of the quantities, sources and methods of water use and disposal, could result in reduction in drilling and completing new oil and natural gas wells or minimize water use or disposal, which could adversely impact the demand for our Fluids Management services.
Demand for our Fluids Management services depends, in large part, on the level of exploration and production of oil and gas and the oil and gas industrys willingness to purchase our services. Most of our customer base uses hydraulic fracturing to drill new oil and gas wells. Hydraulic fracturing is a process that is used to release hydrocarbons, particularly natural gas, from certain geological formations. The process involves the injection of water (typically mixed with significant quantities of sand and small quantities of chemical additives) under pressure into the formation to fracture the surrounding rock and stimulate movement of hydrocarbons through the formation. The process is typically regulated by state oil and gas commissions and has been exempt (except when the fracturing fluids or propping agents contain diesel fuels) since 2005 from United States federal regulation pursuant to the SWDA.
The EPA is conducting a comprehensive study of the potential environmental impacts of hydraulic fracturing activities, and a committee of the United States House of Representatives is also conducting an investigation of hydraulic fracturing practices. The results of the EPA study and House investigation could lead to restrictions on hydraulic fracturing. The EPA is currently working on new guidance for application of SWDA permits for drilling or completing processes that use fracturing fluids or propping agents containing diesel fuels. In addition, the EPA finalized regulations under the CAA in October 2012 regarding certain criteria and hazardous air pollutant emissions from hydraulic fracturing wells and, in October 2011, announced its intention to propose regulations by 2014 under the CWA to regulate wastewater discharges from hydraulic fracturing and other gas production. Legislation has been introduced before Congress to provide for federal regulation of hydraulic fracturing, including, for example, requiring disclosure of chemicals used in the fracturing process or seeking to repeal the exemption from the SWDA. If adopted, such legislation would add an additional level of regulation and necessary permitting at the federal level and could make it more difficult to complete wells using hydraulic fracturing. Similar laws and regulations with respect to chemical disclosure also exist or are being considered by the United States Department of Interior and in several states, including certain states in which we operate, that could restrict hydraulic fracturing. The Delaware River Basin Commission is also considering regulations which may impact hydrofracturing water practices in certain areas of Pennsylvania, New York, New Jersey and Delaware. Some local governments have also sought to restrict drilling in certain areas.
Future United States federal, state or local laws or regulations could significantly restrict, or increase costs associated with hydraulic fracturing and make it more difficult or costly for producers to conduct hydraulic fracturing operations, which could result in a decline in exploration and production. New laws and regulations, and new enforcement policies by regulatory agencies, could also expressly restrict the quantities, sources and methods of water use and disposal in hydraulic fracturing and otherwise increase our costs and our customers cost of compliance, which could minimize water use and disposal needs even if other limits on drilling and completing new wells were not imposed. Any decline in exploration and production or any restrictions on water use and disposal could result in a decline in demand for our services and have a material adverse effect on our business, financial condition, results of operations and cash flows.
Delays or restrictions in obtaining permits by our customers for their operations or by us for our operations could impair our business.
In most states, our customers are required to obtain permits from one or more governmental agencies in order to perform drilling and completion activities and we may be required to procure permits for construction and operation of our disposal wells and pipelines. Such permits are typically required by state agencies, but can also be required by federal and local governmental agencies. The requirements for such permits vary depending on the location where our, or our customers, activities will be conducted. As with all governmental permitting processes, there is a degree of uncertainty as to whether a permit will be granted, the time it will take for a permit to be issued, and the conditions which may be imposed in connection with the granting of the permit. Delays or restrictions in obtaining salt water disposal well permits could adversely impact our growth, which is dependent in part on new disposal capacity.
Our customers have been affected by moratoriums on the issuance of permits that have been imposed upon drilling and completion activities in certain jurisdictions. For example, in December 2010, the State of New York imposed a moratorium on certain drilling and completion activities. In 2011, the state announced plans to lift the moratorium, however, there is a proposal in the New York legislature to extend the moratorium for another year and, as of March 1, 201, the moratorium had not been lifted. A similar moratorium has been in place within the Delaware River Basin pending issuance of regulations by the Delaware River Basin Commission. Other states, including Texas, Arkansas, Pennsylvania, Wyoming and Colorado, have enacted laws and regulations applicable to our business activities, including disclosure of information regarding the substances used in hydraulic fracturing. California is presently considering similar requirements. Some of the drilling and completion activities of our customers may take place on federal land, requiring leases from the federal government to conduct such drilling and completion activities. In some cases, federal agencies have cancelled oil and natural gas leases on federal lands. Consequently, our operations in certain areas of the country may be interrupted or suspended for varying lengths of time, causing a loss of revenue and potentially having a materially adverse effect on our operations. Any such changes could have a material adverse effect on our financial condition and results of operations.
We are subject to the trucking safety regulations, which are likely to be amended, and made stricter, as part of the initiative known as Compliance, Safety, Accountability, or CSA. If our current USDOT safety rating of Satisfactory is downgraded in connection with this initiative, our business and results of our operations may be adversely affected.
As part of the CSA initiative, the FMCSA is expected to open a rulemaking docket in 2012 (originally expected in 2011) for purposes of changing its safety rating methodology. Any new methodology adopted in the rulemaking is likely to link safety ratings more closely to roadside inspection and driver violation data gathered and analyzed from month to month under the FMCSAs new Safety Measurement System, or SMS. This linkage could result in greater variability in safety ratings than the current system, in which a safety rating is based on relatively infrequent on-site compliance audits at a carriers places of business. Preliminary studies by transportation consulting firms indicate that Satisfactory ratings (or any equivalent under a new SMS-based system) may become more difficult to achieve and maintain under such a system. If our operations lose their current Satisfactory rating, which is the highest and best rating under this initiative, we may lose some of our customer contracts that require such a rating, adversely affecting our business prospects and results of operations.
We lease our corporate headquarters offices in Scottsdale, Arizona and we own or lease numerous facilities including administrative offices, sales offices, truck yards, maintenance facilities, warehouses and well disposal sites in 35 states. We also own or lease 46 salt water disposal wells or underground injection wells in Texas, Ohio, Mississippi, North Dakota and Montana as of December 31, 2012. For the year ended December 31, 2012, the total rent expense associated with our leased properties, other than salt water disposal wells, was approximately $2.6 million. We believe that we have satisfactory title to the properties owned and used in our businesses, subject to liens for taxes not yet payable, liens incident to minor encumbrances, liens for credit arrangements (including liens under the Amended Credit Facility) and easements and restrictions that do not materially detract from the value of these properties, our interests in these properties, or the use of these properties in our businesses.
We believe all properties that we currently occupy are suitable for their intended uses. We believe that we have sufficient facilities to conduct our operations. However, we continue to evaluate the purchase or lease of additional properties or the consolidation of our properties, as our business requires.
We are party to legal proceedings and potential claims arising in the ordinary course of our business, including claims related to employment matters, contractual disputes, personal injuries and property damage. In addition, various legal actions, claims and governmental inquiries and proceedings are pending or may be instituted or asserted in the future against us and our subsidiaries. See Litigation in Note 13, Commitments and Contingencies, of the Notes to our Consolidated Financial Statements herein for a description of our legal proceedings.
Our common stock trades on the NYSE under the symbol HEK. The following table sets forth, for the periods indicated, the range of high and low sales prices per share of our common stock as reported on the NYSE:
Prior to November 9, 2011, we also had outstanding units, each consisting of one share of common stock and a warrant entitling the holder to purchase from us one share of common stock at an exercise price of $6.00. Both the units and these warrants had been listed on the NYSE and traded under the symbols HEK.U and HEK.WS, respectively. On November 9, 2011, all remaining unexercised warrants expired and were cancelled. As a result, the units were also cancelled. Both the warrants and the units have been delisted from the NYSE. We also had outstanding privately-placed warrants exercisable for 941,176 shares of our common stock at an exercise price of $6.38 per share that expired unexercised on January 24, 2013, and 626,866 privately-placed warrants exercisable for 501,493 shares of our common stock at an exercise price of $2.02 per share. In June 2012, 606,866 warrants were exercised as part of a cashless transaction that resulted in the issuance of 270,671 shares of our common stock and in July 2012, 20,000 warrants were exercised resulting in the issuance of 16,000 shares of our common stock in exchange for cash proceeds of $32,000.
As of December 31, 2012, there were 52 holders of record of our common stock. We believe that the number of beneficial holders is substantially greater than the number of record holders because a portion of our common stock is held of record in broker street names.
We have not paid any dividends on our common stock to date. The payment of dividends in the future will be contingent upon our revenues and earnings, if any, capital requirements and general financial condition. The payment of any dividends will be within the discretion of our Board of Directors and will be subject to other limitations as may be contained in our Amended Credit Facility, the indenture governing the 2018 Notes or other applicable agreements governing our indebtedness. It is the present intention of our Board of Directors to retain all earnings, if any, for use in our business operations and, accordingly, our board does not anticipate declaring any dividends in the foreseeable future.
Sales of Unregistered Equity Securities
We did not make any sales of unregistered equity securities during year ended December 31, 2012, except as previously reported in our current reports on Form 8-K filed with the SEC.
Repurchase of Equity Securities
During the fourth quarter of 2012, we did not repurchase any options or warrants for shares of our common stock nor did we repurchase any shares of our common stock.
The following performance graph and related information shall not be deemed filed with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act or Securities Exchange Act, except to the extent that we specifically incorporate it by reference into such filing.
The following graph compares the cumulative total shareholder return for our common stock from January 1, 2008, through December 31, 2012, with the comparable cumulative return of two indices, the S&P 500 Index and the Dow Jones Industrial Average Index (DJIA).
The chart assumes $100 invested on November 20, 2007, in our common stock and $100 invested at that same time in each of the two indices.
Securities Authorized for Issuance under Equity Compensation Plans
The following table provides information as of December 31, 2012, with respect to shares of our common stock that may be issued under the Heckmann Corporation 2009 Equity Incentive Plan, which is our only existing equity compensation plan under which grants can be made.
Equity Compensation Plan Information
The following table presents selected consolidated financial information and other operational data for our business. You should read the following information in conjunction with Item 7 of this Annual Report on Form 10-K entitled Managements Discussion and Analysis of Financial Condition and Results of Operations, and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K.
This Managements Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with our Consolidated Financial Statements, and the Notes and Schedules related thereto, which are included in this Annual Report.
We are a services-based company that has operated through two business segments since our April 10, 2012 acquisition of TFI: our Fluids Management Division (which we formerly referred to as Heckman Water Resources or HWR) and our Recycling Division (which we formerly referred to as Heckmann Environmental Services or HES).
Fluids Management provides total water solutions for unconventional oil and gas exploration and production. Fluids Management includes our water delivery and disposal, trucking, fluids handling, treatment and temporary and permanent pipeline transport facilities and water infrastructure services for oil and gas exploration and production companies. Our strategy is to provide an integrated and efficient complete environmental solution to our customers through a full suite of services which we have built and will continue to build through organic growth and acquisitions.
We currently operate multi-modal water disposal, treatment, trucking and pipeline transportation operations in select shale areas in the United States including the Bakken, Marcellus/Utica, Eagle Ford, Haynesville, Barnett, Permian Basin, Mississippian Lime and Tuscaloosa Marine Shale areas. We are currently strategically expanding our business and operations within these and into other hydrocarbon-rich shale areas. We serve customers seeking fresh water acquisition, temporary water transmission and storage, transportation, treatment or disposal of fresh water and complex water flows, such as flowback and produced brine water, in connection with shale oil and gas hydraulic fracturing drilling or hydrofracturing operations. We also transport fresh water for production and provide services for site preparation, water pit excavations and remediation. We provide these services utilizing our scaled infrastructure and asset base, which currently includes 46 owned or leased operating salt water disposal or underground injection wells, approximately 1,200 trucks, 1,200 frac tanks, 50 miles of freshwater delivery pipeline and 50 miles of produced water collection pipeline operating in key unconventional resource basins. Complex water flows, in the forms of flowback and produced water, represent the largest waste stream from these unconventional methods of hydrocarbon exploration and production. Flowback water volumes represent approximately 15%20% of the millions of gallons of water used during fracking that is returned to the surface generally within the first two to three weeks after hydraulic fracturing has commenced and the well starts producing. Produced water volumes, which represent water from the formation produced alongside hydrocarbons over the life of the well, are generally driven by marginal costs of production and frequently create a multi-year demand for our services once the well has been drilled. We provide, and continue to develop, total water service solutions for the effective and efficient delivery, treatment and disposal of fresh water, flowback and produced water flows resulting from increased exploration and production in these unconventional oil and gas fields.
Recycling provides environmental and waste recycling solutions to our customers through collection and recycling services for waste products, including UMO, which we process and sell as RFO, oily water, spent antifreeze, used oil filters and parts washers, and provision of complementary environmental services for a diverse commercial and industrial customer base. Recycling operates a highly scalable network infrastructure of 34 processing facilities, approximately 385 tanker trucks, vacuum trucks and trailers and over 200 railcars. With a geographic presence in 19 states in the Western U.S. stretching from Washington to Texas, Recycling provides its services to a diverse range of more than 20,000 commercial and industrial customer locations.
The following table summarizes our total revenues, loss from continuing operations before income taxes, net income (loss) attributable to common stockholders and EBITDA (defined below) for the years ended December 31, 2012, 2011 and 2010 (in 000s):
During the year ended December 31, 2012, our EBITDA increased $3.5 million from $25.6 million in 2011 to $29.1 million in 2012. The increase is due primarily to a $33.9 million increase in gross profit before depreciation expense less transaction costs of $7.7 million, impairment charges of $6.0 million and loss on extinguishment of debt of $2.6 million.
For trends affecting our business and the markets in which we operate see Recent Developments and Trends Affecting our Results of Operations each presented below and the section entitled Risk Factors in Part I, Item 1A of this Annual Report.
Significant Acquisition Activities
Power Fuels Merger. On November 30, 2012, we and our subsidiary, Rough Rider Acquisition, LLC, completed our merger with Badlands Power Fuels, LLC (Power Fuels) of which Mark D. Johnsrud was the sole member. Prior to the merger, Power Fuels was a privately held North Dakota-based environmental solutions company providing delivery and disposal of environmental products, fluids transportation and handling, water sales, and equipment rental services for unconventional oil and gas exploration and production businesses.
The aggregate preliminary purchase price of approximately $500.9 million was comprised of 95.0 million unregistered shares of our common stock of which 10.0 million shares were placed into escrow for up to three years to pay certain potential indemnity claims and $129.4 million in cash including adjustment for target versus actual debt.
In connection with the Power Fuels merger, we incurred transaction costs of approximately $5.1 million, which are reported in selling, general and administrative expenses in the accompanying consolidated statements of operations for the year ended December 31, 2012. As a result of the Power Fuels Merger on November 30, 2012, Power Fuels and its subsidiaries became wholly-owned subsidiaries.
Appalachian Water Services. On September 4, 2012, we completed the acquisition of a majority interest in Appalachian Water Services, LLC (AWS). AWS owns and operates a wastewater treatment recycling facility specifically designed to treat and recycle water involved in the hydraulic fracturing process in the Marcellus Shale area. The aggregate preliminary purchase price of $13.6 million was comprised of 3,258,508 shares of our common stock registered on our Form S-4 shelf registration statement and $1.5 million of contingent consideration payable in shares of our common stock based upon the achievement of an EBITDA target, as defined in the membership interest purchase agreement.
Thermo Fluids Inc. On April 10, 2012, we completed the acquisition of TFI, a route-based environmental services and waste recycling solutions provider that focuses on the collection and recycling of UMO and the sale of RFO from recovered UMO.
The aggregate purchase price of approximately $245.4 million was comprised of approximately $229.6 million in cash, and 4,050,926 shares of our common stock with an estimated fair value of approximately $15.8 million, which shares were issued in a private placement and are held in escrow in respect of indemnification obligations of the sellers of TFI through the earlier of (i) 30 days after the provision of audited financial statements of TFI for the year ended December 31, 2012 and (ii) April 15, 2013. In connection with the TFI acquisition, we incurred transaction costs of approximately $1.6 million, which are reported in selling, general and administrative expenses in the accompanying consolidated statements of operations for the year ended December 31, 2012.
As more fully described in Note 8 of the Notes to Consolidated Financial Statements herein, in connection with the TFI Acquisition, on April 10, 2012, we (i) issued $250.0 million in aggregate principal amount of 9.875% Senior Notes (the Notes); and (ii) entered into a new $150.0 million senior revolving credit facility (the New Revolving Credit Facility) following repayment and termination of our previous credit facility. On August 17, 2012, we completed a registered exchange offer of the 9.875% Senior Notes. On November 5, 2012, we closed on the issuance by our wholly-owned subsidiary, Rough Rider Escrow, LLC (Rough Rider), of $150.0 million in aggregate principal amount of 9.875% Senior Notes Due 2018 (the Additional Notes and with Notes, are collectively referred to as the 2018 Notes). The net proceeds were used to partially finance the merger with Power Fuels. In addition, in conjunction with the consummation of the Power Fuels Merger, we assumed the 2018 Notes issued by Rough Rider and amended our New Revolving Credit Facility (the Amended Revolving Credit Facility) to, among other things, increase the revolving credit facility thereunder from $150.0 million to $325.0 million.
Trends Affecting Our Operating Results
Our results are driven by demand for our services, which are in turn affected in our Fluids Management Division by production trends in the shale areas in which we operate, in particular the level of drilling activity (which impacts the amount of flowback water being managed) and active wells (which impacts the amount of produced water being managed). Activity in the oil and gas drilling industry is also affected by market prices for those commodities, with persistent low natural gas prices and generally high oil prices driving reduced drilling and production in dry shale areas such as Barnett, Haynesville and Marcellus Shale areas where natural gas is the predominant natural resource, and the relocation of assets and increased drilling activity in the liquids-rich or wet shale areas, such as the Utica, Eagle Ford, Mississippian Lime and Bakken Shale areas, where oil is the predominant natural resource.
Recent declines in natural gas prices have caused many natural gas producers to announce reductions in capital budgets for future periods. These cuts in spending curtailed drilling programs as well as discretionary spending on well services in certain shale areas and accordingly reduced demand for our services in these areas. Beginning in late 2011, we have actively transferred certain operating assets to oil- and liquids-rich wet shale areas where drilling activity is more robust. This redeployment activity occurred primarily in the first six months of 2012. However we continue to seek to strategically relocate our assets to those areas where we believe demand is highest and other market conditions for our services are favorable.
In our Recycling Division, demand for our services is primarily driven by used oil market dynamics. While increased oil prices increase the cost to us of UMO, increases in those prices generally also cause increases in the price of, and demand for, RFO, as a lower cost, higher British Thermal Units (BTU) alternative to diesel fuel and, to re-refiners, as a critical feedstock for the production of base lubricants.
Our results are also driven by a number of other factors, including (i) our available inventory of equipment, which we have been building through acquisitions and capital expenditure growth over the last several years, (ii) transportation costs, which are affected by fuel costs , (iii) utilization rates for our equipment, which are also affected by the level of drilling and production activities, and our ability to relocate our equipment to areas in which oil and gas production activities are growing, (iv) labor costs, which have been generally increasing through the periods discussed due to tight labor market conditions and increased government regulation, including the Affordable Care Act, (v) depreciation and amortization, which have been increasing as we have expanded our asset base, (vi) business mix between our Fluids Management services and our Recycling services, (vii) seasonality and weather events and (viii) our health, safety and environmental performance record.
Our operating results are also affected by our acquisition activities, and the expenses we incur in connection with those activities, which can limit comparability of our results from period to period. We completed two major transactions in 2012 that will substantially change our future operating results from our historical operating results: the TFI Acquisition, completed in April 2012, and our merger with Power Fuels (discussed further below), which was completed on November 30, 2012 and is our largest transaction to date.
Results of Operations
Our consolidated revenues are generated from three primary sources: (1) environmental solutions provided to oil and gas companies operating in unconventional resource areas, (2) equipment rental activities and (3) the sale of reprocessed fluids. Additional information about these revenue sources are as follows:
Cost of sales:
Cost of sales consists primarily of the following:
General and Administrative Expense:
General and administrative expense consists primarily of the following:
Amortization of intangible assets represents the allocation of costs for other identifiable intangible originating from business acquisitions to future periods based on the assets useful lives and/or their projected future cash flows. Intangible assets include customer relationships, customer contracts, disposal permits, vendor relationships and other.
Interest expense includes interest incurred on the outstanding balance of our Amended Revolving Credit Facility including fees on the unutilized portion thereof and interest incurred on our 2018 Notes offset by interest earned on short-term investments.
Other (expense) gains, include gains and losses from changes to contingent consideration estimates incurred in connection with business acquisitions, gains (losses) from the disposition of equipment and realized gains (losses) from the sale or maturity of marketable securities classified as available for sale.
For trends affecting our business and the markets in which we operate see Factors Affecting Our Results of Operations above and also Risk Factors Risks Related to Our Business in Part I, Item 1A of this Annual Report on Form 10-K.
Year Ended December 31, 2012 Compared with Year Ended December 31, 2011
The following table sets forth for each of the periods indicated our statements of operations data and expresses revenue and expense data as a percentage of total revenues for the periods presented (in 000s):
Non-rental revenue for the year ended December 31, 2012 was $336.5 million, up $192.2 million from $144.3 million for the year ended December 31, 2011. The increase was driven primarily by the TFI and Power Fuels acquisitions in 2012 and secondarily by the full year impact of the five acquisitions that closed during the three months ended June 30, 2011. The TFI acquisition (including the results of All Phase) and the Power Fuels merger accounted for approximately $90.3 million and $20.5 million, respectively of the year-over-year increase in non-rental revenues.
Rental Revenue for the year ended December 31, 2012 was $15.4 million, up $2.9 million from $12.5 million for the year ended December 31, 2011. The increase was attributable entirely to the Power Fuels acquisition.
Fluids Management revenue for the year ended December 31, 2012 was $256.7 million, up $99.9 million from $156.8 million. As previously noted, $25.3 million of the increase was due to Power Fuels, with the remainder attributable to a combination of other acquisitions completed during 2012 and 2011 and organic growth, which accounted for approximately $41.6 million and $33.0 million of the remaining increase, respectively. The organic growth was driven primarily by investments and asset redeployments primarily in the Eagle Ford and Marcellus shale areas, due in part from a contract with a major customer that commenced in late 2011. In addition, 2012 also includes increased revenue from our produced water pipeline in the Haynesville shale area (up approximately 80% in 2012 versus 2011), portions of which were under construction and out of service during the period from February 2011 through September 2011. Revenue growth in 2012 was negatively affected by somewhat weaker pricing in certain shale areas due to business mix issues and resulting competitive pressures. Recycling revenue for the year ended December 31, 2012 was $95.3 million and resulted from the TFI Acquisition, which we completed on April 10, 2012.
Cost of Sales and Gross Profit
Cost of sales for the year ended December 31, 2012 was $305.7 million, up $182.2 million from $123.5 million for the year ended December 31, 2011. Consistent with the increase in revenue, the increase in cost of sales was attributable primarily to the TFI acquisition and the Power Fuels merger in 2012 and secondarily to the full year impact of the five acquisitions that closed during the three months ended June 30, 2011. The TFI and Power Fuels transactions accounted for approximately $67.7 million and $18.9 million, respectively of the year-over-year increase in cost of sales. Excluding the impact of the TFI and Power Fuels transactions, depreciation expense increased $14.9 million in 2012, which was attributable to 2011 capital purchases of $150.9 million and equipment acquired in connection with 2011 acquisitions, which totaled approximately $48.5 million. Gross profit increased $13.0 million or 26% from $33.3 million for the year ended December 31, 2011; however, the gross profit margin decreased 810 basis points from 21.3% in 2011 to 13.2% in 2012. Excluding the impact on cost of sales from the acquisition and merger related transactions, the increase in cost of sales and the accompanying decline in gross margin were due to in part to costs incurred to redeploy assets to the oil-rich Eagle Ford Shale area from the Haynesville Shale area in response to a decrease in natural gas drilling activity. These costs were accompanied by additional training costs to onboard new drivers in the Eagle Ford Shale area. In addition, the Company also incurred costs for increased staffing in order to support the Companys growth and integration of the recently acquired businesses including the five acquisitions that closed during the year ended December 31, 2011.
General and Administrative Expenses
General and administrative expenses for the year ended December 31, 2012 totaled $48.0 million, compared to $32.8 million for the year ended December 31, 2011. Operating expenses for 2012 includes transaction costs associated with 2012 acquisition activity and the Power Fuels merger of $7.7 million, stock-based compensation expense of $3.6 million and provision for doubtful accounts of $6.3 million. The corresponding 2011 expenses for transaction costs, stock-based compensation and the provision for doubtful accounts were $0.9 million, $2.4 million, and $2.2 million, respectively.
Amortization of Intangible Assets
Amortization of intangible assets was $16.6 million and $3.9 million for the year ended December 31, 2012 and 2011, respectively. The increase is due to the large increase in intangible assets acquired in connection with the ten acquisitions, including the Power Fuels merger, that were completed during 2012 and 2011.
Impairment of Long-Lived Assets
Impairment of long-lived assets was $3.7 million for the year ended December 31, 2012 and represents primarily the write-off of the carrying values of several saltwater disposal wells in the Haynesville shale area. We reviewed the recoverability of the disposal wells carrying values because of various technical problems that arose, which ultimately make the wells unusable. The impairment charge considered the recent decline in drilling activity in the Haynesville market due to a drop in natural gas prices as well as the estimated costs to both identify the source of the problems and to take corrective action to restore the wells functionality or convert them from salt water to fresh water wells.
Impairment of Intangible Assets
Impairment of intangible assets was $2.4 million for the year ended December 31, 2012 and represents the write-down of a customer relationship intangible associated with a construction business that was part of a prior business acquisition. During 2012, we received information from the Companys primary customer in that market that future construction contracts would be directed to competitors whose core competency is construction.
Pipeline start-up and Commissioning
Pipeline start-up and commissioning expenses for the year ended December 31, 2011 relate to start-up costs for our underground pipeline in the Haynesville Shale area.
Loss from Operations
Loss from operations was $24.3 million and $5.4 million for the years ended December 31, 2012 and 2011, respectively. The year-over-year increase in loss includes the impact of the $6.8 million increase to transaction costs, the impairment charges totaling $6.1 million and the $14.9 million and $14.1 million increases in depreciation and amortization of intangible assets, respectively, mentioned above.
Loss on Extinguishment of Debt
Loss on extinguishment of debt was $2.6 million for the year ended December 31, 2012 and represents the write-off of the unamortized balance of debt issuance costs on the Old Credit Facility in connection the entry into the New Revolving Credit Facility and the repayment of the outstanding balance on the Old Credit Facility.
Interest (Expense) Income, net
Interest expense, net was $26.6 million for the year ended December 31, 2012 as compared to $4.2 million for the year ended December 31, 2011. The increase was due to an increase in average debt outstanding during 2012 and higher average interest rates, driven primarily by the 2018 Notes. In addition, interest income was lower in the 2012 versus 2011 year to date period due lower investment balances during 2012 compared to the same period of 2010, and increased borrowings under our Amended Revolving Credit Facility throughout 2012.
Loss from Equity Investment
During the year ended December 31, 2012, we recorded a small gain from our equity investment in Dodge Water Depot, which is owned 50% by us and 50% by MBI Energy Services. During the year ended December 31, 2011 we recorded a loss of approximately $0.5 million related to our joint venture with Energy Transfer Partners, L.P. which was terminated on July 8, 2011.
Other (Expense) Income, net
Other expense, net for the year ended December 31, 2012 totaled approximately $2.5 million and consists primarily of a $1.7 million loss on the disposition of assets used in the Fluids Management segment. Other expense, net for the year ended December 31, 2011 totaled approximately $6.2 million, consisting primarily of net reductions to liabilities for contingent consideration which were adjusted through earnings. Such changes result from reassessment of the performance-based earnouts related to (a) our acquisition of the Excalibur Energy Services, Inc. in 2011, and (b) the acquisition of Complete Vacuum and Rental, Inc. (CVR) in 2010, and (c) the acquisition of Charis Partners LLC, in July 2009.
Income Tax Benefit
The income tax benefit for the year ended December 31, 2012 was approximately $58.6 million resulting in an effective income tax rate of 104.5%, compared to an income tax benefit for the year ended December 31, 2011 of approximately $3.8 million resulting in an effective income tax rate of 97.2%. The primary factor affecting the effective income tax rate in 2012 is the release of $38.5 million of valuation allowance, which constituted 68.7% of the effective tax rate for the year ended December 31, 2012. The Company determined that the realization of certain deferred tax assets is more likely than not based on future taxable income arising from the reversal of deferred tax liabilities that we acquired in the TFI acquisition and the Power Fuels merger. The primary factors affecting the effective tax rate in 2011 were the loss on the abandonment of China Water, which was offset in part by a valuation allowance. These items resulted in a net increase to the effective tax rate of 67.4% for the year ended December 31, 2011.
Income (Loss) from Continuing Operations
Income from continuing operations was $2.5 million for the year ended December 31, 2012 compared to a loss from continuing operations of $0.1 million for the year ended December 31, 2011, primarily as a result of the items referred to above.
Loss from Discontinued Operations
Our net loss from discontinued operations for the year ended December 31, 2011 was approximately $22.9 million. The loss was attributable to our September 30, 2011 sale and abandonment of our China Water business. Refer to Note 18 in the accompanying notes to the Consolidated Financial Statements herein for additional information.
Year Ended December 31, 2011 Compared with Year Ended December 31, 2010
The following table sets forth for each of the periods indicated our statements of operations data and expresses revenue and expense data as a percentage of total revenues for the periods presented (in 000s):
Revenue for 2011 grew to $156.8 million from $15.2 million in 2010. The significant year-over-year growth in revenue resulted from (a) the full year effect of the Complete Vacuum and Rental, Inc. acquisition which we consummated on November 30, 2010, (b) the five acquisitions that we closed in the second quarter of 2011, and (c) revenues resulting from a significant capital investment program during 2011, including an expansion of the Companys fleet and disposal well assets. Revenues from our pipeline operations were negatively impacted during 2011 as a result of start-up and commissioning activities discussed below.
Cost of Sales and Gross Profit
Cost of sales for the year ended December 31, 2011 was $123.5 million, resulting in total gross profit of approximately $33.3 million, or 21.2% of revenue. Cost of sales for the year ended December 31, 2010 was $11.3 million, resulting in total gross profit of $3.9 million, or 25.5% of sales. Included in cost of sales for the years ended December 31, 2011 and 2010 is depreciation expense of approximately $21.4 million and $3.4 million, respectively. The significantly higher depreciation expense in 2011 is attributable to the acquisitions in 2011 and 2010 and capital expenditures during those periods.
Operating expenses for the year ended December 31, 2011 totaled $38.7 million, compared to $23.4 million for the year ended December 31, 2010. Operating expenses in 2011 included approximately $2.4 million of stock-based compensation, amortization expense of approximately $3.9 million, a $2.2 million increase to the bad debt reserve, and approximately $2.1 million of start-up and commissioning costs related to our underground pipeline in the Haynesville Shale area. Also included in operating expenses for the year ended December 31, 2011 was approximately $0.9 million of transaction costs associated with the acquisitions completed in the second quarter of 2011. Operating expenses for the year ended December 31, 2010 included pipeline start-up and commissioning costs of approximately $11.8 million resulting from repairs and remediation of certain segments of the Haynesville pipeline, amortization expense of $1.2 million, stock-based compensation expense of $1.0 million and $0.5 million in transaction costs related to the
acquisition of Complete Vacuum and Rental, Inc. Excluding these items, general and administrative expense increased largely due to the impact of the 2010 and 2011 acquisitions as well as increased staffing and other costs required to support the Companys growth and the integration of the acquired businesses.
Loss from Operations
Loss from operations was $5.4 million and $19.5 million for December 31, 2011 and 2010, respectively, primarily as a result of the items mentioned above.
Interest (Expense) Income, net
During the year ended December 31, 2011, we recorded net interest expense of approximately $4.2 million as opposed to $2.1 million of interest income for the year ended December 31, 2010. The decrease was primarily due to lower interest rates for invested funds and lower investment balances in the year ended December 31, 2011 compared to the same period of 2010, and increased borrowings under our credit facility throughout 2011.
Loss from Equity Investment
During the year ended December 31, 2011, we recorded a loss of approximately $0.5 million related to our joint venture with Energy Transfer Partners, L.P. that was terminated on July 8, 2011. For the year ended December 31, 2010, we recorded an equity loss of approximately $0.7 related to the joint venture.
Other Income (Expense), net
Other income (expense), net for the year ended December 31, 2011 totaled approximately $6.2 million, consisting primarily of net reductions to liabilities for contingent consideration which were adjusted through earnings. Such changes result from re-assessment of the performance-based earn-outs related to (a), our acquisition of Excalibur Energy Services, Inc. on May 6, 2011, (b) the acquisition of Complete Vacuum and Rental, Inc. in 2010, and (c) the acquisition of Charis Partners LLC, on July 1, 2009.
For the period ended December 31, 2010, other income was primarily attributable to a $4.2 million change in the fair value of the contingent consideration associated with the performance-based earn-out related to the Charis acquisition in 2009. As a result of pipeline start-up and commissioning expenses incurred in the year ended December 31, 2010, management determined that the earn-out obligation related to the 2010 profitability target for the Charis acquisition would not be met. Accordingly, the liability for contingent consideration was adjusted through earnings.
Income Tax Benefit
The income tax benefit for the year ended December 31, 2011 was approximately $3.8 million compared to an income tax benefit for the year ended December 31, 2010 of approximately $3.4 million. The primary factors affecting income taxes and the effective income tax benefit rate in 2011 was the deferred tax assets relating to net operating loss carry forwards and changes to the associated valuation allowance established for net operating loss carry forwards. In 2010, the income tax benefit was primarily attributable to a carryback of net operating losses.
Net loss from continuing operations
Our net loss for the year ended December 31, 2011 was $0.1 million compared to $10.3 million for the year ended December 31, 2010, primarily as a result of the items referred to above.
Loss from Discontinued Operations
Our net loss from discontinued operations for the year ended December 31, 2011 was approximately $22.9 million compared to a net loss from discontinued operations of $4.4 million for the year ended December 31, 2010. The increased loss was attributable to our September 30, 2011 sale and abandonment of our China Water business. Refer to Note 18 in the accompanying Notes to the Consolidated Financial Statements herein for additional information.
Liquidity and Capital Resources
Cash Flows and Liquidity
Our primary source of capital is from cash generated by our operations with additional sources of capital from borrowings available under our Amended Revolving Credit Facility as well as debt and equity accessed through capital markets. Our level of historical acquisition activity was highly capital intensive and required significant investments in order to expand our presence in existing shale markets, access new shale markets and to expand the breadth and scope of services we provide. The following table summarizes our sources and uses of cash for the years ended December 31, 2012, 2011 and 2010 (in 000s):
As of December 31, 2012, we had cash and cash equivalents of $16.2 million, a decrease of $64.0 million from December 31, 2011. As of December 31, 2011, we had cash and cash equivalents of $80.2 million, a decrease of $0.6 million from December 31, 2010 excluding cash associated with discontinued operations. Generally, we manage our cash flow by using any excess cash, after considering our working capital and capital expenditure needs, to pay down the outstanding balance of our revolving credit facility.
Operating Activities Net cash provided by operating activities was $30.7 million for the year ended December 31, 2012 and consisted of the add-back of non-cash items and other adjustments of $20.4 million combined with net income of $2.5 million and a $7.7 million increase in net operating liabilities. The non-cash items included $58.5 million of depreciation and amortization as well as a $60.3 million change in deferred income taxes due primarily to a $38.5 million release of valuation allowance.
Net cash used in operating activities was $14.0 million for the year ended December 31, 2011 and included $9.3 million of net cash used in operating activities from continuing operations and $4.7 million of net cash used in operating activities from discontinued operations. Net cash used in operating activities from continuing operations consisted of the add-back of non-cash items and other adjustments of $42.8 million offset by an increase in operating assets (net of liabilities) of $29.1 million and a net loss of $23.0 million. The non-cash and other adjustments included the add-back of a $22.9 million loss associated with the discontinuance of our wholly-owned subsidiary, China Water. The increase in operating activities included a $31.2 million increase in accounts receivable, which was exacerbated by slower customer payments in the fourth quarter.
Net cash used in operating activities was $4.1 million for the year ended December 31, 2010 and included $3.4 million of net cash used in operating activities from continuing operations and $0.7 million of net cash used in operating activities from discontinued operations. Net cash used in operating activities from continuing operations consisted of the add-back of non-cash items and other adjustments of $7.8 million and changes in operating assets (net of operating liabilities) of $3.5 million offset by a net loss of $14.7 million.
Investing Activities Net cash used in investing activities was $392.7 million for the year ended December 31, 2012 and included cash paid in connection with the Power Fuels merger and the TFI acquisition, which totaled $127.3 million and $229.6 million, respectively, and capital purchases of $45.6 million.
Net cash used in investing activities was $148.1 million for the year ended December 31, 2011 and included $142.3 million of net cash used in investing activities from continuing operations and $5.8 million of net cash used in investing activities from discontinued operations. Net cash used in investing activities from continuing operations was $142.3 million for the year ended December 31, 2011, up $104.6 million from $37.7 million for the year ended December 31, 2010. The increase was primarily attributable to $59.7 million of additional cash paid for acquisitions in 2011 as compared to the prior year period, and an additional $133.5 million of capital expenditures to support business growth in 2011 as compared to 2010. These higher cash requirements for capital investments were partially funded by approximately $87.4 million of additional net cash proceeds realized from the liquidation of availableforsale securities and redemption of certificates of deposit. Net cash used in investing activities by discontinued operations was $5.8 million for the year ended December 31, 2011 compared to $0.5 million in the year ago period.
Financing Activities Net cash provided by financing activities was $298.0 million for the year ended December 31, 2012 compared to $151.0 million for the year ended December 31, 2011. The year-over-year net increase in net cash provided by operating activities was attributable to the larger funding needs necessary to consummate the TFI and Power Fuels acquisitions in 2012 as compared to the funding needs of the relatively smaller acquisitions that were consummated in 2011. The $147.0 million increase in cash provided by financing activities consisted of $399.0 million of proceeds, net of original issue discounts, received in connection with the issuance of the 2018 Notes, $147.0 million of net proceeds drawn from our Amended Revolving Credit Facility and $74.4 million of cash proceeds received in connection with an equity offering of our common shares. Cash provided by financing activities was offset by a $140.2 million repayment of our old credit facility, a $150.4 million repayment of debt acquired in connection with the Power Fuels acquisition and $26.2 million of deferred financing fees associated with the 2018 Notes and the Amended Revolving Credit Facility.
Net cash provided by financing activities from continuing operations was $151.0 million for the year ended December 31, 2011 compared to $1.6 million of cash used in financing activities from continuing operations for the year ended December 31, 2010. The increase was primarily attributable to $47.9 million of cash proceeds received in the fourth quarter of 2011 from the exercise of
warrants for approximately 7.9 million shares of our common stock at an exercise price of $6.00 per warrant and net borrowings under our Old Credit Facility totaling $109.9 million. Financing activities from discontinued operations were not significant during 2011 and 2010.
We are highly leveraged and a substantial portion of our liquidity needs arise from debt service requirements and from funding our costs of operations, and capital expenditures including acquisitions. As of December 31, 2012, we had $566.1 million of indebtedness outstanding, consisting of $147.0 million under the Amended Revolving Credit Facility, $400.0 million of 2018 Notes and $20.0 million under capital lease and other notes payable obligations. The 2018 Notes, which were issued in separate tranches, are presented net of unamortized original issue discounts and original issue premiums of $1.2 million and $0.3 million, respectively, in our consolidated balance sheet at December 31, 2012.
Availability under the Amended Revolving Credit Facility is equal to $325.0 million of aggregate commitments less the sum of outstanding revolving advances and outstanding letters of credit including both drawn and undrawn amounts. Availability for future borrowings as of December 31, 2012 was $177.0 million, which is net of $147.0 million of the outstanding borrowings on our Amended Revolving Credit Facility and $1.0 million of outstanding letters of credit. Substantially all of our assets are subject to liens under our Amended Revolving Credit Facility.
The Amended Revolving Credit Facility contains a number of covenants that, among other things, limit or restrict our ability to incur additional indebtedness; incur liens (other than liens securing capital leases and purchase money debt); make further negative pledges; make loans, advances and other investments, including acquisitions (provided that acquisitions shall be permitted to the extent that the target is in the water or environmental services industry, that the representations and warranties are true and correct in all material respects as of the acquisition date and certain pro forma ratios are met); declare dividends, distributions and issuances of equity interest or repayment of the same; make fundamental changes; make prepayments, redemptions and purchases of subordinated and certain other debt; engage in transactions with affiliates; pay dividends and make other payments affecting subsidiaries; make changes in lines of business, fiscal year and accounting practices; make material amendments to our organization documents; engage in sales-leaseback transactions; engage in hedging transactions; make capital expenditures and incur operating lease obligations. The indentures governing the 2018 Notes also contain restrictive covenants that, among other things, limit our ability to transfer or sell assets; pay dividends or make certain distributions, buy subordinated indebtedness or securities, make certain investments or make other restricted payments; incur or guarantee additional indebtedness or issue preferred stock; create or incur liens securing indebtedness; incur dividend or other payment restrictions affecting restricted subsidiaries; consummate a merger, consolidation or sale of all or substantially all of our assets; enter into transactions with affiliates; engage in business other than a business that is the same or similar, reasonably related, complementary or incidental to our current business and/or that of our restricted subsidiaries; and make certain acquisitions or investments.
Capital expenditures for the year ended December 31, 2012, excluding acquisition and merger related activity totaled $45.6 million, reflecting capital outlays primarily related to pipeline construction, expansion projects and disposal wells. Substantially all transportation fleet additions in 2012 were financed through capital leases. We expect that our capital expenditures will decrease during 2013 as we focus on improving the utilization of our existing assets. Our capital expenditure program is subject to market conditions, including customer activity levels, commodity prices, industry capacity and specific customer needs. We may also incur additional capital expenditures for acquisitions. Our planned capital expenditures will likely be financed through a combination of cash on hand, cash flow from operations, borrowings under our Amended Credit Facility and capital leases, and in the case of acquisitions, issuances of equity. We may also issue additional debt securities.
We believe that cash generated from operations, together with cash on hand and amounts available under the Amended Revolving Credit Facility will be adequate to permit us to meet our debt service obligations, ongoing costs of operations, working capital needs and capital expenditure requirements for the next twelve months and the foreseeable future. Should operating cash flows or activity levels prove to be insufficient to warrant our currently planned capital spending levels, we expect to adjust our capital spending plans accordingly. Our future financial and operating performance, ability to service or refinance our debt and ability to comply with covenants and restrictions contained in our debt agreements will be subject to future economic conditions and to financial, business and other factors, many of which are beyond our control. See Cautionary Note for Forward-Looking Statements and Risk Factors in Part I, Item 1A of this Annual Report.
From time to time, we evaluate various alternatives for the use of excess cash generated from our operations including paying down debt, funding acquisitions and repurchasing common stock or debt securities. Our capacity to repurchase common stock is limited to $3.0 million per year by the Amended Revolving Credit Facility at December 31, 2012 unless certain payment conditions are satisfied.
The following table details the contractual cash obligations for debt, operating leases and purchase obligations as of December 31, 2012.
As a supplement to the financial statements in this Annual Report on Form 10-K, which are prepared in accordance with U.S. GAAP, we also present EBITDA. EBITDA is consolidated net income (loss) from continuing operations before net interest expense, income taxes and depreciation and amortization. We present EBITDA because we believe this information is useful to financial statement users in evaluating our financial performance. We also use EBITDA to evaluate our financial performance, make business decisions, including developing budgets, managing expenditures, forecasting future periods, and evaluating capital structure impacts of various strategic scenarios. EBITDA is not a measure of performance calculated in accordance with U.S. GAAP and there are material limitations to its usefulness on a stand-alone basis. EBITDA does not include reductions for cash payments for our obligations to service our debt, fund our working capital and pay our income taxes. In addition, certain items excluded from EBTIDA such as interest, income taxes, depreciation and amortization are significant components in understanding and assessing our financial performance. All companies do not calculate EBITDA in the same manner and our presentation may not be comparable to those presented by other companies. Financial statement users should use EBITDA in addition to, and not as an alternative to, net income (loss) from continuing operations as defined under U.S. GAAP.
The table below provides a reconciliation between net loss, as determined in accordance with U.S. GAAP, and EBITDA:
Critical Accounting Policies and Estimates
Our discussion and analysis of financial condition and results of operations are based upon our audited consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts in the consolidated financial statements and accompanying notes. Actual results, however, may materially differ from our calculated estimates.
We believe the following critical accounting policies affect the more significant judgments and estimates used in the preparation of our financial statements and changes in these judgments and estimates may impact future results of operations and financial condition. For additional discussion of our accounting policies see Note 1 to our consolidated financial statements for the year ended December 31, 2012 included in this Annual Report on Form 10-K.
Allowance for Doubtful Accounts
Accounts receivable are recognized and carried at the original invoice amount less an allowance for doubtful accounts. We provide an allowance for doubtful accounts to reflect the expected uncollectibility of trade receivables. We perform ongoing credit evaluations of prospective and existing customers and adjust credit limits based upon payment history and the customers current credit worthiness, as determined by a review of their current credit information. In addition, we continuously monitor collections and payments from customers and maintain a provision for estimated credit losses based upon historical experience and any specific customer collection issues that have been identified. Inherent in the assessment of the allowance for doubtful accounts are certain judgments and estimates including, among others, the customers willingness or ability to pay, the Companys compliance with customer invoicing requirements, the effect of general economic conditions and the ongoing relationship with the customer. If the financial condition of a specific customer or our general customer base were to deteriorate, resulting in an impairment of their ability to make payments, additional allowances may be required. Accounts receivable are presented net of allowances for doubtful accounts of approximately $6.0 million and $2.6 million at December 31, 2012 and 2011, respectively.
Accounting for Business Combinations
We allocate the purchase price of acquisitions to the assets acquired and liabilities assumed based on their estimated fair value at the date of acquisition. Any purchase price in excess of the net fair value of the assets acquired and liabilities assumed is allocated to goodwill. The fair value of certain of our assets and liabilities is determined by (1) using estimates of replacement costs for tangible fixed assets and (2) using discounted cash flow valuation methods for estimating identifiable intangibles such as customer contracts and customer relationship intangibles (Income Approach). The purchase price allocation requires subjective estimates that, if incorrectly estimated, could be material to our consolidated financial statements including the amount of depreciation and amortization expense recognized. The determination of the final purchase price allocation could extend over several quarters resulting in the use of preliminary estimates that are subject to adjustment until finalized. The income approach used to value identifiable intangible assets utilizes forward-looking assumptions and projections, but considers factors unique to our businesses and related long-range plans that may not be comparable to other companies and that are not yet publicly available. The determination of fair value under the income approach requires significant judgment on our part. Our judgment is required in developing assumptions about future revenue growth, projected capital expenditures, changes in working capital, general and administrative expenses, attrition rates, and the weighted average cost of capital. The estimated future cash flows and projected capital expenditures used under the income approach are based on our business plans and forecasts, which consider historical results adjusted for future expectations. Future expectations include assumptions related to including economic trends, market conditions and other factors which are beyond managements control.
Contingent consideration primarily consists of earn-out obligations assumed in connection with business combinations that are payable by us to the former owners of an acquiree as part of the exchange for control of the acquiree if specified future events occur or conditions are met. Contingent consideration is recorded at the acquisition date fair value, which is measured at the present value of the consideration expected to be transferred. The fair value of contingent consideration is remeasured at the end of each reporting period with the change in fair value recognized as other income (expense) in the consolidated statement of operations. Estimates of the fair value of contingent consideration are impacted by changes to cash flow projections, growth rates, discount rates and probabilities of achieving future milestones. Contingent consideration obligations were $10.8 million at December 31, 2012 of which $2.0 million and $8.8 million were classified as current and long-term, respectively, in our consolidated balance sheet.
Goodwill represents the excess of the purchase price over the fair value of the net assets of businesses acquired. Goodwill is not amortized. Instead, goodwill is required to be tested for impairment annually and between annual tests if events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The goodwill
impairment test involves a two-step process; however, if after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. In evaluating whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount, an entity shall assess all relevant events and circumstances indicating whether it is more likely than not the fair value of a reporting unit is less than its carrying value, which include but are not limited to one or more of the following: (1) macroeconomic conditions such as a deterioration in general economic conditions, limitations on accessing capital or other developments in equity and capital markets, (2) industry and market conditions such as a deterioration in the environment in which an entity operates, an increased competitive environment, a change in the market for an entity, (3) cost factors such as increases in raw materials or labor, (4) overall financial performance such as negative or declining cash flows or a decline in actual or planned revenue or earnings compared with actual and projected results or relevant prior periods, (5) entity specific events such as changes in management, key personnel, strategy, or customers, (6) events affecting a reporting unit such as a change in the composition or carrying amount of its net assets, a more-likely-than not expectation of selling or disposing all, or a portion, or a reporting unit and (5) a sustained decrease in share price.
In the event a determination is made that it is more likely than not that the fair value of a reporting unit is less than its carrying value, the first step of the two-step process must be performed. The first step of the test, used to identify potential impairment, compares the estimated fair value of a reporting unit with its carrying amount, including goodwill. If the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is not considered to be impaired and the second step of the impairment test is unnecessary. If the carrying amount of a reporting unit exceeds its fair value, the second step of the impairment test must be performed to measure the amount of the impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of reporting unit goodwill with the carrying amount of that goodwill. The implied fair value of goodwill is determined in the same manner as goodwill recognized in a business combination. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.
An entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. At September 30, 2012 we elected to bypass the qualitative assessment and performed step one of the goodwill impairment test for each of our three reporting units: the pipeline reporting unit, the Recycling Division reporting unit (which is also an operating segment) and the Fluids Management Division reporting unit excluding the pipeline operations. Refer to Note 16 in the accompanying consolidated financial statements for additional information on our operating segments. To measure the fair value of each reporting unit, several valuation techniques were used. The Fluids Management Division reporting unit and the Recycling Division reporting unit used the discounted cash flow method (Income Approach) and the guideline public company method (Market Approach). The pipeline reporting unit relied solely on the income approach. The Income Approach is based on managements operating budget and internal five-year forecast. This approach utilizes forward-looking assumptions and projections, and considers factors impacting long-range plans that may not be comparable to other companies and that are not yet publicly available. The Market Approach considers potentially comparable companies and transactions within the industries where our reporting units participate, and applies their trading multiples to our reporting units. This approach utilizes data from actual marketplace transactions, but reliance on its results is limited by difficulty in identifying companies that are specifically comparable to us, considering the diversity of the our businesses, their relative sizes and levels of complexity. The fair values of the reporting units are evaluated in aggregate using the market capitalization method whereby the sum of the reporting units fair values reconciled to our total market capitalization. Management uses this comparison as additional evidence of the fair value of the Company, as its market capitalization may be suppressed by other factors such as the control premium associated with a controlling shareholder. Management evaluates and weights the results based on a combination of the Income and Market Approaches, and, in situations where the Income Approach results differ significantly from the Market Approach, management re-evaluates and adjusts, if necessary, its assumptions. The discount rates used in the income approach model during the third quarter 2012 impairment test were 11.0% for the Recycling and Fluids Management Divisions and 10.0% for the Pipeline operations.
Based on the results of our 2012 third quarter goodwill impairment test, the fair values of our reporting units were determined to exceed their respective carrying amounts and accordingly, the second step of the impairment test was not necessary. The Companys step 1 test for reporting units indicated the fair value of the Recycling Division, Fluids Management Division and Pipeline operations exceeded their respective carrying values by 2%, 16% and 27%, respectively. Therefore a hypothetical decrease of 2%, 16% and 27% in the Recycling Division, Fluids Management Division and Pipeline operations fair values, respectively, would be an indication of impairment and trigger the need to perform a second step to measure the amount of impairment.
At December 31, 2012, we evaluated whether any changes or goodwill triggering events existed and concluded there were none. If adverse changes to our business were to occur in the future, such as a sustained drop in the price of oil and natural gas, the loss of a loss of one or more key customers, increased competition from other environmental services companies, an increase in governmental regulation, etc. our goodwill could be impaired.
Impairment of Long-Lived Assets and Intangible Assets with Finite Useful Lives
We review long-lived assets including intangible assets with finite useful lives for impairment whenever events or changes in circumstances indicate the carrying value of a long-lived asset (or asset group) may not be recoverable. If an impairment indicator is present, we evaluate recoverability by comparing the estimated future cash flows of the category classes, on an undiscounted basis, to their carrying values. The category class represents the lowest level for which identifiable cash flows are largely independent of the cash flows of other groups of assets and liabilities. If the undiscounted cash flows exceed the carrying value, the asset group is recoverable and no impairment is present. If the undiscounted cash flows are less than the carrying value, the impairment is measured as the difference between the carrying value and the fair value of the long-lived asset (or asset group). Our determination that an event or change in circumstance has occurred potentially indicating the carrying amount of an asset (or asset group) may not be recoverable generally includes but is not limited to one or more of the following: (1) a deterioration in an assets financial performance compared to historical results, (2) a shortfall in an assets financial performance compared to forecasted results, (3) changes affecting the utility and estimated future demands for the asset, (4) a significant decrease in the market price of an asset, (4) a current expectation that a long-lived asset will be sold or disposed of significantly before the end of its previously estimated useful life and a significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition.
During the year ended December 31, 2012, we recognized a $3.7 million impairment loss on three salt water disposal wells primarily in the Haynesville shale area. We tested the disposal wells for recoverability after the wells developed technical problems which required us to suspend their use unusable. The estimated future cash flows used to test the recoverability and measure the fair values of the disposal wells included an estimate of future expenditures necessary to identify the source of the problems and to take corrective action to restore the wells functionality or convert them to an alternate use. During the year ended December 31, 2012, we also recognized a $2.4 million impairment loss related to the write-down of a customer relationship intangible associated with a portion of a prior business acquisition. The impairment review and associated write-down was triggered by managements updated assessment of the reduced growth prospects of the business and the related impact on its expected financial performance. During the years ended December 31, 2011 and 2010, we concluded impairment indicators were not present and it was therefore not necessary to test the assets for recoverability during those years. We could recognize future impairments to the extent adverse events or changes in circumstances result in conditions in which long-lived assets are not recoverable.
Valuation of Deferred Tax Assets
We account for income taxes using the asset and liability method. Under this method, deferred tax assets and liabilities are recorded for the future tax consequences attributable to differences between the financial statement carrying amounts of assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a tax rate change on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. We record valuation allowances to reduce net deferred tax assets to the amount considered more likely than not to be realized. Changes in estimates of future taxable income can materially change the amount of such valuation allowances.
We are subject to federal income taxes and state income taxes in those jurisdictions in which we operate. We exercise judgment with regard to income taxes in the following areas: (1) interpreting whether expenses are deductible in accordance with federal income tax and state income tax codes, (2) estimating annual effective federal and state income tax rates and (3) assessing whether deferred tax assets are, more likely than not, expected to be realized. The accuracy of these judgments impacts the amount of income tax expense we recognize each period.
As a matter of law, we are subject to examination by federal and state taxing authorities. We have estimated and provided for income taxes in accordance with settlements reached with the Internal Revenue Service in prior audits. Although we believe that the amounts reflected in our tax returns substantially comply with the applicable federal and state tax regulations, both the IRS and the various state taxing authorities can take positions contrary to our position based on their interpretation of the law. A tax position that is challenged by a taxing authority could result in an adjustment to our income tax liabilities and related tax provision.
We measure and record tax contingency accruals in accordance with accounting principles generally accepted in the United States (GAAP) which prescribes a threshold for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return. Only positions meeting the more likely than not recognition threshold at the effective date may be recognized or continue to be recognized. A tax position is measured at the largest amount that is greater than 50 percent likely of being realized upon ultimate settlement.
We recognize revenues in accordance with Accounting Standards Codification 605 (ASC 605 Revenue Recognition) and Staff Accounting Bulletin No 104, and accordingly all of the following criteria must be met for revenues to be recognized: persuasive evidence of an arrangement exists, delivery has occurred or services have been rendered, the price to the buyer is fixed and determinable and collectibility is reasonably assured. The majority of our revenue results from contracts with direct customers and revenues are generated upon performance of contracted services.
Services provided to our customers primarily include the transportation of fresh water and saltwater by Company-owned trucks or through a temporary or permanent water transport pipeline. Revenues are also generated through fees from our disposal wells and rental of tanks and other equipment. Certain customers, limited to those under contract with us to utilize the pipeline, have an obligation to dispose of a minimum quantity (number of barrels) of saltwater over the contract period. Transportation and disposal rates are generally based on a fixed fee per barrel of disposal water or, in certain circumstances, transportation is based on an hourly rate. Revenue is recognized based on the number of barrels transported or disposed or at hourly rates for transportation. Rates for other services are based on negotiated rates with our customers and revenue is recognized when the services have been performed.
Our Fluids Management Division derives the majority of its revenue from the transportation of fresh and salt water by Company-owned trucks or through a temporary or permanent water transport pipeline to customer sites for use in drilling and hydraulic fracturing activities and from customer sites to remove and dispose of backflow and produced water originating from oil and gas wells. Revenues are also generated through fees charged for use of our disposal wells and from the rental of tanks and other equipment. Certain customers, limited to those under contract with us to utilize the pipeline, have an obligation to dispose of a minimum quantity (number of barrels) of saltwater over the contract period. Transportation and disposal rates are generally based on a fixed fee per barrel of disposal water or, in certain circumstances, transportation is based on an hourly rate. Revenue is recognized based on the number of barrels transported or disposed or at hourly rates for transportation. Rates for other services are based on negotiated rates with our customers and revenue is recognized when the services have been performed.
Our Recycling Division derives the majority of its revenue from the sale of used motor oil and antifreeze after it is refined by one of its processing facilities. Revenue is recognized upon shipment or delivery, dependent on contracted terms, of salable fuel oil or upon recovery service provided in the receipt of waste oil and antifreeze per specific customer contract terms. Transportation costs charged to customers are included in revenue.
Recent Accounting Pronouncements
Recent Accounting Pronouncements
In February 2013, the Financial Accounting Standards Board (the FASB) issued Accounting Standards Update (ASU) No. 2013-02, Reporting of Amounts Reclassified out of Accumulated Other Comprehensive Income (ASU 2013-02). The amendments in this update do not change the current requirements for reporting net income or other comprehensive income in financial statements. However, the amendments require an entity to provide information about the amounts reclassified out of accumulated other comprehensive income by component. In addition, an entity is required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. The amendments in this update are effective prospectively for reporting periods beginning after December 15, 2012, which for us is the reporting period starting January 1, 2013. We do not anticipate the adoption of ASU 2013-02 will have a material impact on our consolidated financial statements. As permitted under ASU 2013-02, we have elected to present reclassification adjustments from each component of accumulated other comprehensive income within a single note to the financial statements beginning in the first quarter of 2013, if applicable.
In July 2012, the FASB issued ASU No. 2012-02, Testing Indefinite-Lived Intangible Assets for Impairment (ASU 2012-02). The amendments in this update provide an entity the option to first assess qualitative factors to determine whether the existence of events and circumstances indicates that it is more likely than not that the indefinite-lived intangible asset is impaired. If, after assessing the totality of events and circumstances, an entity concludes that it is not more likely than not that the indefinite lived intangible asset is impaired, then the entity is not required to take further action. However, if an entity concludes otherwise, then it is required to determine the fair value of the indefinite-lived intangible asset and perform the quantitative impairment test by comparing the fair value with the carrying amount in accordance with Accounting Standards Codification subtopic 350-30, General Intangibles other than Goodwill. An entity also has the option to bypass the qualitative assessment for any indefinite-lived intangible asset in any period and proceed directly to performing the quantitative impairment test. An entity will be able to resume performing the qualitative assessment in any subsequent period. The amendments in this update are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012, which for us are the annual and interim periods starting January 1, 2013. As of December 31, 2012, we did not have any intangible assets with indefinite lives. At this time, we do not anticipate the adoption of ASU 2012-02 will have a material impact on our consolidated financial statements.
In September 2011, the FASB issued ASU No. 2011-08, Testing Goodwill for Impairment (ASU 2011-08). The amendments in this update provide an entity the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying
amount. If, after assessing the totality of events or circumstances, an entity determines it is not more likely than not that the fair value of the reporting unit is less than its carrying amount, then performing the two-step impairment test is unnecessary. However, if an entity concludes otherwise, then it is required to perform the first step of the two-step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The amendment does not change the requirement to perform the second step of the interim goodwill impairment test to measure the amount of an impairment loss, if any, if the carrying amount of a reporting unit exceeds its fair value. Under the amendments in this update, an entity has the option to bypass the qualitative assessment for any reporting unit in any period and proceed directly to performing the first step of the two-step goodwill impairment test. An entity may resume performing the qualitative assessment in any subsequent period. The amendments in this update were effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011, which for us were the annual and interim periods starting January 1, 2012. As permitted under ASU 2011-08 we elected to bypass the qualitative assessment at September 30, 2012 and instead proceeded directly to performing the first step of the two-step goodwill impairment test. Refer to the goodwill discussion in the significant accounting policies section of Note 1 to the accompanying consolidated financial statements for additional information.
Inflationary factors, such as increases in our cost structure, could impair our operating results. Although we do not believe that inflation has had a material impact on our financial position or results of operations to date, a high rate of inflation in the future may have an adverse effect on our ability to maintain current levels of gross margin and selling, general and administrative expenses as a percentage of sales revenue if the selling prices of our products do not increase with these increased costs.
We are subject to market risk exposures arising from declines in oil and natural gas drilling activity in unconventional areas, which is primarily a function of the market price for oil and natural gas. Various factors beyond our control affect the market prices for oil and natural gas, including but not limited to the level of consumer demand, governmental regulation, the price and availability of alternative fuels, political instability in foreign markets, weather-related factors and the overall economic environment. During 2012, in response to a drop in natural gas prices we redeployed resources to oil-rich shale areas where drilling activity was more robust. Market prices for oil and natural gas have been volatile and unpredictable for several years, and we expect this volatility to continue in the future. Prolonged declines in the market price of oil and/or natural gas could contribute to declines in drilling activity and accordingly would reduce demand for our services. We attempt to manage this risk by strategically aligning our assets with those areas where we believe demand is highest and market conditions for our services are most favorable.
As of December 31, 2012 the outstanding principal balance on our amended revolving credit facility was $147.0 million with variable rates of interest based generally on London inter-bank offered rate (LIBOR) plus a margin of between 2.50% and 3.75% based on a ratio of the Companys total debt to EBITDA, or an alternate interest rate equal to the higher of the Federal Funds Rate as published by the Federal Reserve Bank of New York plus 1/2 of 1.00%, the prime commercial lending rate of the administrative agent under the Credit Agreement, and monthly LIBOR plus 1.00%, plus a margin of between 1.50% and 2.75% based on the Companys total debt to EBITDA. We have assessed our exposure to changes in interest rates on variable rate debt by analyzing the sensitivity to our earnings assuming various changes in market interest rates. Assuming a hypothetical increase of 1% to the interest rates on the average outstanding balance of our variable rate debt portfolio during 2012 our net interest expense for the year ended December 31, 2012 would have increased by an estimated $0.8 million.
The financial statements and supplementary data required by Regulation S-X are included in Item 15. Exhibits, Financial Statements Schedules contained in Part IV, Item 15 of this Annual Report on Form 10-K.
Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in company reports filed or submitted under the Securities Exchange Act of 1934, as amended (the Exchange Act) is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of our disclosure controls and procedures was performed under the supervision of, and with the participation of, management, including our Chief Executive Officer and Chief Financial Officer, as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective.
Managements Report on Internal Control over Financial Reporting
The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Companys internal control system is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the consolidated financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
The Companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of consolidated financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are being made only in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the Companys assets that could have a material effect on the consolidated financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Companys internal control over financial reporting as of December 31, 2012. The Company acquired 100% of the outstanding shares of Thermo Fluids, Inc. on April 10, 2012 and Badlands Power Fuels, LLC on November 30, 2012 and management excluded Thermo Fluids, Inc. and Badlands Power Fuels, LLCs internal control over financial reporting from its assessment of the effectiveness of the Companys internal control over financial reporting as of December 31 2012. The Companys consolidated financial statements include 4% and 12% in total assets (excluding goodwill and intangible assets subject to the acquirers internal controls over financial reporting from the assets excluded) and 27% and 7% in total revenues associated with Thermo Fluids, Inc. and Badlands Power Fuels, LLC, respectively as of and for the year December 31 2012.
In making its assessment of internal control over financial reporting, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework. Based on this assessment, management concluded that our internal control over financial reporting was effective as of December 31, 2012.
Our independent registered public accounting firm, KPMG LLP, has issued an audit report on the effectiveness of our internal control over financial reporting. This report has been included on page 50 of this Annual Report on Form 10-K.
Changes in Internal Control over Financial Reporting
An evaluation of our internal controls over financial reporting was performed under the supervision of, and with the participation of, management, including our Chief Executive Officer and Chief Financial Officer, to determine whether any changes have occurred during the quarter ended December 31, 2012 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Following the acquisition of Thermo Fluids, Inc. in April 2012 and Badlands Power Fuels, LLC. in November 2012, the Company commenced the process of aligning the processes and controls of these acquisitions into our existing control environment. This process was ongoing during the last fiscal quarter of 2012.
Report of Independent Registered Public Accounting Firm
The Board of Directors
We have audited Heckmann Corporations (The Company) internal control over financial reporting as of December 31, 2012, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Heckmann Corporations management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Managements Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.
We conducted our audit 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 effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A companys internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A companys internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Heckmann Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Heckmann Corporation and subsidiaries as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the years in the two-year period ended December 31, 2012, and our report dated March 18, 2013 expressed an unqualified opinion on those consolidated financial statements.
Heckmann Corporation acquired 100% of the outstanding shares of Thermo Fluids, Inc. on April 10, 2012 and Badlands Power Fuels, LLC on November 30, 2012 and management excluded Thermo Fluids, Inc. and Badlands Power Fuels, LLCs internal control over financial reporting from its assessment of the effectiveness of the Companys internal control over financial reporting as of December 31 2012. The Companys consolidated financial statements included 4% and 12% in total assets (excluding goodwill and intangible assets subject to the acquirers internal control over financial reporting from the assets excluded) and 27% and 7% in total revenues associated with Thermo Fluids, Inc. and Badlands Power Fuels, LLC, respectively as of and for the year December 31 2012. Our audit of internal control over financial reporting of the Company also excluded an evaluation of the internal control over financial reporting of Thermo Fluids, Inc. and Badlands Power Fuels, LLC.
/s/ KPMG, LLP
March 18, 2013
On January 7, 2013, we filed with the New York Stock Exchange (NYSE) the Annual CEO Certification regarding our compliance with the NYSEs corporate governance listing standards as required by Section 303A(12)(a) of the NYSE Listed Company Manual. In addition, we have filed as exhibits to this Annual Report on Form 10-K for the year ended December 31, 2012, the applicable certifications of its Chief Executive Officer and its Chief Financial Officer required under Rule 13a-14(a) of the Securities Exchange Act of 1934, as amended, regarding the quality of our public disclosures.
The information required by this item is incorporated by reference from our proxy statement to be filed pursuant to Regulation 14A within 120 days after our year ended December 31, 2012 in connection with our 2013 Annual Meeting of Stockholders, or Proxy Statement.
The information required by this item is incorporated by reference to our Proxy Statement.
The information required by this item is incorporated by reference to our Proxy Statement.
The information required by this item is incorporated by reference to our Proxy Statement.
The information required by this item is incorporated by reference to our Proxy Statement.
(a) The following documents are filed as part of this Annual Report on Form 10-K:
All financial statement schedules have been omitted since they are not required, not applicable, or the information is otherwise included in the audited consolidated financial statements.
(b) The exhibits listed on the Exhibit Index following the audited consolidated financial statements are filed with this Annual Report on Form 10-K or incorporated by reference as set forth below.
Pursuant to the requirements of Section 13 or 15(d) of the Securities Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Scottsdale, State of Arizona, on March 18, 2013.
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Mark D. Johnsrud, Jay C. Parkinson and Damian C. Georgino, and each of them, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K and to file the same, with all exhibits thereto and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents and each of them, full power and authority to do and perform each and every act and thing requisite and necessary to be done in connection therewith as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming all that said attorneys-in-fact and agents, or any of them, or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Act of 1934, this report has been signed by the following persons in the capacities and on the dates indicated.
HECKMANN CORPORATION AND SUBSIDIARIES
The following financial statements of the Company and its subsidiaries required to be included in Item 15(a)(1) of Form 10-K are listed below:
Supplementary Financial Data:
The supplementary financial data of the Registrant and its subsidiaries required to be included in Item 15(a)(2) of Form 10-K have been omitted as not applicable or because the required information is included in the Consolidated Financial Statements or in the notes thereto.
The Board of Directors
We have audited the accompanying consolidated balance sheets of Heckmann Corporation and subsidiaries (the Company) as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, changes in equity, and cash flows for each of the years in the two-year period ended December 31, 2012. These consolidated financial statements are the responsibility of the Companys 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 Heckmann Corporation and subsidiaries as of December 31, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Companys internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 18, 2013 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting.
/s/ KPMG LLP
March 18, 2013
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders
We have audited the accompanying consolidated statements of operations, comprehensive loss, changes in equity and cash flows of Heckmann Corporation and subsidiaries (the Company) for the year ended December 31, 2010. The Companys management is responsible for these financial statements. Our responsibility is to express an opinion on these financial statements based on our audit.
We conducted our audit 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 financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the 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 audit provides a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the results of operations and cash flows of Heckmann Corporation and subsidiaries for the year ended December 31, 2010, in conformity with accounting principles generally accepted in the United States of America.
/s/ GHP Horwath, P.C.
March 14, 2011 (December 7, 2011 as to the effects of the discontinued operations presentation for 2010 as described in Note 18).
CONSOLIDATED BALANCE SHEETS
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except share and per share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
HECKMANN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
HECKMANN CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
(In thousands, except share data)
The accompanying notes are an integral part of these consolidated financial statements.
CONSOLIDATED STATEMENTS OF CASH FLOWS