Basis of Presentation

The unaudited condensed consolidated financial statements of Fairmount Santrol Holdings Inc. (formerly FMSA Holdings Inc.) and its consolidated subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (which are of a normal, recurring nature) and disclosures necessary for a fair presentation of the financial position, results of operations, comprehensive income and cash flows of the reported interim periods. The condensed consolidated balance sheet as of December 31, 2014 was derived from audited financial statements, but does not include all disclosures required by GAAP. Interim results are not necessarily indicative of the results to be expected for the full year or any other interim period. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements as filed in the 2014 Annual Report on Form 10-K and notes thereto and information included elsewhere in this Quarterly Report on Form 10-Q.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In April 2015, the FASB issued Accounting Standards Update No. 2015-05 – Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40), which provides guidance on whether a cloud computing arrangement includes a software license. Under Subtopic 350-40, if a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance provides that an entity can elect to adopt the amendments either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The amendments will be effective for annual periods beginning after December 15, 2015. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11 – Inventory (Topic 330) – Simplifying the Measurement of Inventory. An entity should measure inventory within the scope of this update at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments in this update more closely align the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards (IFRS). The amendment is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

In August 2015, the FASB issued Accounting Standards Update No. 2015-14, which deferred the application of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, and the interim periods within that year. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09 – Revenue from Contracts with Customers (ASU 2014-09). Under ASU 2014-09, companies recognize revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled, in exchange for those goods or services (ASC Topic 606). The new requirements significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. Additionally, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. As such, for a public business entity with a calendar year-end, the ASU would be effective on January 1, 2018, for both its interim and annual reporting periods. This proposal represents a one-year deferral from the original effective date. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

At September 30, 2015 and December 31, 2014, inventories consisted of the following:

At September 30, 2015 and December 31, 2014, property, plant and equipment consisted of the following:

At September 30, 2015 and December 31, 2014, long-term debt consisted of the following:

On September 5, 2013, the Company entered into the Second Amended and Restated Credit Agreement (the “2013 Amended Credit Agreement”). The 2013 Amended Credit Agreement initially contained a revolving credit facility (“Revolving Credit Facility”) and two tranches of term loans, a term B-1 facility (“Term B-1 Loans”) and a term B-2 facility (“Term B-2 Loans”). The Revolving Credit Facility and the Term B-1 and B-2 Loans are secured by a first priority lien on substantially all of the Company’s domestic assets.

As of April 30, 2015, the Company entered into the Third Amendment to the Second Amended and Restated Credit Agreement (the “April 2015 Amendment”) to the 2013 Amended Credit Agreement. The April 2015 Amendment provides for the extension of the maturity date of $46,036 of outstanding Term B-1 Loans from March 15, 2017 (the “Stated B-1 Maturity Date”) to September 5, 2019 (the “Extended Maturity Date,” which is the same maturity date applicable to Term B-2 Loans under the 2013 Amended Credit Agreement). The Company paid a fee of approximately $1,151 to the lender as a consent fee.

As of May 15, 2015, the Company entered into the Fourth Amendment to the Second Amended and Restated Credit Agreement (the “May 2015 Amendment”). The May 2015 Amendment provides for the extension of the maturity date of $115,458 of outstanding Term B-1 Loans from the Stated B-1 Maturity Date to the Extended Maturity Date. Such loans (together with the other loans whose maturity dates were extended under the April 2015 Amendment, Extended Term B-1 Loans) effectively will be converted to Term B-2 Loans, and will be treated as Term B-2 Loans under the Credit Agreement for all purposes (including pricing), except for certain minor administrative differences and except that, prior to the Stated B-1 Maturity Date, Extended Term B-1 Loans shall continue to amortize as Term B-1 Loans. Upon giving effect to the April and May 2015 Amendments, the maturity date of approximately $161,495 in principal amount of outstanding Term B-1 Loans was so extended. The Company paid a fee of approximately $2,886 to the lender as a consent fee for the May 2015 Amendment.

After the April and May 2015 Amendments, $156,619 in principal amount of outstanding Term B-1 Loans mature on March 15, 2017 and $1,073,706 in principal amount of outstanding Term B-2 Loans (including Extended Term B-1 Loans) mature on September 5, 2019.

As of September 30, 2015, the Company entered into an amendment to the 2013 Amended Credit Agreement that modified the Revolving Credit Facility. These modifications consisted primarily of (i) a reduction in the U.S. revolving commitments from $124,000 to $99,000 (while the aggregate Canadian revolving commitment remained at $1,000) and (ii) changes in the financial covenant governing the availability of amounts under the Revolving Credit Facility if, and only if, the Company has drawn, including letters of credit, more than $31,250 on the Revolving Credit Facility. Generally, if the Company’s leverage ratio is greater than 4.75:1.00 during the period from the third quarter of 2015 through the fourth quarter of 2016, so long as the stated quarterly adjusted EBITDA thresholds are exceeded, the amount available to borrow under the Revolving Credit Facility is increased from $31,250 to $40,000. Commencing with the end of the first quarter of 2017, the quarterly adjusted EBITDA thresholds are discontinued and the full amount of the revolving commitment ($100,000) is available so long as the Company’s leverage ratio does not exceed a revised limit (6.50:1.00 for the first quarter of 2017 declining quarterly to 4.75:1.00 for the fourth quarter of 2017). As of September 30, 2015, the Company’s leverage ratio was 5.31:1.00.

As of September 30, 2015, there was $28,467 available borrowing remaining on the Revolving Credit Facility and $11,533 committed to outstanding letters of credit.

The table below shows the computation of basic and diluted earnings per share for the nine months ended September 30, 2015 and 2014:

Because the Company experienced a loss in the three months and nine months ended September 30, 2015, respectively, the calculation of diluted weighted average shares outstanding is not appropriate because the effect of including these potential common shares would be antidilutive. The calculation of diluted weighted average shares outstanding for the nine months ended September 30, 2014 excludes 219,674 potential common shares, respectively, because the effect of including these potential common shares would be antidilutive.

The Company enters into interest rate swap agreements as a means to partially hedge its variable interest rate risk on debt instruments. The current notional value of these swap agreements is $520,225 at September 30, 2015 and effectively fixes the variable rate in a range of 0.83% to 3.115%. The total notional amount of these instruments is scheduled to increase over time to provide a partial hedge against variable interest rate debt. The interest rate swap agreements mature at various dates between October 31, 2015 and September 5, 2019.

The derivative instruments are recorded on the balance sheet at their fair values. Changes in the fair value of derivatives are recorded each period in current earnings or in other comprehensive income, depending on whether a derivative is designated as part of a hedging relationship and, if it is, depending on the type of hedging relationship. For cash flow hedges in which the Company is hedging the variability of cash flows related to a variable-rate liability, the effective portion of the gain or loss on the derivative instrument is reported in other comprehensive income in the periods during which earnings are impacted by the variability of the cash flows of the hedged item. The ineffective portion of all hedges is recognized in current period earnings. As interest expense is accrued on the debt obligation, amounts in accumulated other comprehensive income (loss) related to the interest rate swaps are reclassified into income to obtain a net cost on the debt obligation equal to the effective yield of the fixed rate of each swap. In the event that an interest rate swap is terminated prior to maturity, gains or losses in accumulated other comprehensive income (loss) remain deferred and are reclassified into earnings in the periods in which the hedged forecasted transaction affects earnings.

The Company formally designates and documents instruments at inception that qualify for hedge accounting of underlying exposures in accordance with GAAP. Both at inception and for each reporting period, the Company assesses whether the financial instruments used in hedging transactions are effective in offsetting changes in cash flows of the related underlying exposure.

The following table summarizes the fair values and the respective classification in the Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014:

The Company recognized $30 and $14 in interest expense, representing the ineffective portion of interest rate swap agreements designated as hedges, in the nine months ended September 30, 2015 and 2014, respectively.

Financial instruments held by the Company include cash equivalents, accounts receivable, accounts payable, long-term debt (including the current portion thereof) and interest rate swaps. The Company is also liable for contingent consideration from an acquisition that is subject to fair value measurement. Fair value is defined as the price that would be received to sell an asset, or paid to transfer a liability, in an orderly transaction between market participants at the measurement date. In determining fair value, the Company utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and/or the risks inherent in the inputs to the valuation technique.

Based on the examination of the inputs used in the valuation techniques, the Company is required to provide the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial assets and liabilities carried at fair value will be classified and disclosed in one of the following three categories:

A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

The book value of cash equivalents, accounts receivable and accounts payable are considered to be representative of their fair values because of their short maturities. The carrying value of the Company’s long-term debt (including the current portion thereof) is recognized at amortized cost. The value of the Company’s Term B-1, Extended Term, and Term B-2 loans differs from amortized costs and is valued at prices obtained from a readily-available source for trading non-public debt, which represent quoted prices for identical or similar assets in markets that are not active, and therefore is considered Level 2. The fair value of the Company’s Term B-1 loan was $136,261 and $295,750, Extended Term loan was $118,893 and $0, and Term B-2 loan was $680,686 and $796,500 at September 30, 2015 and December 31, 2014, respectively.

In accordance with ASC 360-10, the fair value of certain of the Company’s long-lived assets held and used with a carrying value of $17,104 was written down to fair value of $7,634 and the fair value of certain of the Company’s long-lived assets held-for-sale with a carrying value of $2,336 was written down to a fair value of $0. The resulting impairment charges of $9,470 and $2,336, respectively, were based on management’s estimate of the disposed value of the assets and were recognized in restructuring and other charges in income from operations in the current period.

The following tables present the amounts carried at fair value as of September 30, 2015 and December 31, 2014 for the Company’s other financial instruments.

The Company granted options to purchase 1,630,952 and 680,000 shares of common stock in the nine months ended September 30, 2015 and 2014, respectively. The average grant date fair value was $3.96 and $9.52 for options issued in the nine months ended September 30, 2015 and 2014, respectively. The Company was not publicly traded in the nine months ended September 30, 2014. The company issued restricted stock units of 363,126 in the nine months ended September 30, 2015. No restricted stock units were issued in the nine months ended September 30, 2014.

The Company computes and applies to ordinary income an estimated annual effective tax rate on a quarterly basis based on current and forecasted business levels and activities, including the mix of domestic and foreign results and enacted tax laws. The estimated annual effective tax rate is updated quarterly based on actual results and updated operating forecasts. Ordinary income refers to income (loss) before income tax expense excluding significant, unusual, or infrequently occurring items. The tax effect of an unusual or infrequently occurring item is recorded in the interim period in which it occurs as a discrete item of tax.

For the three months ended September 30, 2015, the Company recorded tax expense of $28,117 on loss before income taxes of $18,012. For the nine months ended September 30, 2015, the Company recorded tax expense of $12,057 on income before income taxes of $10,949. For the three months ended September 30, 2014, the Company recorded tax expense of $21,436 on income before income taxes of $75,598. For the nine months ended September 30, 2014, the Company recorded tax expense of $53,848 on income before income taxes of $186,825. The effective tax rate for the three and nine months ended September 30, 2015 was negative 156.1% and positive 110.1%, respectively, as compared with 28.4% and 28.8% for the three and nine months ended September 30, 2014, respectively. The effective tax rate for the three months ended September 30, 2015 does not bear the customary relationship to book income or expense because of changes to the current and forecasted business levels, the variability of book income or less between quarters, and a proportionately greater impact on taxable income from the statutory percentage depletion allowance.

The Company maintained two multiemployer defined benefit pension plans covering union employees at certain facilities that provide benefits based upon years of service or a combination of employee earnings and length of service. As part of its recent efficiency and cost-reduction initiatives, the Company has closed these facilities and is in the process of negotiating a withdrawal from the plans. The estimated withdrawal liability for these plans was recorded in the second quarter of 2015.

Net periodic benefit cost recognized for other Company defined benefit pension plans for the nine months ended September 30, 2015 and 2014 is as follows:

The Company contributed $48 and $182 during the nine months ended September 30, 2015 and 2014, respectively. Total expected employer contributions during the year ending December 31, 2015 are $63.

The components of accumulated other comprehensive income (loss) attributable to Fairmount Santrol Holdings Inc. at September 30, 2015 and December 31, 2014 were as follows:

The following table presents the changes in accumulated other comprehensive income by component for the nine months ended September 30, 2015:

The following table presents the reclassifications out of accumulated other comprehensive income during the nine months ended September 30, 2015:

Certain subsidiaries are defendants in lawsuits in which the alleged injuries are claimed to be silicosis-related and to have resulted, in whole or in part, from exposure to silica-containing products, allegedly including those sold by certain subsidiaries. In the majority of cases, there are numerous other defendants. In accordance with its insurance obligations, the defense of these actions has been tendered to and the cases are being defended by the subsidiaries’ insurance carriers. Management believes that the Company’s substantial level of existing and available insurance coverage combined with various open indemnities is more than sufficient to cover any exposure to silicosis-related expenses. An estimate of the possible loss, if any, cannot be made at this time.

The Company has entered into numerous mineral rights agreements, in which payments under the agreements are expensed as incurred. Certain agreements require annual payments while other agreements require payments based upon annual tons mined and others a combination thereof.

The Company leases certain machinery, equipment (including railcars), buildings and office space under operating lease arrangements. Total rent expense associated with these leases was $50,681 and $40,291 for the nine months ended September 30, 2015 and 2014, respectively.

The Company is subject to a contingent consideration arrangement related to the purchase of Self-Suspending Proppant LLC (“SSP”), which was accounted for as an acquisition of a group of assets. The contingent consideration is based on a fixed percentage of the cumulative product margin, less certain adjustments, generated by sales of Propel SSP and other products incorporating SSP technology for the five years commencing on October 1, 2015. Because the earnout is dependent on future sales and the related cost of sales, the amounts of which are highly uncertain, it is not currently possible to estimate the amounts that will be paid. The contingent consideration will be accrued and capitalized as part of the cost of the SSP assets at the time a payment is probable and reasonably estimable.

The Company had purchases from an affiliated entity for freight, logistic services and consulting services related to its operations in China of $176 and $2,327 in the nine months ended September 30, 2015 and 2014, respectively.

The Company had purchases from an affiliated entity for material purchases related to its operations in China of $62 and $0 in the nine months ended September 30, 2015 and 2014, respectively.

The Company paid management fees of $0 and $811 in the nine months ended September 30, 2015 and 2014, respectively. Concurrent with the Company’s initial public offering on October 3, 2014, the Company no longer pays a management fee to American Securities LLC.

The Company organizes its business into two reportable segments, Proppant Solutions and Industrial & Recreational Products. The reportable segments are consistent with how management views the markets served by the Company and the financial information reviewed by the chief operating decision maker in deciding how to allocate resources and assess performance.

The chief operating decision maker primarily evaluates an operating segment’s performance based on segment contribution margin, which excludes certain corporate costs not associated with the operations of the segment. These corporate costs are separately stated below and include costs that are related to functional areas such as operations management, corporate purchasing, accounting, treasury, information technology, legal and human resources.

As a result of recent challenging conditions in the proppant market, the Company has taken actions to rationalize its overall operational footprint and reduce selling, general and administrative costs. The restructuring program primarily consists of workforce reductions and idling and closure of excess facilities. The expected completion date of these activities is December 31, 2015, although a continued sustained downturn in the oil and gas market could extend the duration of this restructuring process. A summary of the restructuring and other costs recognized for the nine months ended September 30, 2015 is as follows:

As a result of these actions, the Company has determined that certain of the impacted facilities in the Proppant Solutions segment will not be necessary for ongoing operations and management has made the decision to offer the facilities for sale. The assets and liabilities of these facilities have been reclassified in the Condensed Consolidated Balance Sheets as assets held-for-sale.

While these restructuring activities primarily were driven by the decline in proppant demand in 2015, certain plants supporting the Industrial & Recreational Products segment have been adversely impacted as well. A summary of the restructuring and other costs by operating segment is as follows:

As a result of challenging conditions in the proppant market, the Company has made the decision to sell certain of its operations in the Proppant Solutions segment that it views as non-core to its business. These assets are classified as held-for-sale and have been marked down to their estimated fair values as of September 30, 2015.

Goodwill represents the excess of purchase price over the fair value of net assets acquired. The Company evaluates goodwill on an annual basis in the fourth quarter or when management believes indicators of impairment exist. Due to the significant changes in the oil and gas business climate during the nine months ended September 30, 2015 and the Company’s decline in stock price, the Company assessed qualitative factors and determined that it could not conclude it was more likely than not that the fair value of its goodwill exceeded its carrying value for the goodwill recorded in the Proppant Solutions reporting unit.

Accordingly, the Company proceeded to a quantitative evaluation of potential impairment of its goodwill. This evaluation included the income (or discounted cash flows) approach. Key assumptions include future growth or recovery rates in the business, the long-term discount rate, and expected terminal values of a business exit. The Company estimated the value of our two goodwill reporting units based on management’s best current available estimates of the future cash flows to arrive at the income approach estimate of fair value. Based on these estimates, the Company has concluded there has been no impairment loss as of September 30, 2015.

However, market conditions impacting the proppant business are uncertain, and a sustained downturn in the Company’s key markets could result in the recognition of an impairment loss on goodwill in a future period. This non-cash impairment charge could be material.

Basis of Presentation

The unaudited condensed consolidated financial statements of Fairmount Santrol Holdings Inc. (formerly FMSA Holdings Inc.) and its consolidated subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. In the opinion of management, the unaudited condensed consolidated financial statements reflect all adjustments (which are of a normal, recurring nature) and disclosures necessary for a fair presentation of the financial position, results of operations, comprehensive income and cash flows of the reported interim periods. The condensed consolidated balance sheet as of December 31, 2014 was derived from audited financial statements, but does not include all disclosures required by GAAP. Interim results are not necessarily indicative of the results to be expected for the full year or any other interim period. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements as filed in the 2014 Annual Report on Form 10-K and notes thereto and information included elsewhere in this Quarterly Report on Form 10-Q.

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Recent Accounting Pronouncements

In April 2015, the FASB issued Accounting Standards Update No. 2015-05 – Intangibles – Goodwill and Other – Internal-Use Software (Subtopic 350-40), which provides guidance on whether a cloud computing arrangement includes a software license. Under Subtopic 350-40, if a cloud computing arrangement includes a software license, then the customer should account for the software license element of the arrangement consistent with the acquisition of other software licenses. If a cloud computing arrangement does not include a software license, the customer should account for the arrangement as a service contract. The guidance provides that an entity can elect to adopt the amendments either prospectively to all arrangements entered into or materially modified after the effective date or retrospectively. The amendments will be effective for annual periods beginning after December 15, 2015. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

In July 2015, the FASB issued Accounting Standards Update No. 2015-11 – Inventory (Topic 330) – Simplifying the Measurement of Inventory. An entity should measure inventory within the scope of this update at the lower of cost or net realizable value. Net realizable value is the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. Subsequent measurement is unchanged for inventory measured using LIFO or the retail inventory method. The amendments in this update more closely align the measurement of inventory in GAAP with the measurement of inventory in International Financial Reporting Standards (IFRS). The amendment is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

In August 2015, the FASB issued Accounting Standards Update No. 2015-14, which deferred the application of ASU 2014-09 to annual reporting periods beginning after December 15, 2017, and the interim periods within that year. In May 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update No. 2014-09 – Revenue from Contracts with Customers (ASU 2014-09). Under ASU 2014-09, companies recognize revenue in a manner that depicts the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled, in exchange for those goods or services (ASC Topic 606). The new requirements significantly enhance comparability of revenue recognition practices across entities, industries, jurisdictions, and capital markets. Additionally, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue that is recognized. As such, for a public business entity with a calendar year-end, the ASU would be effective on January 1, 2018, for both its interim and annual reporting periods. This proposal represents a one-year deferral from the original effective date. The Company is in the process of evaluating the effect of the new guidance on its financial statements and disclosures.

At September 30, 2015 and December 31, 2014, inventories consisted of the following:

At September 30, 2015 and December 31, 2014, property, plant and equipment consisted of the following:

At September 30, 2015 and December 31, 2014, long-term debt consisted of the following:

The table below shows the computation of basic and diluted earnings per share for the nine months ended September 30, 2015 and 2014:

The following table summarizes the fair values and the respective classification in the Condensed Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014:

The following tables present the amounts carried at fair value as of September 30, 2015 and December 31, 2014 for the Company’s other financial instruments.