10-K 1 a13-25267_110k.htm 10-K

Table of Contents

 

 

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 


 

Form 10-K

 

(Mark One)

 

x

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

 

For the fiscal year ended December 31, 2013

 

or

 

o

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

 

For the transition period from                      to                     

 

Commission file no.: 001-33078

 

Exterran Partners, L.P.

(Exact name of registrant as specified in its charter)

 

Delaware

 

22-3935108

(State or other jurisdiction of

 

(I.R.S. Employer

incorporation or organization)

 

Identification No.)

 

 

 

16666 Northchase Drive, Houston, Texas

 

77060

(Address of principal executive offices)

 

(Zip code)

 

(281) 836-7000

(Registrant’s telephone number, including area code)

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Units representing limited partner interests

 

NASDAQ Global Select Market

 

Securities Registered Pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o 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 o 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  o

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s 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.  x

 

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

 

Large accelerated filer  x

 

Accelerated filer  o

Non-accelerated filer  o

 

Smaller reporting company  o

(Do not check if a smaller reporting company)

 

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

The aggregate market value of common units held by non-affiliates of the registrant (treating directors and executive officers of the registrant’s general partner and holders of 5% or more of the common units outstanding, for this purpose, as if they were affiliates of the registrant) as of June 30, 2013, the last business day of the registrant’s most recently completed second fiscal quarter, was $740,975,179. This calculation does not reflect a determination that such persons are affiliates for any other purpose.

 

As of February 18, 2014, there were 49,420,743 common units outstanding.

 


 

DOCUMENTS INCORPORATED BY REFERENCE: NONE

 

 

 



Table of Contents

 

Table of Contents

 

 

 

Page

PART I

Item 1.

Business

4

Item 1A.

Risk Factors

15

Item 1B.

Unresolved Staff Comments

31

Item 2.

Properties

31

Item 3.

Legal Proceedings

31

Item 4.

Mine Safety Disclosures

32

 

 

 

PART II

Item 5.

Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

33

Item 6.

Selected Financial Data

34

Item 7.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

38

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

49

Item 8.

Financial Statements and Supplementary Data

50

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

50

Item 9A.

Controls and Procedures

50

Item 9B.

Other Information

52

 

 

 

PART III

Item 10.

Directors, Executive Officers and Corporate Governance

52

Item 11.

Executive Compensation

56

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

75

Item 13.

Certain Relationships and Related Transactions and Director Independence

76

Item 14.

Principal Accountant Fees and Services

81

 

 

 

PART IV

Item 15.

Exhibits and Financial Statement Schedules

81

 

SIGNATURES

84

 

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PART I

 

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains “forward-looking statements.” All statements other than statements of historical fact contained in this report are forward-looking statements, including, without limitation, statements regarding Exterran Partners, L.P.’s (“we,” “our,” “us” or “the Partnership”) business growth strategy and projected costs; future financial position; the sufficiency of available cash flows to fund continuing operations and make cash distributions; the expected amount of our capital expenditures; future revenue, gross margin and other financial or operational measures related to our business; the future value of our equipment; plans and objectives of our management for our future operations; and any potential contribution of additional assets from Exterran Holdings, Inc. (individually, and together with its wholly-owned subsidiaries, “Exterran Holdings”) to us. You can identify many of these statements by looking for words such as “believe,” “expect,” “intend,” “project,” “anticipate,” “estimate,” “will continue” or similar words or the negative thereof.

 

Known material factors that could cause our actual results to differ from those in these forward-looking statements are described below, in Part I, Item 1A (“Risk Factors”) and Part II, Item 7 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations”). Important factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include, among other things:

 

·          conditions in the oil and natural gas industry, including a sustained decrease in the level of supply or demand for oil or natural gas or a sustained decrease in the price of oil or natural gas, which could cause a decline in the demand for our natural gas compression services;

 

·          our reduced profit margins or the loss of market share resulting from competition or the introduction of competing technologies by other companies;

 

·          our dependence on Exterran Holdings to provide services and compression equipment, including its ability to hire, train and retain key employees and to timely and cost effectively obtain compression equipment and components necessary to conduct our business;

 

·          our dependence on and the availability of cost caps from Exterran Holdings to generate sufficient cash to enable us to make cash distributions at our current distribution rate;

 

·          changes in economic or political conditions, including terrorism and legislative changes;

 

·          the inherent risks associated with our operations, such as equipment defects, impairments, malfunctions and natural disasters;

 

·          loss of our status as a partnership for federal income tax purposes;

 

·          the risk that counterparties will not perform their obligations under our financial instruments;

 

·          the financial condition of our customers;

 

·          our ability to implement certain business and financial objectives, such as:

 

·          growing our asset base and asset utilization;

 

·          winning profitable new business;

 

·          integrating acquired businesses;

 

·          generating sufficient cash;

 

·          accessing the capital markets at an acceptable cost; and

 

·          purchasing additional contract operation contracts and equipment from Exterran Holdings;

 

·          liability related to the provision of our services;

 

·          changes in governmental safety, health, environmental or other regulations, which could require us to make significant expenditures; and

 

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·          our level of indebtedness and ability to fund our business.

 

All forward-looking statements included in this report are based on information available to us on the date of this report. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this report.

 

Item 1.  Business

 

General

 

We are a Delaware limited partnership formed in June 2006 to provide natural gas contract operations services to customers throughout the United States of America (“U.S.”). We completed our initial public offering in October 2006. We are the market leader in the U.S. full-service natural gas compression business. As of December 31, 2013, public unitholders held a 59% ownership interest in us and Exterran Holdings owned our remaining equity interests, including our general partner interest and all of our incentive distribution rights. Exterran General Partner, L.P., our general partner, is an indirect, wholly-owned subsidiary of Exterran Holdings and has sole responsibility for conducting our business and for managing our operations, which are conducted through our wholly-owned limited liability company, EXLP Operating LLC. Because our general partner is a limited partnership, its general partner, Exterran GP LLC, conducts our business and operations. Exterran GP LLC’s board of directors and officers, which we sometimes refer to as our board of directors and our officers, make decisions on our behalf. All of those directors are elected by Exterran Holdings.

 

Our contract operations services primarily include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining equipment to provide natural gas compression services to our customers. We monitor our customers’ compression services requirements over time and, as necessary, modify the level of services and related equipment we employ to address changing operating conditions.

 

We are a party to an omnibus agreement with Exterran Holdings, our general partner and others (as amended and/or restated, the “Omnibus Agreement”), which includes, among other things:

 

·          certain agreements not to compete between Exterran Holdings and its affiliates, on the one hand, and us and our affiliates, on the other hand;

 

·          Exterran Holdings’ obligation to provide all operational staff, corporate staff and support services reasonably necessary to operate our business and our obligation to reimburse Exterran Holdings for such services, subject to certain limitations and the cost caps discussed below;

 

·          the terms under which we, Exterran Holdings, and our respective affiliates may transfer, exchange or lease compression equipment among one another;

 

·          the terms under which we may purchase newly-fabricated contract operations equipment from Exterran Holdings;

 

·          Exterran Holdings’ grant to us of a license to use certain intellectual property, including our logo; and

 

·          Exterran Holdings’ and our obligations to indemnify each other for certain liabilities.

 

Our general partner does not receive any compensation for managing our business, but it is entitled to reimbursement of all direct and indirect expenses incurred on our behalf subject to caps included in the Omnibus Agreement. Exterran Holdings and our general partner are also entitled to distributions on their limited partner interest and general partner interest, respectively and, if specified requirements are met, our general partner is entitled to distributions on its incentive distribution rights. From January 1, 2013 through December 31, 2013, our general partner received $6.1 million in distributions on its incentive distribution rights. For further discussion of our cash distribution policy, see “Cash Distribution Policy” included in Part II, Item 5 (“Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities”).

 

During each of the years ended December 31, 2012 and 2011, we acquired from Exterran Holdings contract operations service agreements and a fleet of compressor units used to provide compression services under those agreements (the 2012 and 2011 acquisitions are referred to as the “March 2012 Contract Operations Acquisition” and the “June 2011 Contract Operations Acquisition,” respectively).

 

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In March 2013, we acquired from Exterran Holdings contract operations customer service agreements with 50 customers and a fleet of 363 compressor units used to provide compression services under those agreements, comprising approximately 256,000 horsepower, or 8% (by then available horsepower) of the combined U.S. contract operations business of Exterran Holdings and us (the “March 2013 Contract Operations Acquisition”). The acquired assets also included 204 compressor units, comprising approximately 99,000 horsepower, previously leased from Exterran Holdings to us and contracts relating to approximately 6,000 horsepower of compressor units we already owned and previously leased to Exterran Holdings. At the acquisition date, the acquired fleet assets had a net book value of $158.5 million, net of accumulated depreciation of $94.9 million. Total consideration for the transaction was approximately $174.0 million, excluding transaction costs. In connection with this acquisition, we issued approximately 7.1 million common units to Exterran Holdings and approximately 145,000 general partner units to our general partner.

 

In connection with the March 2013 Contract Operations Acquisition, we amended the Omnibus Agreement to, among other things, extend the caps (after taking into account any such costs that we incur and pay directly) on our obligation to reimburse Exterran Holdings for any cost of sales that it incurs in the operation of our business and any cash selling, general and administrative (“SG&A”) expense allocated to us for an additional year such that the caps will terminate on December 31, 2014. Cost of sales was capped at $21.75 per operating horsepower per quarter through December 31, 2013, and is capped at $22.50 per operating horsepower per quarter from January 1, 2014 through December 31, 2014. SG&A costs were capped at $7.6 million per quarter from November 10, 2009 through June 9, 2011, $9.0 million per quarter from June 10, 2011 through March 7, 2012, $10.5 million per quarter from March 8, 2012 through March 31, 2013 and $12.5 million per quarter from April 1, 2013 through December 31, 2013, and are capped at $15.0 million per quarter from January 1, 2014 through December 31, 2014. For further discussion of the Omnibus Agreement, please see Note 3 to the Consolidated Financial Statements included in Part II, Item 8 (“Financial Statements”).

 

Exterran Holdings intends for us to be the primary long-term growth vehicle for its U.S. contract operations business and intends, but is not obligated, to offer us the opportunity to purchase the remainder of its U.S. contract operations business over time. Likewise, we are not required to purchase any additional portions of such business. The consummation of any future purchase of additional portions of Exterran Holdings’ U.S. contract operations business and the timing of any such purchase will depend upon, among other things, our ability to reach an agreement with Exterran Holdings regarding the terms of such purchase, which will require the approval of the conflicts committee of our board of directors. The timing of such transactions would also depend on, among other things, market and economic conditions and our access to additional debt and equity capital. Future acquisitions of assets from Exterran Holdings may increase or decrease our operating performance, financial position and liquidity. Unless otherwise indicated, this discussion in Part I, Item 1 (“Business”) excludes any future potential transfers of additional contract operations customer service agreements and equipment from Exterran Holdings to us.

 

Natural Gas Compression Industry Overview

 

Natural gas compression is a mechanical process whereby the pressure of a given volume of natural gas is increased to a desired higher pressure for transportation from one point to another. It is essential to the production and transportation of natural gas. Compression is typically required several times during the natural gas production and transportation cycle, including (i) at the wellhead, (ii) throughout gathering and distribution systems, (iii) into and out of processing and storage facilities and (iv) along intrastate and interstate pipelines.

 

·          Wellhead and Gathering Systems — Natural gas compression is used to transport natural gas from the wellhead through the gathering system. At some point during the life of natural gas wells reservoir, pressures typically fall below the line pressure of the natural gas gathering or pipeline system used to transport the natural gas to market. At that point, natural gas no longer naturally flows into the pipeline. Compression equipment is applied in both field and gathering systems to boost the pressure levels of the natural gas flowing from the well allowing it to be transported to market. Changes in pressure levels in natural gas fields require periodic changes to the size and/or type of on-site compression equipment. Additionally, compression is used to reinject natural gas into producing oil wells to maintain reservoir pressure and help lift liquids to the surface, which is known as secondary oil recovery or natural gas lift operations. Typically, these applications require low- to mid-range horsepower compression equipment located at or near the wellhead. Compression equipment is also used to increase the efficiency of a low-capacity natural gas field by providing a central compression point from which the natural gas can be produced and injected into a pipeline for transmission to facilities for further processing.

 

·          Pipeline Transportation Systems — Natural gas compression is used during the transportation of natural gas from the gathering systems to storage or the end user. Natural gas transported through a pipeline loses pressure over the length of the pipeline. Compression is staged along the pipeline to increase capacity and boost pressure to overcome the friction and hydrostatic losses inherent in normal operations. These pipeline applications generally require larger horsepower compression equipment (1,500 horsepower and higher).

 

·          Storage Facilities — Natural gas compression is used in natural gas storage projects for injection and withdrawals during the normal operational cycles of these facilities.

 

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·          Processing Applications — Compressors may also be used in combination with natural gas production and processing equipment and to process natural gas into other marketable energy sources. In addition, compression services are used for compression applications in refineries and petrochemical plants.

 

Many natural gas producers, transporters and processors outsource their compression services due to the benefits and flexibility of contract compression. Changing well and pipeline pressures and conditions over the life of a well often require producers to reconfigure or replace their compressor units to optimize the well production or gathering system efficiency.

 

We believe outsourcing compression operations to compression service providers such as us offers customers:

 

·          the ability to efficiently meet their changing compression needs over time while limiting the underutilization of their owned compression equipment;

 

·          access to the compression service provider’s specialized personnel and technical skills, including engineers and field service and maintenance employees, which we believe generally leads to improved production rates and/or increased throughput;

 

·          the ability to increase their profitability by transporting or producing a higher volume of natural gas through decreased compression downtime and reduced operating, maintenance and equipment costs by allowing the compression service provider to efficiently manage their compression needs; and

 

·          the flexibility to deploy their capital on projects more directly related to their primary business by reducing their compression equipment and maintenance capital requirements.

 

We believe the U.S. natural gas compression services industry continues to have growth potential over time due to, among other things, increased natural gas production from unconventional sources and aging producing natural gas fields that will require more compression to continue producing the same volume of natural gas.

 

Contract Operations Services Overview

 

We provide comprehensive contract operations services, including the personnel, equipment, tools, materials and supplies to meet our customers’ natural gas compression needs. Based on the operating specifications at the customer’s location and the customer’s unique compression needs, these services include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining equipment. When providing contract operations services, we work closely with a customer’s field service personnel so that the compression services can be adjusted to efficiently match changing characteristics of the natural gas reservoir and the natural gas produced. We routinely repackage or reconfigure a portion of our existing fleet to adapt to our customers’ compression services needs. We utilize both slow and high speed reciprocating compressors primarily driven by internal natural gas fired combustion engines. We also utilize rotary screw compressors for specialized applications.

 

Our equipment is maintained in accordance with established maintenance schedules. These maintenance procedures are updated as technology changes and as Exterran Holdings develops new techniques and procedures. Because Exterran Holdings’ field technicians provide maintenance on substantially all of our contract operations equipment, they are familiar with the condition of our equipment and can readily identify potential problems. In our and Exterran Holdings’ experience, these maintenance procedures maximize equipment life and unit availability, minimize avoidable downtime and lower the overall maintenance expenditures over the equipment life. Generally, each of our compressor units undergoes a major overhaul once every three to seven years, depending on the type, size and utilization of the unit. If a unit requires maintenance or reconfiguration, Exterran Holdings’ maintenance personnel service it as quickly as possible to meet our customers’ needs.

 

Our customers typically contract for our contract operations services on a site-by-site basis for a specific monthly service rate that is generally reduced if we fail to operate in accordance with the contract requirements. Following the initial minimum term for our contract compression services, which is typically between six and twelve months, contract compression services generally continue until terminated by either party with 30 days’ advance notice. Our customers generally are required to pay our monthly service fee even during periods of limited or disrupted natural gas flows, which enhances the stability and predictability of our cash flows. Additionally, because we typically do not take title to the natural gas we compress, and the natural gas we use as fuel for our compressors is supplied by our customers, we have limited direct exposure to commodity price fluctuations. See “General Terms of our Contract Operations Customer Service Agreements,” below, for a more detailed description.

 

We intend to continue to work with Exterran Holdings to manage our respective U.S. fleets as one pool of compression equipment from which we can each readily fulfill our respective customers’ service needs. When one of Exterran Holdings’ salespersons is advised of a new contract operations services opportunity allocable to us, he or she will obtain relevant information concerning the project, including natural gas flow, pressure and natural gas composition, and then review our and Exterran Holdings’ fleets for an available and appropriate compressor unit. If we have enough lead time for a potential project, we may choose to purchase newly-fabricated equipment from Exterran Holdings or others to fulfill our customers’ needs. Please read Part III, Item 13 (“Certain Relationships and Related Transactions and Director Independence”) for additional information regarding our ability to share or exchange compression equipment with, or purchase equipment from, Exterran Holdings.

 

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The size and horsepower of our natural gas compressor fleet on December 31, 2013 is summarized in the following table:

 

Range of Horsepower Per Unit

 

Number of Units

 

Aggregate
Horsepower
(in thousands)

 

% of
Horsepower

 

0-200

 

2,452

 

279

 

11

%

201-500

 

1,643

 

447

 

18

%

501-800

 

373

 

231

 

10

%

801-1,100

 

220

 

209

 

9

%

1,101-1,500

 

662

 

895

 

37

%

1,501 and over

 

171

 

356

 

15

%

Total(1)

 

5,521

 

2,417

 

100

%

 


(1)                  Includes 274 compressor units, comprising approximately 109,000 horsepower, leased from Exterran Holdings and excludes 24 compressor units, comprising approximately 8,000 horsepower, leased to Exterran Holdings (see Note 3 to the Financial Statements).

 

Over the last several years, Exterran Holdings has undertaken efforts to standardize its compressor fleet around major components and key suppliers. Because a significant portion of our fleet consists of Exterran Holdings’ former fleet, we benefit from these efforts, as well. Standardization of our fleet:

 

·          enables us to minimize our fleet operating costs and maintenance capital requirements;

 

·          facilitates low-cost compressor resizing; and

 

·          allows us to develop improved technical proficiency in our maintenance and overhaul operations, which enables us to achieve high run-time rates while maintaining lower operating costs.

 

As mentioned above, pursuant to the Omnibus Agreement, Exterran Holdings provides us with all operational staff, corporate staff and support services necessary to run our business.

 

Business Strategy

 

We intend to continue to capitalize on our competitive strengths to meet our customers’ needs through the following key strategies:

 

·          Leverage our relationship with Exterran Holdings.  Our relationship with Exterran Holdings provides us numerous revenue and cost advantages, including the ability to access new and idle compression equipment, deploy that equipment in most of the major natural gas producing regions in the U.S. and provide maintenance and operational support on a more cost effective basis than we could without this relationship.

 

·          Build our business organically by capitalizing on the long-term fundamentals for the U.S. natural gas compression industry.  We believe our ability to efficiently meet our customers’ evolving compression needs, our long-standing customer relationships and our large compressor fleet will enable us to capitalize on what we believe are long-term fundamentals for the U.S. natural gas compression industry. These fundamentals include increased unconventional natural gas production, decreasing natural reservoir pressures, significant natural gas resources in the U.S. and the continued need for compression services.

 

·          Grow our business through acquisitions.  We plan to grow over time through accretive acquisitions of assets from Exterran Holdings, third-party compression providers and natural gas transporters or producers. Including our initial public offering, we have completed eight acquisitions from Exterran Holdings of compressor units comprising approximately 2.4 million horsepower. Exterran Holdings intends, but is not obligated, to offer us the opportunity to purchase the remainder of its U.S. contract operations business over time. The consummation of any future purchase of additional portions of Exterran Holdings’ business and the timing of any such purchase will depend upon, among other things, our ability to reach an agreement with Exterran Holdings regarding the terms of such purchase, which will require the approval of the conflicts committee of our board of directors. The timing of such transactions would also depend on, among other things, market and economic conditions and our access to additional debt and equity capital.

 

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Competitive Strengths

 

We believe we have the following key competitive strengths:

 

·          Our relationship with Exterran Holdings.  Our relationship with Exterran Holdings and our access to its personnel, fabrication operations, logistical capabilities, geographic scope and operational efficiencies allow us to provide a full complement of contract operations services. We and Exterran Holdings intend to continue to manage our respective U.S. compression fleets as one pool of compression equipment from which we can more easily fulfill our respective customers’ needs. This relationship also gives us an advantage in pursuing compression opportunities throughout the U.S. As of December 31, 2013, Exterran Holdings owned approximately 1.0 million horsepower of compression equipment, excluding the compression equipment owned by us, in its U.S. contract operations business. We believe we will benefit from Exterran Holdings’ intention to offer us the opportunity to purchase that business over time. Exterran Holdings also intends, but is not obligated, to offer us the opportunity to purchase newly-fabricated compression equipment.

 

·          Focus on providing superior customer serviceWe believe that our regionally-based network, local presence, experience and in-depth knowledge of customers’ operating needs and growth plans enable us to respond to our customers’ needs and meet their evolving demands on a timely basis. In addition, we focus on achieving a high level of mechanical reliability for the services we provide in order to maximize our customers’ production levels. Our sales efforts concentrate on demonstrating our commitment to enhancing our customers’ cash flow through superior customer service.

 

·          Stable fee-based cash flows.  We charge a fixed monthly fee for our contract operations services that our customers are generally required to pay, regardless of the volume of natural gas we compress in that month. We believe this fee structure reduces volatility and enhances our ability to generate relatively stable and predictable cash flows.

 

·          Large fleet in many major producing regions.  Our large fleet and numerous operating locations throughout the U.S. combined with our ability, as a result of our relationship with Exterran Holdings, to efficiently move equipment among producing regions, means that we are not dependent on production activity in any particular region.

 

Oil and Natural Gas Industry Cyclicality and Volatility

 

Changes in oil and natural gas exploration and production spending normally results in changes in demand for our services; however, we believe our contract operations business is typically less impacted by commodity prices than certain other energy service products and services because:

 

·          compression is necessary for natural gas to be delivered from the wellhead to end users;

 

·          the need for compression services and equipment has grown over time due to the increased production of natural gas, the natural pressure decline of natural gas producing basins and the increased percentage of natural gas production from unconventional sources; and

 

·          our contract operations business is tied primarily to natural gas production and consumption, which are generally less cyclical in nature than exploration activities.

 

Because we typically do not take title to the natural gas we compress, and the natural gas we use as fuel for our compressors is supplied by our customers, our direct exposure to commodity price risk is further reduced.

 

Seasonal Fluctuations

 

Our results of operations have not historically reflected any material seasonal tendencies and we currently do not believe that seasonal fluctuations will have a material impact on us in the foreseeable future.

 

Customers

 

Our current customer base consists of companies engaged in various aspects of the oil and natural gas industry, including natural gas producers, processors, gatherers, transporters and storage providers. We have entered into preferred vendor arrangements with some of our customers that give us preferential consideration for the compression needs of these customers. In exchange, we provide these customers with enhanced product availability, product support and favorable pricing. No customer individually accounted for 10% or more of our total revenue during the year ended December 31, 2013.

 

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Sales and Marketing

 

Our marketing and client service functions are coordinated and performed by Exterran Holdings’ sales and field service personnel. Salespeople and field service personnel regularly visit our customers to ensure customer satisfaction, to determine customer needs as to services currently being provided and to ascertain potential future compression services requirements. This ongoing communication allows us to quickly identify and respond to customer requests.

 

General Terms of our Contract Operations Customer Service Agreements

 

The following discussion describes select material terms common to our standard contract operations service agreements. We typically enter into a master service agreement with each customer that sets forth the general terms and conditions of our services, and then enter into a separate supplemental service agreement for each distinct site at which we will provide contract operations services.

 

Term and Termination.  Our customers typically contract for our contract operations services on a site-by-site basis. Following the initial minimum term for our contract compression services, which is typically between six and twelve months, contract compression services generally continue until terminated by either party with 30 days’ advance notice.

 

Fees and Expenses.  Our customers pay a fixed monthly fee for our contract operations services, which generally is based on expected natural gas volumes and pressures associated with a specific application. Our customers generally are required to pay our monthly fee even during periods of limited or disrupted natural gas flows. We are typically responsible for the costs and expenses associated with our compression equipment used to provide the contract operations services, other than fuel gas, which is provided by our customers.

 

Service Standards and Specifications.  We provide contract operations services according to the particular specifications of each job, as set forth in the applicable contract. These are typically turn-key service contracts under which we supply all service and support and use our own compression equipment to provide the contract operations services as necessary for a particular application. In certain circumstances, if the availability of our services does not meet certain percentages specified in our contracts, our customers are generally entitled, upon request, to specified credits against our service fees.

 

Title; Risk of Loss.  We own and retain title to or have an exclusive possessory interest in all compression equipment used to provide the contract operations services and we generally bear risk of loss for such equipment to the extent not caused by gas conditions, our customers’ acts or omissions or the failure or collapse of the customer’s over-water job site upon which we provide the contract operations services.

 

Insurance.  Typically, both we and our customers are required to carry general liability, worker’s compensation, employers’ liability, automobile and excess liability insurance. Exterran Holdings insures our property and operations and is substantially self-insured for worker’s compensation, employer’s liability, property, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles Exterran Holdings absorbs under its insurance arrangements for these risks.

 

Suppliers

 

Currently, our sole supplier of newly-fabricated equipment is Exterran Holdings. Pursuant to the Omnibus Agreement, we may purchase newly-fabricated compression equipment from Exterran Holdings or its affiliates at Exterran Holdings’ cost to fabricate such equipment plus a fixed margin of 10%, which may be modified with the approval of Exterran Holdings and the conflicts committee of our board of directors. We may also transfer, exchange or lease compression equipment with Exterran Holdings. Alternatively, we can purchase newly-fabricated or already existing compression equipment from third parties.

 

We rely on Exterran Holdings, who in turn relies on a limited number of suppliers, for some of the components used in our products. We and Exterran Holdings believe alternative sources of these components are generally available but at prices that may not be as economically advantageous to us as those offered by our existing suppliers. We believe Exterran Holdings’ relations with its suppliers are satisfactory.

 

Competition

 

The natural gas compression services business is highly competitive. Overall, we experience considerable competition from companies that may be able to more quickly adapt to changes within our industry and changes in economic conditions as a whole, more readily take advantage of available opportunities and adopt more aggressive pricing policies. We believe we are competitive with respect to price, equipment availability, customer service, flexibility in meeting customer needs, technical expertise, quality and reliability of our compressors and related services.

 

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Increased size and geographic scope offer compression services providers operating and cost advantages. As the number of compression applications and size of the compression fleet increases, the number of required sales, administrative and maintenance personnel increases at a lesser rate, resulting in operational efficiencies and potential cost advantages. Additionally, broad geographic scope allows compression service providers to more efficiently provide services to all customers, particularly those with compression applications in remote locations. Our relationship with Exterran Holdings allows us to access a large, diverse fleet of compression equipment and a broad geographic base of operations and related operational personnel that we believe gives us more flexibility in meeting our customers’ needs than many of our competitors. We also believe that our relationship with Exterran Holdings provides us with resources that allow us to efficiently manage our customers’ compression services needs.

 

Non-competition Arrangement with Exterran Holdings

 

Under the Omnibus Agreement, subject to the provisions described below, Exterran Holdings has agreed not to offer or provide compression services in the U.S. to our contract operations services customers that are not also contract operations services customers of Exterran Holdings. Compression services include natural gas contract compression services, but exclude fabrication of compression equipment, sales of compression equipment or material, parts or equipment that are components of compression equipment, leasing of compression equipment without also providing related compression equipment service, gas processing operations services and operation, maintenance, service, repairs or overhauls of compression equipment owned by third parties. Similarly, we have agreed not to offer or provide compression services to Exterran Holdings’ U.S. contract operations services customers that are not also our contract operations services customers.

 

Some of our customers are also Exterran Holdings’ contract operations services customers, which we refer to as overlapping customers. We and Exterran Holdings have agreed, subject to the exceptions described below, not to provide contract operations services to an overlapping customer at any site at which the other was providing such services to an overlapping customer on the date of the most recent amendment to the Omnibus Agreement, each being referred to as a “Partnership site” or an “Exterran site.” Pursuant to the Omnibus Agreement, if an overlapping customer requests contract operations services at a Partnership site or an Exterran site, whether in addition to or in replacement of the equipment existing at such site on the date of the most recent amendment to the Omnibus Agreement, we may provide contract operations services if such overlapping customer is a Partnership overlapping customer, and Exterran Holdings will be entitled to provide such contract operations services if such overlapping customer is an Exterran overlapping customer. Additionally, any additional contract operations services provided to a Partnership overlapping customer will be provided by us and any additional services provided to an Exterran overlapping customer will be provided by Exterran Holdings.

 

Exterran Holdings also has agreed that new customers for contract compression services are for our account unless the new customer is unwilling to contract with us or unwilling to do so under our form of compression services agreement. In that case, Exterran Holdings may provide compression services to the new customer. If we or Exterran Holdings enter into a compression services contract with a new customer, either we or Exterran Holdings, as applicable, will receive the protection of the applicable non-competition arrangements described above in the same manner as if such new customer had been a compression services customer of either us or Exterran Holdings on the date of the Omnibus Agreement.

 

The non-competition arrangements described above do not apply to:

 

·          our provision of contract compression services to a particular Exterran Holdings customer or customers, with the approval of Exterran Holdings;

 

·          Exterran Holdings’ provision of contract compression services to a particular customer or customers of ours, with the approval of the conflicts committee of our board of directors;

 

·          our purchase and ownership of not more than five percent of any class of securities of any entity that provides contract compression services to Exterran Holdings’ contract compression services customers;

 

·          Exterran Holdings’ purchase and ownership of not more than five percent of any class of securities of any entity that provides contract compression services to our contract compression services customers;

 

·          Exterran Holdings’ ownership of us;

 

·          our acquisition, ownership and operation of any business that provides contract compression services to Exterran Holdings’ contract compression services customers if Exterran Holdings has been offered the opportunity to purchase the business for its fair market value from us and Exterran Holdings declines to do so. However, if neither the Omnibus Agreement nor the non-competition arrangements described above have already terminated, we will agree not to provide contract compression services to Exterran Holdings’ customers that are also customers of the acquired business at the sites at which Exterran Holdings is providing contract operations services to them at the time of the acquisition;

 

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·          Exterran Holdings’ acquisition, ownership and operation of any business that provides contract compression services to our contract operations services customers if we have been offered the opportunity to purchase the business for its fair market value from Exterran Holdings and we decline to do so with the concurrence of the conflicts committee of our board of directors. However, if neither the Omnibus Agreement nor the non-competition arrangements described above have already terminated, Exterran Holdings will agree not to provide contract operations services to our customers that are also customers of the acquired business at the sites at which we are providing contract operations services to them at the time of the acquisition; or

 

·          a situation in which one of our customers (or its applicable business) and a customer of Exterran Holdings (or its applicable business) merge or are otherwise combined, in which case, each of we and Exterran Holdings may continue to provide contract operations services to the applicable combined entity or business without being in violation of the non-competition provisions, but Exterran Holdings and the conflicts committee of our board of directors must negotiate in good faith to implement procedures or such other arrangements, as necessary, to protect the value to each of Exterran Holdings and us of the business of providing contract operations services to each such customer or its applicable business.

 

Unless the Omnibus Agreement is terminated earlier due to a change of control of Exterran GP LLC, our general partner or us, the non-competition provisions of the Omnibus Agreement will terminate on December 31, 2014 or on the date on which a change of control of Exterran Holdings occurs, whichever event occurs first. If a change of control of Exterran Holdings occurs, and neither the Omnibus Agreement nor the non-competition arrangements have already terminated, Exterran Holdings will agree for the remaining term of the non-competition arrangements not to provide contract operations services to our customers at any site where we are providing contract operations services at the time of the change of control.

 

Environmental and Other Regulations

 

Government Regulation

 

Our operations are subject to stringent and complex U.S. federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to protection of the environment and to occupational safety and health. Compliance with these environmental laws and regulations may expose us to significant costs and liabilities and cause us to incur significant capital expenditures in our operations. Failure to comply with these laws and regulations may result in the assessment of administrative, civil and criminal penalties, imposition of investigatory and remedial obligations, and the issuance of injunctions delaying or prohibiting operations. We believe that our operations are in substantial compliance with applicable environmental and safety and health laws and regulations and that continued compliance with currently applicable requirements would not have a material adverse effect on us. However, the clear trend in environmental regulation is to place more restrictions on activities that may affect the environment, and thus, any changes in these laws and regulations that result in more stringent and costly waste handling, storage, transport, disposal, emission or remediation requirements could have a material adverse effect on our results of operations and financial position.

 

The primary U.S. federal environmental laws to which our operations are subject include the Clean Air Act (“CAA”) and regulations thereunder, which regulate air emissions; the Clean Water Act (“CWA”) and regulations thereunder, which regulate the discharge of pollutants in industrial wastewater and storm water runoff; the Resource Conservation and Recovery Act (“RCRA”) and regulations thereunder, which regulate the management and disposal of hazardous and non-hazardous solid wastes; and the Comprehensive Environmental Response, Compensation, and Liability Act (“CERCLA”) and regulations thereunder, known more commonly as “Superfund,” which imposes liability for the remediation of releases of hazardous substances in the environment. We are also subject to regulation under the federal Occupational Safety and Health Act (“OSHA”) and regulations thereunder, which regulate the protection of the safety and health of workers. Analogous state and local laws and regulations may also apply.

 

Air Emissions

 

The CAA and analogous state laws and their implementing regulations regulate emissions of air pollutants from various sources, including natural gas compressors, and also impose various monitoring and reporting requirements. Such laws and regulations may require a facility to obtain pre-approval for the construction or modification of certain projects or facilities expected to produce air emissions or result in the increase of existing air emissions, obtain and strictly comply with air permits containing various emissions and operational limitations, or utilize specific emission control technologies to limit emissions. Our standard contract operations contract typically provides that the customer will assume permitting responsibilities and certain environmental risks related to site operations.

 

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On August 20, 2010, the U.S. Environmental Protection Agency (“EPA”) published new regulations under the CAA to control emissions of hazardous air pollutants from existing stationary reciprocal internal combustion engines. The rule would have required us to undertake certain expenditures and activities, including purchasing and installing emissions control equipment, such as oxidation catalysts or non-selective catalytic reduction equipment, on a portion of our engines located at certain sources of hazardous air pollutants and all our engines over a certain size regardless of location, following prescribed maintenance practices for engines (which are consistent with our existing practices), and implementing additional emissions testing and monitoring. Following legal challenges to the 2010 rule, the EPA reconsidered the rule and published revisions to the rule on January 30, 2013. The revised rule requires management practices for all covered engines but requires catalyst installation only on larger equipment at sites that are not deemed to be “remote.” Based on feedback from our customers regarding the sites at which we provide contract operations services to them using such equipment, we estimate that the vast majority of those sites are “remote,” and, as such, we do not anticipate these rules, as currently drafted, will have a material adverse impact on our business, financial condition, results of operations or ability to make cash distributions to our unitholders. Compliance with the final rule was required by October 2013.

 

On May 21, 2012, the EPA issued new ozone nonattainment designations for all areas except Chicago, in relation to the 2008 national ambient air quality standard (“NAAQS”) for ozone. Among other things, these new designations add Wise County to the Dallas-Fort Worth (“DFW”) nonattainment area. This new designation will require Texas to modify its State Implementation Plan (“SIP”) to include a plan for Wise County, Texas to come into compliance with the ozone NAAQS. This modification process started in January 2014, and the State of Texas anticipates having new regulations in place by mid-2015. If Texas implements the same control requirements in Wise County that are already in place in the other counties in the DFW nonattainment area, we could be required to modify or remove and replace a significant amount of equipment we currently utilize in Wise County. However, at this point we cannot predict what Texas’ new SIP will require or what equipment will still be operating in Wise County when it comes into effect and, as a result, we cannot currently accurately predict the impact or cost to comply.

 

On August 16, 2012, the EPA published final rules that establish new air emission controls for natural gas and natural gas liquids production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds, and a separate set of emission standards to address hazardous air pollutants frequently associated with production and processing activities. Among other things, the rules establish specific requirements regarding emissions from compressors and controllers at natural gas gathering and boosting stations and processing plants together with dehydrators and storage tanks at natural gas processing plants, compressor stations and gathering and boosting stations. In addition, the rules establish new requirements for leak detection and repair of leaks at natural gas processing plants that exceed 500 parts per million in concentration.

 

In addition, in January 2011, the Texas Commission on Environmental Quality (“TCEQ”) finalized revisions to certain air permit programs that significantly increase air emissions-related requirements for new and certain existing oil and gas production and gathering sites in the Barnett Shale production area. The final rule established new emissions standards for engines, which could impact the operation of specific categories of engines by requiring the use of alternative engines, compressor packages or the installation of aftermarket emissions control equipment. The rule became effective for the Barnett Shale production area in April 2011, and the lower emissions standards will become applicable between 2020 and 2030 depending on the type of engine and the permitting requirements. A number of other states where our engines are operated have adopted or are considering adopting additional regulations that could impose new air permitting or pollution control requirements for engines, some of which could entail material costs to comply. At this point, however, we cannot predict whether any such rules would require us to incur material costs.

 

These new regulations and proposals, when finalized, and any other new regulations requiring the installation of more sophisticated pollution control equipment or the adoption of other environmental protection measures, could have a material adverse impact on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

Climate change legislation and regulatory initiatives could result in increased compliance costs.

 

The U.S. Congress has considered legislation to restrict or regulate emissions of greenhouse gases, such as carbon dioxide and methane. One bill, passed by the House of Representatives, if enacted by the full Congress, would have required greenhouse gas emissions reductions by covered sources of as much as 17% from 2005 levels by 2020 and by as much as 83% by 2050. It presently appears unlikely that comprehensive climate legislation will be passed by either house of Congress in the near future, although energy legislation and other initiatives continue to be proposed that may be relevant to greenhouse gas emissions issues. In addition, almost half of the states, either individually or through multi-state regional initiatives, have begun to address greenhouse gas emissions, primarily through the planned development of emission inventories or regional greenhouse gas cap and trade programs. Although most of the state-level initiatives have to date been focused on large sources of greenhouse gas emissions, such as electric power plants, it is possible that smaller sources such as our gas-fired compressors could become subject to greenhouse gas-related regulation. Depending on the particular program, we could be required to control emissions or to purchase and surrender allowances for greenhouse gas emissions resulting from our operations.

 

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Independent of Congress, the EPA has been pursuing regulations controlling greenhouse gas emissions under its existing CAA authority. The EPA has adopted rules requiring many facilities, including petroleum and natural gas systems, to inventory and report their greenhouse gas emissions. These rules triggered reporting obligations for some sites we operated in 2013.

 

In addition, the EPA in June 2010 published a final rule providing for the tailored applicability of air permitting requirements for greenhouse gas emissions. The EPA reported that the rulemaking was necessary because without it certain permitting requirements would apply as of January 2011 at an emissions level that would have greatly increased the number of required permits and, among other things, imposed undue costs on small sources and overwhelmed the resources of permitting authorities. In the rule, the EPA established two initial steps of phase-in to minimize those burdens, excluding certain smaller sources from greenhouse gas permitting until at least April 30, 2016. On January 2, 2011, the first step of the phase-in applied only to new projects at major sources (as defined under those CAA permitting programs) that, among other things, increase net greenhouse gas emissions by 75,000 tons per year. On July 1, 2011, the second step of the phase-in began requiring permitting for otherwise minor sources of air emissions that have the potential to emit at least 100,000 tons per year of greenhouse gases. On June 29, 2012, the EPA issued final regulations for “Phase III” of its program, retaining the permitting thresholds established in Phases I and II. These rules will affect some of our and our customers’ largest new or modified facilities going forward.

 

Although it is not currently possible to predict how any proposed or future greenhouse gas legislation or regulation by Congress, the states or multi-state regions will impact our business, any legislation or regulation of greenhouse gas emissions that may be imposed in areas in which we conduct business could result in increased compliance costs or additional operating restrictions or reduced demand for our services, and could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

Water Discharges

 

The CWA and analogous state laws and their implementing regulations impose restrictions and strict controls with respect to the discharge of pollutants into state waters or waters of the U.S. The discharge of pollutants into regulated waters is prohibited, except in accordance with the terms of a permit issued by the EPA or an analogous state agency. In addition, the CWA regulates storm water discharges associated with industrial activities depending on a facility’s primary standard industrial classification. Many of Exterran Holdings’ facilities on which we may store inactive compression units have applied for and obtained industrial wastewater discharge permits as well as sought coverage under local wastewater ordinances. In addition, many of those facilities have filed notices of intent for coverage under statewide storm water general permits and developed and implemented storm water pollution prevention plans, as required. U.S. federal laws also require development and implementation of spill prevention, controls, and countermeasure plans, including appropriate containment berms and similar structures to help prevent the contamination of navigable waters in the event of a petroleum hydrocarbon tank spill, rupture, or leak at such facilities.

 

Waste Management and Disposal

 

The RCRA and analogous state laws and their implementing regulations govern the generation, transportation, treatment, storage and disposal of hazardous and non-hazardous solid wastes. During the course of our operations, we generate wastes (including, but not limited to, used oil, antifreeze, filters, sludges, paints, solvents and abrasive blasting materials) in quantities regulated under RCRA. The EPA and various state agencies have limited the approved methods of disposal for these types of wastes. CERCLA and analogous state laws and their implementing regulations impose strict, and under certain conditions, joint and several liability without regard to fault or the legality of the original conduct on classes of persons who are considered to be responsible for the release of a hazardous substance into the environment. These persons include current and past owners and operators of the facility or disposal site where the release occurred and any company that transported, disposed of, or arranged for the transport or disposal of the hazardous substances released at the site. Under CERCLA, such persons may be subject to joint and several liability for the costs of cleaning up the hazardous substances that have been released into the environment, for damages to natural resources and for the costs of certain health studies. In addition, where contamination may be present, it is not uncommon for neighboring landowners and other third parties to file claims for personal injury, property damage and recovery of response costs allegedly caused by hazardous substances or other pollutants released into the environment.

 

While we do not own any material facilities or properties, we use Exterran Holdings’ properties for the storage and maintenance and repair of inactive compressor units and lease some properties used in support of our operations. Although we have utilized operating and disposal practices that were standard in the industry at the time, hydrocarbons, hazardous substances, or other regulated wastes may have been disposed of or released on or under the properties used or leased by us or on or under other locations where such materials have been taken for disposal by companies sub-contracted by us. In addition, many of these properties have been previously owned or operated by third parties whose treatment and disposal or release of hydrocarbons, hazardous substances or other regulated wastes was not under our control. These properties and the materials released or disposed thereon may be subject to CERCLA, RCRA and analogous state laws. Under such laws, we could be required to remove or remediate historical property contamination, or to perform certain operations to prevent future contamination. At certain of such sites, Exterran Holdings is currently working with the prior owners who have undertaken to monitor and clean up contamination that occurred prior to Exterran Holdings’ acquisition of these sites. We are not currently under any order requiring that we undertake or pay for any cleanup activities. However, we cannot provide any assurance that we will not receive any such order in the future.

 

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Occupational Safety and Health

 

We are subject to the requirements of OSHA and comparable state statutes. These laws and the implementing regulations strictly govern the protection of the safety and health of employees. The OSHA hazard communication standard, the EPA community right-to-know regulations under Title III of CERCLA and similar state statutes require that we organize and/or disclose information about hazardous materials used or produced in our operations.

 

Indemnification for Environmental Liabilities

 

Under the Omnibus Agreement, Exterran Holdings has agreed to indemnify us, for a three-year period following each applicable asset acquisition from Exterran Holdings, against certain potential environmental claims, losses and expenses associated with the ownership and operation of the acquired assets that occur before the acquisition date. Exterran Holdings’ maximum liability for environmental indemnification obligations under the Omnibus Agreement cannot exceed $5 million, and Exterran Holdings will not have any obligation under the environmental or any other indemnification until our aggregate losses exceed $250,000. Exterran Holdings will have no indemnification obligations with respect to environmental claims made as a result of additions to or modifications of environmental laws promulgated after such acquisition date. We have agreed to indemnify Exterran Holdings against environmental liabilities occurring on or after the applicable acquisition date related to our assets to the extent Exterran Holdings is not required to indemnify us.

 

Employees and Labor Relations

 

We do not have any employees. Under the Omnibus Agreement, we reimburse Exterran Holdings for the allocated costs of its personnel who provide direct or indirect support for our operations. Exterran Holdings considers its employee relations to be satisfactory.

 

Available Information

 

Our website address is www.exterran.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to those reports are available on our website, without charge, as soon as reasonably practicable after they are filed electronically with the Securities and Exchange Commission (“SEC”). Information on our website is not incorporated by reference in this report or any of our other securities filings. Paper copies of our filings are also available, without charge, from Exterran Partners, L.P., 16666 Northchase Drive, Houston, Texas 77060, Attention: Investor Relations. Alternatively, the public may read and copy any materials we file with the SEC at its Public Reference Room at 100 F Street, NE, Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC also maintains a website that contains reports, proxy and information statements and other information regarding issuers who file electronically with the SEC. The SEC’s website address is www.sec.gov.

 

Additionally, we make available free of charge on our website:

 

·          the Code of Business Conduct and Ethics of Exterran GP LLC; and

 

·          the charters of the audit, conflicts and compensation committees of Exterran GP LLC.

 

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Item 1A.  Risk Factors

 

As described in Part I (“Disclosure Regarding Forward-Looking Statements”), this report contains forward-looking statements regarding us, our business and our industry. The risk factors described below, among others, could cause our actual results to differ materially from the expectations reflected in the forward-looking statements. If any of the following risks actually occurs, our business, financial condition, results of operations and our ability to make cash distributions to our unitholders could be negatively impacted.

 

Risks Related to Our Business

 

We have been in the past and in the future may be dependent on our cost caps to generate sufficient cash from operating surplus to enable us to make cash distributions at our current distribution rate. These caps expire on December 31, 2014. If Exterran Holdings does not extend the caps, their expiration would likely reduce the amount of cash flow available to unitholders and, accordingly, may impair our ability to maintain or increase our distributions.

 

Pursuant to the Omnibus Agreement, our obligation to reimburse Exterran Holdings for (i) any cost of sales that it incurs in the operation of our business and (ii) any SG&A costs allocated to us is capped (after taking into account any such costs we incur and pay directly) through December 31, 2014. Cost of sales was capped at $21.75 per operating horsepower per quarter at December 31, 2013, and is capped at $22.50 per operating horsepower per quarter from January 1, 2014 through December 31, 2014. SG&A costs were capped at $12.5 million per quarter at December 31, 2013, and are capped at $15.0 million per quarter from January 1, 2014 through December 31, 2014.

 

Our cost of sales exceeded the cap provided in the Omnibus Agreement by $12.4 million, $16.6 million and $26.5 million during 2013, 2012, and 2011, respectively. Our SG&A expenses exceeded the cap provided in the Omnibus Agreement by $12.8 million, $8.2 million and $5.9 million during 2013, 2012 and 2011, respectively. Accordingly, our EBITDA, as further adjusted, and our distributable cash flow (please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”) for a discussion of EBITDA, as further adjusted, and distributable cash flow) would have been approximately $25.2 million, $24.8 million and $32.4 million lower during 2013, 2012 and 2011, respectively, without the benefit of the cost caps. As a result, without the benefit of the cost caps, our distributable cash flow coverage (distributable cash flow for the period divided by distributions declared to all unitholders for the period, including incentive distribution rights) would have been 1.13x, 1.02x and 0.78x during 2013, 2012 and 2011, respectively, rather than the actual distributable cash flow coverage (which includes the benefit of cost caps) of 1.36x, 1.29x and 1.22x during 2013, 2012, and 2011, respectively. As a result, without the benefit of the cost caps, we would not have generated sufficient available cash from operating surplus during 2011 to pay distributions at the level paid during that year without incurring borrowings.

 

These cost caps expire on December 31, 2014 and Exterran Holdings is under no obligation to extend them. If Exterran Holdings does not extend the caps, their expiration would likely reduce the amount of cash flow available to unitholders and, accordingly, may impair our ability to maintain or increase our distributions.

 

Low natural gas prices in the U.S. could decrease demand for our natural gas compression services and, as a result, adversely affect our business and decrease our revenue and cash available for distribution.

 

Our revenue, earnings and financial position are affected by, among other things, market conditions that impact demand and pricing for natural gas compression services. Oil and natural gas prices and the level of drilling and exploration activity can be volatile. For example, oil and natural gas exploration and development activity and the number of well completions typically decline when there is a sustained reduction in oil or natural gas prices or significant instability in energy markets. Even the perception of longer-term lower oil or natural gas prices by oil and natural gas exploration, development and production companies can result in their decision to cancel, reduce or postpone major expenditures or to reduce or shut in well production. In April 2012, natural gas prices in the U.S. fell to their lowest levels in more than a decade at around $2.00 per MMBtu. As a result, certain companies reduced their natural gas drilling and production activities, particularly in more mature and predominantly dry gas areas, where we provide a significant amount of contract operations services, which led to a decline in our business in these areas during 2012. Since then, natural gas prices in the U.S. have improved somewhat to approximately $4.30 per MMBtu as of December 31, 2013, but natural gas prices in 2013 continued to cause certain companies to reduce their natural gas drilling and production activities in more mature and predominantly dry gas areas in the U.S., which led to a continued decline in our contract operations business in these areas in 2013. During periods of lower natural gas prices, natural gas production growth could be limited or decline in the U.S., particularly in dry gas areas, and the level of production activity and the demand for our contract operations services could decrease, which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders. A reduction in demand for our services could also force us to reduce our pricing substantially. Additionally, compression services for unconventional natural gas sources constitute an increasing percentage of our business. Some of these unconventional sources are less economic to produce in lower natural gas price environments.

 

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In addition, we review our long-lived assets for impairment when events or changes in circumstances indicate the carrying value may not be recoverable. Goodwill is assessed for impairment at least annually. A decline in demand for oil and natural gas or prices for those commodities, or instability in the U.S. energy markets could cause a reduction in demand for our services and result in a reduction of our estimates of future cash flows and growth rates in our business. These events could cause us to record impairments of long-lived assets. For example, during the years ended December 31, 2013, 2012 and 2011, we recorded long-lived asset impairments of $5.4 million, $29.6 million and $1.1 million, respectively. Included in the impairments recorded in recent years are idle units we retired from our fleet, and we expect to either sell these units or to re-utilize their key components. Selling these compressor units is expected to take several years, and if we are not able to sell these units or re-utilize their key components for the amount we estimated in our impairment analysis, we could be required to record an additional impairment. The impairment of our goodwill, intangible assets or other long-lived assets could have a material adverse effect on our results of operations.

 

Due to our significant relationship with Exterran Holdings, adverse developments concerning Exterran Holdings could adversely affect us, even if we have not suffered any similar developments.

 

Through its subsidiaries, Exterran Holdings owns all of our general partner interests and a significant amount of our limited partner interests. Our access to Exterran Holdings’ personnel, fabrication operations, logistical capabilities, geographic scope and operational efficiencies allows us to provide a full complement of contract operations services. In addition, we benefit from a number of arrangements, including the cost caps, in the Omnibus Agreement between us and Exterran Holdings (please see Note 3 to the Financial Statements for further discussion of the Omnibus Agreement). A material adverse effect upon Exterran Holding’s assets, liabilities, financial condition, business or operations could impact Exterran Holdings’ ability to continue to provide these benefits to us. As a result, we could experience a material adverse effect upon our business, results of operations, financial condition and ability to make cash distributions to our unitholders, even if we have not suffered any similar developments.

 

As we continue to acquire additional compression equipment from Exterran Holdings we expect that our maintenance capital expenditures will increase, which could reduce the amount of cash available for distribution.

 

Exterran Holdings manages its and our respective U.S. fleets as one pool of compression equipment from which we can each readily fulfill our respective customers’ service needs. When we or Exterran Holdings are advised of a contract operations services opportunity, Exterran Holdings reviews both our and its fleet for an available and appropriate compressor unit. Given that the majority of the idle compression equipment has been and is currently held by Exterran Holdings, much of the idle compression equipment required for these contract operations services opportunities has been held by Exterran Holdings. Under the Omnibus Agreement, the owner of the equipment being transferred is required to pay the costs associated with making the idle equipment suitable for the proposed customer and then has generally leased the equipment to the recipient of the equipment or exchanged the equipment for other equipment of the recipient. Since Exterran Holdings has owned the majority of such equipment, Exterran Holdings has generally had to bear a larger portion of the maintenance capital expenditures associated with making transferred equipment ready for service. For equipment that is then leased to the recipient, the maintenance capital cost is a component of the lease rate that is paid under the lease. As we acquire more compression equipment, we expect that more of our equipment will be available to satisfy our or Exterran Holdings’ customer requirements. As a result, we expect that our maintenance capital expenditures will increase, which could reduce our cash available for distribution.

 

We have a substantial amount of debt that could limit our ability to fund future growth and operations and increase our exposure to risk during adverse economic conditions.

 

At December 31, 2013, we had approximately $758.0 million in outstanding debt obligations. Many factors, including factors beyond our control, may affect our ability to make payments on our outstanding indebtedness. These factors include those discussed elsewhere in these Risk Factors and those listed in the Disclosure Regarding Forward-Looking Statements section included in Part I of this report.

 

Our substantial debt and associated commitments could have important adverse consequences. For example, these commitments could:

 

·                  make it more difficult for us to satisfy our contractual obligations;

 

·                  increase our vulnerability to general adverse economic and industry conditions;

 

·                  limit our ability to fund future working capital, capital expenditures, acquisitions or other corporate requirements;

 

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·                  increase our vulnerability to interest rate fluctuations because the interest payments on a portion of our debt are based upon variable interest rates and a portion can adjust based upon our credit statistics;

 

·                  limit our flexibility in planning for, or reacting to, changes in our business and our industry;

 

·                  place us at a disadvantage compared to our competitors that have less debt or less restrictive covenants in such debt; and

 

·                  limit our ability to refinance our debt in the future or borrow additional funds.

 

A substantial portion of our cash flow must be used to service our debt obligations, and future interest rate increases could reduce the amount of our cash available for distribution.

 

At December 31, 2013, we had $758.0 million in outstanding debt obligations, consisting of $345.0 million outstanding under our 6% senior notes due April 2021 (the “6% Notes”), $263.0 million outstanding under our revolving credit facility and $150.0 million outstanding under our term loan. The senior secured credit agreement (the “Credit Agreement”) requires that we make mandatory prepayments of the term loan with the net cash proceeds of certain asset transfers. Borrowings under our senior secured credit facility bear interest at floating rates. We have effectively fixed a portion of the floating rate debt through the use of interest rate swaps; however, changes in economic conditions could result in higher interest rates, thereby increasing our interest expense and reducing our funds available for capital investment, operations or distributions to our unitholders. As of December 31, 2013, after taking into consideration interest rate swaps, we had $163.0 million of outstanding indebtedness that was effectively subject to floating interest rates. A 1% increase in the effective interest rate on our outstanding debt subject to floating interest rates at December 31, 2013 would result in an annual increase in our interest expense of approximately $1.6 million.

 

Covenants in our Credit Agreement may impair our ability to operate our business.

 

The Credit Agreement contains various covenants with which we must comply, including, but not limited to, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay dividends and distributions. The Credit Agreement also contains various covenants requiring mandatory prepayments from the net cash proceeds of certain asset transfers. We must maintain various consolidated financial ratios, including a ratio of EBITDA (as defined in the Credit Agreement) to Total Interest Expense (as defined in the Credit Agreement) of not less than 2.75 to 1.0, a ratio of Total Debt (as defined in the Credit Agreement) to EBITDA of not greater than 5.25 to 1.0 (subject to a temporary increase to 5.5 to 1.0 for any quarter during which an acquisition meeting certain thresholds is completed and for the following two quarters after the acquisition closes) and a ratio of Senior Secured Debt (as defined in the Credit Agreement) to EBITDA of not greater than 4.0 to 1.0. As of December 31, 2013, we maintained a 7.5 to 1.0 EBITDA to Total Interest Expense ratio, a 3.1 to 1.0. Total Debt to EBITDA ratio and a 1.7 to 1.0 Senior Secured Debt to EBITDA ratio. A material adverse effect on our assets, liabilities, financial condition, business or operations that, taken as a whole, impacts our ability to perform our obligations under the Credit Agreement, could lead to a default under that agreement.

 

The breach of any of our covenants could result in a default under our Credit Agreement which could cause our indebtedness under our Credit Agreement to become due and payable. A default under one of our debt agreements would trigger cross-default provisions under our other debt agreement, which would accelerate our obligation to repay our indebtedness under those agreements. If the repayment obligations on any of our indebtedness were to be so accelerated, we may not be able to repay the debt or refinance the debt on acceptable terms, and our financial position would be materially adversely affected. As of December 31, 2013, we are in compliance with all financial covenants under our Credit Agreement.

 

Our inability to fund purchases of additional compression equipment could adversely impact our results of operations and cash available for distribution.

 

We may not be able to maintain or grow our asset and customer base unless we have access to sufficient capital to purchase additional compression equipment. Cash flow from our operations and availability under our senior secured credit facility may not provide us with sufficient cash to fund our capital expenditure requirements, including any funding requirements related to acquisitions. Additionally, pursuant to our partnership agreement, we intend to distribute all of our “available cash,” as defined in our partnership agreement, to our unitholders on a quarterly basis. Therefore, a significant portion of our cash flow from operations will be used to fund such distributions. As a result, we intend to fund our growth capital expenditures and acquisitions, including future acquisitions of compression services contracts and equipment from Exterran Holdings, with external sources of capital including additional borrowings under our senior secured credit facility and/or public or private offerings of equity or debt. Our ability to grow our asset and customer base could be impacted by any limits on our ability to access equity and debt capital.

 

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We may not have sufficient cash from operations following the establishment of cash reserves and payment of fees and expenses, including cost reimbursements to our general partner, to enable us to make cash distributions to holders of our common units at our current distribution rate.

 

We may not have sufficient available cash from operating surplus each quarter to enable us to make cash distributions at our current distribution rate. The amount of cash we can distribute on our units principally depends upon the amount of cash we generate from our operations, which will fluctuate from quarter to quarter based on, among other things, the risks described in this section.

 

In addition, the actual amount of cash we will have available for distribution will depend on other factors, including:

 

·          the level of capital expenditures we make;

 

·          the cost of acquisitions;

 

·          our debt service requirements and other liabilities;

 

·          fluctuations in our working capital needs;

 

·          our ability to refinance our debt in the future or borrow funds and access capital markets;

 

·          restrictions contained in our debt agreements; and

 

·          the amount of cash reserves established by our general partner.

 

Failure to generate sufficient cash flow, together with the absence of alternative sources of capital, could adversely impact our results of operations and cash available for distribution to our unitholders.

 

The erosion of the financial condition of our customers could adversely affect our business.

 

Many of our customers finance their exploration and development activities through cash flow from operations, the incurrence of debt or the issuance of equity. During times when the oil or natural gas markets weaken, our customers are more likely to experience a downturn in their financial condition. A reduction in borrowing bases under reserve-based credit facilities and the lack of availability of debt or equity financing could result in a reduction in our customers’ spending for our services. For example, our customers could seek to preserve capital by canceling month-to-month contracts or determining not to enter into any new natural gas compression service contracts, thereby reducing demand for our services. Reduced demand for our services could adversely affect our business, financial condition, results of operations and ability to make cash distributions to our unitholders. In addition, in the event of the financial failure of a customer, we could experience a loss on all or a portion of our outstanding accounts receivable associated with that customer.

 

Our agreement not to compete with Exterran Holdings could limit our ability to grow.

 

We have entered into an Omnibus Agreement with Exterran Holdings and several of its subsidiaries. The Omnibus Agreement includes certain agreements not to compete between us and our affiliates, on the one hand, and Exterran Holdings and its affiliates, on the other hand. This agreement not to compete with Exterran Holdings could limit our ability to grow. For further discussion of the Omnibus Agreement, please see Note 3 to the Financial Statements.

 

We face significant competitive pressures that may cause us to lose market share and harm our financial performance.

 

Our business is highly competitive and there are low barriers to entry. We experience competition from companies that may be able to adapt more quickly to technological changes within our industry and changes in economic and market conditions, more readily take advantage of acquisitions and other opportunities and adopt more aggressive pricing policies. Our ability to renew or replace existing contracts with our customers at rates sufficient to maintain current revenue and cash flows could be adversely affected by the activities of our competitors. If our competitors substantially increase the resources they devote to the development and marketing of competitive services or substantially decrease the prices at which they offer their services, we may not be able to compete effectively. In addition, we could face significant competition from new entrants into our industry. Some of our existing competitors or new entrants may expand or fabricate new compressor units that would create additional competition for the services we provide to our customers. In addition, our customers may purchase and operate their own compressor fleets in lieu of using our natural gas compression services. Any of these competitive pressures could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

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Threats of cyber attacks or terrorism could affect our business.

 

We may be threatened by problems such as cyber attacks, computer viruses or terrorism that may disrupt our operations and harm our operating results. Our industry requires the continued operation of sophisticated information technology systems and network infrastructure. Despite our implementation of security measures, our technology systems are vulnerable to disability or failures due to hacking, viruses, acts of war or terrorism and other causes. If our information technology systems were to fail and we were unable to recover in a timely way, we might be unable to fulfill critical business functions, which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

In addition, our assets may be targets of terrorist activities that could disrupt our ability to service our customers. We may be required by our regulators or by the future terrorist threat environment to make investments in security that we cannot currently predict. The implementation of security guidelines and measures and maintenance of insurance, to the extent available, addressing such activities could increase costs. These types of events could materially adversely affect our business and results of operations. In addition, these types of events could require significant management attention and resources, and could adversely affect our reputation among customers and the public.

 

We may not be able to grow our cash flows if we do not expand our business, which could limit our ability to maintain or increase distributions to our unitholders.

 

Our ability to grow the per unit distribution on our units is dependent in part upon our ability to expand our business. Our future growth will depend upon a number of factors, some of which we cannot control. These factors include our ability to:

 

·          acquire additional U.S. contract operations services business from Exterran Holdings;

 

·          consummate accretive acquisitions;

 

·          enter into contracts for new services with our existing customers or new customers; and

 

·          obtain required financing for our existing and new operations.

 

A deficiency in any of these factors could adversely affect our ability to achieve growth in the level of our cash flows or realize benefits from acquisitions.

 

If we do not make acquisitions on economically acceptable terms, our future growth and our ability to maintain or increase distributions to our unitholders could be limited.

 

Our ability to grow depends, in part, on our ability to make accretive acquisitions. If we are unable to make accretive acquisitions either because we are: (i) unable to identify attractive acquisition candidates or negotiate acceptable purchase contracts with them, (ii) unable to obtain financing for these acquisitions on economically acceptable terms, or (iii) outbid by competitors, then our future growth and ability to maintain or increase distributions could be limited. Furthermore, even if we make acquisitions that we believe will be accretive, these acquisitions may nevertheless result in a decrease in the cash generated from operations per unit.

 

Any acquisition involves potential risks, including, among other things:

 

·          an inability to integrate successfully the businesses we acquire;

 

·          the assumption of unknown liabilities;

 

·          limitations on rights to indemnity from the seller;

 

·          mistaken assumptions about the cash generated or anticipated to be generated by the business acquired or the overall costs of equity or debt;

 

·          the diversion of management’s attention from other business concerns;

 

·          unforeseen operating difficulties; and

 

·          customer or key employee losses at the acquired businesses.

 

If we consummate any future acquisitions, our capitalization and results of operations may change significantly, and unitholders will not have the opportunity to evaluate the economic, financial and other relevant information that we will consider in determining the application of our future funds and other resources. In addition, competition from other buyers could reduce our acquisition opportunities or cause us to pay a higher price than we might otherwise pay.

 

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Exterran Holdings continues to own and operate a substantial U.S. contract compression business, competition from which could adversely impact our results of operations and cash available for distribution.

 

Exterran Holdings and its affiliates, other than us, are prohibited from competing directly or indirectly with us with respect to certain of our existing customers and certain locations where we currently conduct business, and with respect to any new contract compression services customer that approaches either Exterran Holdings or ourselves, until the earliest to occur of December 31, 2014, a change of control of Exterran Holdings or our general partner, or the removal or withdrawal of our general partner. Otherwise, Exterran Holdings is not prohibited from owning assets or engaging in businesses that compete directly or indirectly with us. Exterran Holdings continues to own and operate a U.S. contract operations business, including natural gas compression, and continues to engage in international contract operations, fabrication and aftermarket service activities. Exterran Holdings is a large, established participant in the contract operations business, and has significantly greater resources, including idle compression equipment, operating personnel, fabrication operations, vendor relationships and experience, than we have, which factors may make it more difficult for us to compete with it with respect to commercial activities as well as for acquisition candidates. Exterran Holdings and its affiliates may acquire, fabricate or dispose of additional natural gas compression or other assets in the future without any obligation to offer us the opportunity to purchase any of those assets. As a result, competition from Exterran Holdings could adversely impact our results of operations and cash available for distribution.

 

We may be unable to grow through acquisitions of the remainder of Exterran Holdings’ U.S. contract operations business, which could limit our ability to maintain or increase distributions to our unitholders.

 

Exterran Holdings is under no obligation to offer us the opportunity to purchase the remainder of its U.S. contract operations business, and its board of directors owes fiduciary duties to the stockholders of Exterran Holdings, and not our unitholders, in making any decision to offer us this opportunity. Likewise, we are not required to purchase any additional portions of such business.

 

The consummation of any such purchases will depend upon, among other things, our ability to reach an agreement with Exterran Holdings regarding the terms of such purchases (which will require the approval of the conflicts committee of our board of directors) and our ability to finance such purchases on acceptable terms. Additionally, Exterran Holdings may be limited in its ability to consummate sales of additional portions of such business to us by the terms of its existing or future credit facilities or indentures. Furthermore, our senior secured credit facility includes covenants that may limit our ability to finance acquisitions. If a sale of any additional portion of Exterran Holdings’ U.S. contract operations business would be restricted or prohibited by such covenants, we or Exterran Holdings may be required to seek waivers of such provisions or refinance those debt instruments in order to consummate a sale, neither of which may be accomplished timely, if at all. If we are unable to grow through additional acquisitions of the remainder of Exterran Holdings’ U.S. contract operations business, our ability to maintain or increase distributions to our unitholders may be limited.

 

Many of our compression services contracts with customers have short initial terms, and after the initial term are cancelable on short notice, and we cannot be sure that such contracts will be extended or renewed after the end of the initial contractual term. Any such nonrenewals, or renewals at reduced rates, or the loss of contracts with any significant customer, could adversely impact our results of operations and cash available for distribution.

 

The length of our compression services contracts with customers varies based on operating conditions and customer needs. Our initial contract terms are not long enough to enable us to recoup the cost of acquiring the equipment we use to provide compression services, and these contracts are typically cancelable on short notice after the initial term. We cannot be sure that a substantial number of these contracts will be extended or renewed by our customers or that any of our customers will continue to contract with us. The inability to negotiate extensions or renew a substantial portion of our compression services contracts, the renewal of such contracts at reduced rates, the inability to contract for additional services with our customers or the loss of all or a significant portion of our services contracts with any significant customer could lead to a reduction in revenue and net income and could require us to record additional asset impairments. This could have a material adverse effect upon our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

Our ability to manage and grow our business effectively may be adversely affected if Exterran Holdings loses management or operational personnel.

 

Most of our officers are also officers or employees of Exterran Holdings. Additionally, we do not have any of our own employees, but rather rely on Exterran Holdings’ employees to operate our business. We believe that Exterran Holdings’ ability to hire, train and retain qualified personnel will continue to be challenging and important as we grow. When general industry conditions are good, the supply of experienced operational, fabrication and field personnel, in particular, decreases as other energy and manufacturing companies’ needs for the same personnel increase. Our ability to grow and to continue our current level of service to our customers will be adversely impacted if Exterran Holdings is unable to successfully hire, train and retain these important personnel.

 

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If we are unable to purchase compression equipment from Exterran Holdings or others, we may not be able to retain existing customers or compete for new customers, which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

Exterran Holdings is under no obligation to offer or sell to us newly-fabricated or idle compression equipment and may choose not to do so timely or at all. We may not be able to purchase newly-fabricated or idle compression equipment from third-party producers or marketers of such equipment or from our competitors. If we are unable to purchase compression equipment on a timely basis to meet the demands of our customers, our existing customers may terminate their contractual relationships with us, or we may not be able to compete for business from new or existing customers, either of which could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

Our reliance on Exterran Holdings as an operator of our assets and our limited ability to control certain costs could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

Pursuant to the Omnibus Agreement, Exterran Holdings provides us with all administrative and operational services, including without limitation all operations, marketing, maintenance and repair, periodic overhauls of compression equipment, inventory management, legal, accounting, treasury, insurance administration and claims processing, risk management, health, safety and environmental, information technology, human resources, credit, payroll, internal audit, taxes and engineering services necessary to run our business. Our operational success and ability to execute our growth strategy depends significantly upon Exterran Holdings’ satisfactory operation of our assets and performance of these services. Our reliance on Exterran Holdings as an operator of our assets and our resulting limited ability to control certain costs could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.

 

We indirectly depend on particular suppliers and are vulnerable to product shortages and price increases, which could have a negative impact on our results of operations.

 

Some of the components used in our compressors are obtained by Exterran Holdings from a single source or a limited group of suppliers. Exterran Holdings’ reliance on these suppliers involves several risks, including price increases, inferior component quality and a potential inability to obtain an adequate supply of required components in a timely manner. Exterran Holdings does not have long-term contracts with some of these sources, and its partial or complete loss of certain of these sources could have a negative impact on our results of operations and could damage our customer relationships. Further, since any increase in component prices for compression equipment fabricated by Exterran Holdings for us will be passed on to us, a significant increase in the price of one or more of these components could have a negative impact on our results of operations.

 

From time to time, we are subject to various claims, litigation and other proceedings that could ultimately be resolved against us, requiring material future cash payments or charges, which could impair our financial condition or results of operations.

 

The size, nature and complexity of our business make us susceptible to various claims, both in litigation and binding arbitration proceedings. We are currently, and may in the future become, subject to various claims, which, if not resolved within amounts we have accrued, could have a material adverse effect on our financial position, results of operations or cash flows, including our ability to make cash distributions to our unitholders. Similarly, any claims, even if fully indemnified or insured, could negatively impact our reputation among our customers and the public, and make it more difficult for us to compete effectively or obtain adequate insurance in the future. See Part I, Item 3 (“Legal Proceedings”) and also Note 13 (“Commitments and Contingencies”) to the Financial Statements included in this report for additional information regarding certain legal proceedings to which we are a party, including ongoing litigation regarding our qualification as a heavy equipment dealer, the qualification of our natural gas compressors as heavy equipment and the resulting appraisal of our natural gas compressors for ad valorem tax purposes under revised Texas statutes.

 

Federal, state and local legislative and regulatory initiatives relating to hydraulic fracturing could result in increased costs and additional delays to our exploration and production customers in drilling and completing natural gas wells, which could adversely affect demand for our contract operations services.

 

Hydraulic fracturing is an important and common practice that exploration and production operators use to stimulate production of hydrocarbons, particularly natural gas, from dense subsurface rock formations. The process involves the injection of water, sand and chemicals under pressure into formations to fracture the surrounding rock and stimulate production. The process is typically regulated by state oil and gas commissions but the EPA has asserted federal regulatory authority under the federal Safe Drinking Water Act over hydraulic fracturing involving the use of diesel. In addition, a number of agencies including EPA, the U.S. Department of Energy, and the U.S. Department of the Interior, along with Congressional committees, have been pursuing studies and other inquiries into the potential environmental effects of hydraulic fracturing, the outcome of which could reach conclusions that could give rise to new legislation or regulations. Legislation has been introduced before Congress to provide for federal regulation of hydraulic fracturing under the Safe Drinking Water Act and to require disclosure of the chemicals used in the hydraulic fracturing process. The U.S. Bureau of Land Management on May 24, 2013 proposed regulations that, when finalized, will govern hydraulic fracturing on public lands. At the state level, some states have adopted and other states are considering adopting legal requirements that could impose more stringent permitting, disclosure, and well construction requirements on hydraulic fracturing activities. Local governments also may seek to adopt ordinances within their jurisdictions regulating the time, place and manner of drilling activities in general or hydraulic fracturing activities in particular. In the event that new or more stringent federal, state, or local legal restrictions relating to the hydraulic fracturing process are adopted in areas where our natural gas exploration and production customers operate, those customers could incur potentially significant added costs to comply with such requirements and experience delays or curtailment in the pursuit of production or development activities, which could reduce demand for our contract operations services, and as a result could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

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New regulations, proposed regulations and proposed modifications to existing regulations under the CAA, if implemented, could result in increased compliance costs.

 

On August 20, 2010, the EPA published new regulations under the CAA to control emissions of hazardous air pollutants from existing stationary reciprocal internal combustion engines. The rule would have required us to undertake certain expenditures and activities, including purchasing and installing emissions control equipment, such as oxidation catalysts or non-selective catalytic reduction equipment, on a portion of our engines located at certain sources of hazardous air pollutants and all our engines over a certain size regardless of location, following prescribed maintenance practices for engines (which are consistent with our existing practices), and implementing additional emissions testing and monitoring. Following legal challenges to the 2010 rule, the EPA reconsidered the rule and published revisions to the rule on January 30, 2013. The revised rule requires management practices for all covered engines but requires catalyst installation only on larger equipment at sites that are not deemed to be “remote.” Based on feedback from our customers regarding the sites at which we provide contract operations services to them using such equipment, we estimate that the vast majority of those sites are “remote,” and, as such, we do not anticipate these rules, as currently drafted, will have a material adverse impact on our business, financial condition, results of operations or ability to make cash distributions to our unitholders.

 

On May 21, 2012, the EPA issued new ozone nonattainment designations for all areas except Chicago, in relation to the 2008 NAAQS for ozone. Among other things, these new designations add Wise County, Texas to the DFW nonattainment area. This new designation will require Texas to modify its SIP to include a plan for Wise County to come into compliance with the ozone NAAQS. This modification process started in January 2014, and the State of Texas anticipates having new regulations in place by mid-2015. If Texas implements the same control requirements in Wise County that are already in place in the other counties in the DFW nonattainment area, we could be required to modify or remove and replace a significant amount of equipment we currently utilize in Wise County. However, at this point we cannot predict what Texas’ new SIP will require or what equipment will still be operating in Wise County when it comes into effect and, as a result, we cannot currently accurately predict the impact or cost to comply.

 

On August 16, 2012, the EPA published final rules that establish new air emission controls for natural gas and natural gas liquids production, processing and transportation activities, including New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds, and a separate set of emission standards to address hazardous air pollutants frequently associated with production and processing activities. Among other things, the rules establish specific requirements regarding emissions from compressors and controllers at natural gas gathering and boosting stations and processing plants together with dehydrators and storage tanks at natural gas processing plants, compressor stations and gathering and boosting stations. In addition, the rules establish new requirements for leak detection and repair of leaks at natural gas processing plants that exceed 500 parts per million in concentration.

 

In addition, in January 2011, the TCEQ finalized revisions to certain air permit programs that significantly increase air emissions-related requirements for new and certain existing oil and gas production and gathering sites in the Barnett Shale production area. The final rule established new emissions standards for engines, which could impact the operation of specific categories of engines by requiring the use of alternative engines, compressor packages or the installation of aftermarket emissions control equipment. The rule became effective for the Barnett Shale production area in April 2011, and the lower emissions standards will become applicable between 2020 and 2030 depending on the type of engine and the permitting requirements. A number of other states where our engines are operated have adopted or are considering adopting additional regulations that could impose new air permitting or pollution control requirements for engines, some of which could entail material costs to comply. At this point, however, we cannot predict whether any such rules would require us to incur material costs.

 

These new regulations and proposals, when finalized, and any other new regulations requiring the installation of more sophisticated pollution control equipment or the adoption of other environmental protection measures, could have a material adverse impact on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

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We are subject to substantial environmental regulation, and changes in these regulations could increase our costs or liabilities.

 

We are subject to stringent and complex federal, state and local laws and regulations, including laws and regulations regarding the discharge of materials into the environment, emission controls and other environmental protection and occupational safety and health concerns. Environmental laws and regulations may, in certain circumstances, impose strict liability for environmental contamination, which may render us liable for remediation costs, natural resource damages and other damages as a result of our conduct that was lawful at the time it occurred or the conduct of, or conditions caused by, prior owners or operators or other third parties. In addition, where contamination may be present, it is not uncommon for neighboring land owners and other third parties to file claims for personal injury, property damage and recovery of response costs. Remediation costs and other damages arising as a result of environmental laws and regulations, and costs associated with new information, changes in existing environmental laws and regulations or the adoption of new environmental laws and regulations could be substantial and could negatively impact our financial condition or results of operations. Moreover, failure to comply with these environmental laws and regulations may result in the imposition of administrative, civil and criminal penalties and the issuance of injunctions delaying or prohibiting operations.

 

We may need to apply for or amend facility permits or licenses from time to time with respect to storm water or wastewater discharges, waste handling, or air emissions relating to manufacturing activities or equipment operations, which subjects us to new or revised permitting conditions that may be onerous or costly to comply with. In addition, certain of our customer service arrangements may require us to operate, on behalf of a specific customer, petroleum storage units such as underground tanks or pipelines and other regulated units, all of which may impose additional compliance and permitting obligations.

 

We conduct operations at numerous facilities in a wide variety of locations across the continental U.S. The operations at many of these facilities require U.S. federal, state or local environmental permits or other authorizations. Additionally, natural gas compressors at many of our customers’ facilities require individual air permits or general authorizations to operate under various air regulatory programs established by rule or regulation. These permits and authorizations frequently contain numerous compliance requirements, including monitoring and reporting obligations and operational restrictions, such as emission limits. Given the large number of facilities in which we operate, and the numerous environmental permits and other authorizations that are applicable to our operations, we may occasionally identify or be notified of technical violations of certain requirements existing in various permits or other authorizations. Occasionally, we have been assessed penalties for our non-compliance, and we could be subject to such penalties in the future.

 

We routinely deal with natural gas, oil and other petroleum products. Hydrocarbons or other hazardous substances or wastes may have been disposed or released on, under or from properties used by us to provide contract operations services or inactive compression storage or on or under other locations where such substances or wastes have been taken for disposal. These properties may be subject to investigatory, remediation and monitoring requirements under U.S. federal, state and local environmental laws and regulations.

 

The modification or interpretation of existing environmental laws or regulations, the more vigorous enforcement of existing environmental laws or regulations, or the adoption of new environmental laws or regulations may also negatively impact oil and natural gas exploration and production, gathering and pipeline companies, including our customers, which in turn could have a negative impact on us.

 

Climate change legislation and regulatory initiatives could result in increased compliance costs.

 

The U.S. Congress has considered legislation to restrict or regulate emissions of greenhouse gases, such as carbon dioxide and methane. One bill, passed by the House of Representatives, if enacted by the full Congress, would have required greenhouse gas emissions reductions by covered sources of as much as 17% from 2005 levels by 2020 and by as much as 83% by 2050. It presently appears unlikely that comprehensive climate legislation will be passed by either house of Congress in the near future, although energy legislation and other initiatives continue to be proposed that may be relevant to greenhouse gas emissions issues. In addition, almost half of the states, either individually or through multi-state regional initiatives, have begun to address greenhouse gas emissions, primarily through the planned development of emission inventories or regional greenhouse gas cap and trade programs. Although most of the state-level initiatives have to date been focused on large sources of greenhouse gas emissions, such as electric power plants, it is possible that smaller sources such as our gas-fired compressors could become subject to greenhouse gas-related regulation. Depending on the particular program, we could be required to control emissions or to purchase and surrender allowances for greenhouse gas emissions resulting from our operations.

 

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Independent of Congress, the EPA has been pursuing regulations controlling greenhouse gas emissions under its existing CAA authority. The EPA has adopted rules requiring many facilities, including petroleum and natural gas systems, to inventory and report their greenhouse gas emissions. These rules triggered reporting obligations for some sites we operated in 2013.

 

In addition, the EPA in June 2010 published a final rule providing for the tailored applicability of air permitting requirements for greenhouse gas emissions. The EPA reported that the rulemaking was necessary because without it certain permitting requirements would apply as of January 2011 at an emissions level that would have greatly increased the number of required permits and, among other things, imposed undue costs on small sources and overwhelmed the resources of permitting authorities. In the rule, the EPA established two initial steps of phase-in to minimize those burdens, excluding certain smaller sources from greenhouse gas permitting until at least April 30, 2016. On January 2, 2011, the first step of the phase-in applied only to new projects at major sources (as defined under those CAA permitting programs) that, among other things, increase net greenhouse gas emissions by 75,000 tons per year. On July 1, 2011, the second step of the phase-in began requiring permitting for otherwise minor sources of air emissions that have the potential to emit at least 100,000 tons per year of greenhouse gases. On June 29, 2012, the EPA issued final regulations for “Phase III” of its program, retaining the permitting thresholds established in Phases I and II. These rules will affect some of our and our customers’ largest new or modified facilities going forward.

 

Although it is not currently possible to predict how any proposed or future greenhouse gas legislation or regulation by Congress, the states or multi-state regions will impact our business, any legislation or regulation of greenhouse gas emissions that may be imposed in areas in which we conduct business could result in increased compliance costs or additional operating restrictions or reduced demand for our services, and could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.

 

Our operations entail inherent risks that may result in substantial liability. We do not insure against all potential losses and could be seriously harmed by unexpected liabilities.

 

Our operations entail inherent risks including equipment defects, malfunctions and failures and natural disasters which could result in uncontrollable flows of natural gas or well fluids, fires and explosions. These risks may expose us to substantial liability for personal injury, wrongful death, property damage, pollution and other environmental damages. Exterran Holdings insures our property and operations against many of these risks; however, the insurance it carries may not be adequate to cover our claims or losses. Exterran Holdings currently has minimal amount of insurance on our offshore assets. In addition, Exterran Holdings is substantially self-insured for worker’s compensation, employer’s liability, property, auto liability, general liability and employee group health claims in view of the relatively high per-incident deductibles it absorbs under its insurance arrangements for these risks. Further, insurance covering the risks we expect to face or in the amounts we desire may not be available in the future or, if available, the premiums may not be commercially justifiable. If we were to incur substantial liability and such damages were not covered by insurance or were in excess of policy limits, or if we were to incur liability at a time when we are not able to obtain liability insurance, our business, results of operations and financial condition could be negatively impacted.

 

Risks Inherent in an Investment in Our Common Units

 

Exterran Holdings controls our general partner, which has sole responsibility for conducting our business and managing our operations. Exterran Holdings has conflicts of interest, which may permit it to favor its own interests to our unitholders’ detriment.

 

Exterran Holdings owns and controls our general partner. Most of our executive officers are officers of Exterran Holdings. Therefore, conflicts of interest may arise between Exterran Holdings and its affiliates, including our general partner, on the one hand, and us and our unitholders, on the other hand. In resolving these conflicts of interest, our general partner may favor its own interests and the interests of its affiliates over the interests of our unitholders. These conflicts include, among others, the following situations:

 

·          neither our partnership agreement nor any other agreement requires Exterran Holdings to pursue a business strategy that favors us. Exterran Holdings’ directors and officers have a fiduciary duty to make these decisions in the best interests of the owners of Exterran Holdings, which may be contrary to our interests;

 

·          our general partner controls the interpretation and enforcement of contractual obligations between us and our affiliates, on the one hand, and Exterran Holdings, on the other hand, including provisions governing administrative services, acquisitions and transfers of compression equipment and non-competition provisions;

 

·          our general partner controls whether we agree to acquire additional contract operations customers or assets from Exterran Holdings that are offered to us by Exterran Holdings and the terms of such acquisitions;

 

·          our general partner is allowed to take into account the interests of parties other than us, such as Exterran Holdings and its affiliates, in resolving conflicts of interest;

 

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·          other than as provided in our Omnibus Agreement with Exterran Holdings, Exterran Holdings and its affiliates are not limited in their ability to compete with us. Exterran Holdings will continue to engage in U.S. and international contract operations services as well as third-party sales coupled with aftermarket service contracts and may, in certain circumstances, compete with us with respect to any future acquisition opportunities;

 

·          Exterran Holdings’ U.S. and international contract compression services businesses and its third-party equipment customers may compete with us for newly-fabricated and idle compression equipment and Exterran Holdings is under no obligation to offer equipment to us for purchase or use;

 

·          all of the officers and employees of Exterran Holdings who provide services to us also will devote significant time to the business of Exterran Holdings, and will be compensated by Exterran Holdings for the services rendered to it;

 

·          our general partner has limited its liability and reduced its fiduciary duties, and has also restricted the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty;

 

·          our general partner determines the amount and timing of asset purchases and sales, borrowings, issuance of additional partnership securities and reserves, each of which can affect the amount of cash that is distributed to unitholders;

 

·          our general partner determines the amount and timing of any capital expenditures and whether a capital expenditure is a maintenance capital expenditure, which reduces operating surplus, or an expansion capital expenditure, which does not reduce operating surplus. This determination can affect the amount of cash that is distributed to our unitholders;

 

·          our general partner determines which costs incurred by it and its affiliates are reimbursable by us and Exterran Holdings determines the allocation of shared overhead expenses;

 

·          our partnership agreement does not restrict our general partner from causing us to pay it or its affiliates for any services rendered to us or entering into additional contractual arrangements with any of these entities on our behalf;

 

·          our general partner intends to limit its liability regarding our contractual and other obligations and, in some circumstances, is entitled to be indemnified by us;

 

·          our general partner may exercise its limited right to call and purchase common units if it and its affiliates own more than 80% of the common units; and

 

·          our general partner decides whether to retain separate counsel, accountants or others to perform services for us.

 

Cost reimbursements due to our general partner and its affiliates for services provided, which are determined by our general partner, are substantial and reduce our cash available for distribution to our unitholders.

 

Pursuant to the Omnibus Agreement we entered into with Exterran Holdings, our general partner, and others, Exterran Holdings receives reimbursement for the payment of operating expenses related to our operations and for the provision of various general and administrative services for our benefit. Payments for these services are substantial and reduce the amount of cash available for distribution to unitholders. In addition, under Delaware partnership law, our general partner has unlimited liability for our obligations, such as our debts and environmental liabilities, except for our contractual obligations that are expressly made without recourse to our general partner. To the extent our general partner incurs obligations on our behalf, we are obligated to reimburse or indemnify it. If we are unable or unwilling to reimburse or indemnify our general partner, our general partner may take actions to cause us to make payments of these obligations and liabilities. Any such payments could reduce the amount of cash otherwise available for distribution to our unitholders.

 

Our partnership agreement limits our general partner’s fiduciary duties to holders of our common units and restricts the remedies available to holders of our common units for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty.

 

Our partnership agreement contains provisions that reduce the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty laws. For example, our partnership agreement:

 

·          permits our general partner to make a number of decisions in its individual capacity, as opposed to in its capacity as our general partner. This entitles our general partner to consider only the interests and factors that it desires, and it has no duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or any limited partner. Examples include the exercise of its limited call right, the exercise of its rights to transfer or vote the units it owns, the exercise of its registration rights and its determination whether or not to consent to any merger or consolidation of the partnership or amendment to our partnership agreement;

 

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·          provides that our general partner will not have any liability to us or our unitholders for decisions made in its capacity as a general partner so long as it acted in good faith, meaning it believed the decision was in the best interests of our partnership;

 

·          generally provides that affiliated transactions and resolutions of conflicts of interest not approved by the conflicts committee of our board of directors acting in good faith and not involving a vote of unitholders must be on terms no less favorable to us than those generally being provided to or available from unrelated third parties or must be “fair and reasonable” to us, as determined by our general partner in good faith and that, in determining whether a transaction or resolution is “fair and reasonable,” our general partner may consider the totality of the relationships between the parties involved, including other transactions that may be particularly advantageous or beneficial to us;

 

·          provides that our general partner and its officers and directors will not be liable for monetary damages to us, our limited partners or assignees for any acts or omissions unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that the general partner or those other persons acted in bad faith or engaged in fraud or willful misconduct or, in the case of a criminal matter, acted with knowledge that the conduct was criminal; and

 

·          provides that in resolving conflicts of interest, it will be presumed that in making its decision the general partner acted in good faith, and in any proceeding brought by or on behalf of any limited partner or us, the person bringing or prosecuting such proceeding will have the burden of overcoming such presumption.

 

Holders of our common units have limited voting rights and are not entitled to elect our general partner or its general partner’s directors, which could reduce the price at which the common units will trade.

 

Unlike the holders of common stock in a corporation, unitholders have only limited voting rights on matters affecting our business and, therefore, limited ability to influence management’s decisions regarding our business. Unitholders do not elect our general partner or its general partner’s board of directors, and have no right to elect our general partner or its general partner’s board of directors on an annual or other continuing basis. Our board of directors is chosen by its sole member, a subsidiary of Exterran Holdings. Furthermore, if the unitholders are dissatisfied with the performance of our general partner, they have little ability to remove our general partner. As a result of these limitations, the price at which the common units trade could be diminished because of the absence or reduction of a takeover premium in the trading price.

 

Even if holders of our common units are dissatisfied, they cannot currently remove our general partner without its consent.

 

Unitholders are unable to remove our general partner without its consent because our general partner and its affiliates own sufficient units to be able to prevent its removal. The vote of the holders of at least 66 2/3% of all outstanding common units voting together as a single class is required to remove our general partner. As of December 31, 2013, our general partner and its affiliates owned 40% of our aggregate outstanding common units.

 

Control of our general partner may be transferred to a third party without unitholder consent.

 

Our general partner, which is indirectly wholly owned by Exterran Holdings, may transfer its general partner interest to a third party in a merger, or in a sale of all or substantially all of its assets without the consent of the unitholders. Furthermore, our partnership agreement does not restrict the ability of Exterran Holdings, the owner of our general partner, from transferring all or a portion of its ownership interest in our general partner to a third party. The new owners of our general partner would then be in a position to replace the board of directors and officers of our general partner’s general partner with its own choices and thereby influence the decisions taken by the board of directors and officers.

 

We may issue additional units without unitholder approval, which would dilute our unitholders’ existing ownership interests.

 

Our partnership agreement does not limit the number of additional limited partner interests that we may issue at any time without the approval of our unitholders. The issuance of additional common units or other equity securities of equal or senior rank by us will have the following effects:

 

·          our unitholders’ proportionate ownership interest in us will decrease;

 

·          the amount of cash available for distribution on each unit may decrease;

 

·          the ratio of taxable income to distributions may increase;

 

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·          the relative voting strength of each previously outstanding unit may be diminished; and

 

·          the market price of the common units may decline.

 

Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units, other than our general partner and its affiliates, including Exterran Holdings.

 

Unitholders’ voting rights are further restricted by our partnership agreement provision providing that any units held by a person that owns 20% or more of any class of units then outstanding, other than our general partner, its affiliates, including Exterran Holdings, their transferees and persons who acquired such units with the prior approval of our board of directors, cannot vote on any matter. Our partnership agreement also contains provisions limiting the ability of unitholders to call meetings or to acquire information about our operations, as well as other provisions.

 

Affiliates of our general partner may sell common units in the public or private markets, which could have an adverse impact on the trading price of the common units.

 

At December 31, 2013, Exterran Holdings and its affiliates held 19,618,918 common units. The sale of these common units in the public or private markets could have an adverse impact on the price of the common units or on any trading market that may develop.

 

Our general partner has a limited call right that may require unitholders to sell their units at an undesirable time or price.

 

If at any time our general partner and its affiliates own more than 80% of the common units, our general partner will have the right, but not the obligation, which it may assign to any of its affiliates or to us, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price not less than their then-current market price. As a result, unitholders may be required to sell their common units at an undesirable time or price and may not receive any return on their investment. Unitholders may also incur a tax liability upon a sale of their units. At December 31, 2013, our general partner and its affiliates owned 40% of our aggregate outstanding common units.

 

Unitholder liability may not be limited if a court finds that unitholder action constitutes control of our business.

 

A general partner of a partnership generally has unlimited liability for the obligations of the partnership, except for those contractual obligations of the partnership that are expressly made without recourse to the general partner. Our partnership is organized under Delaware law and we conduct business in a number of other states. The limitations on the liability of holders of limited partner interests for the obligations of a limited partnership have not been clearly established in some of the other states in which we do business. Unitholders could be liable for any and all of our obligations as if they were a general partner if:

 

·          a court or government agency determined that we were conducting business in a state but had not complied with that particular state’s partnership statute; or

 

·          a unitholder’s right to act with other unitholders to remove or replace our general partner, to approve some amendments to our partnership agreement or to take other actions under our partnership agreement constitutes “control” of our business.

 

Unitholders may have liability to repay distributions that were wrongfully distributed to them.

 

Under certain circumstances, unitholders may have to repay amounts wrongfully returned or distributed to them. Under Section 17-607 of the Delaware Revised Uniform Limited Partnership Act, we may not make a distribution to our unitholders if the distribution would cause our liabilities to exceed the fair value of our assets. Delaware law provides that for a period of three years from the date of the impermissible distribution, limited partners who received the distribution and who knew at the time of the distribution that it violated Delaware law will be liable to the limited partnership for the distribution amount. Substituted limited partners are liable for the obligations of the assignor to make contributions to the partnership that are known to the substituted limited partner at the time it became a limited partner and for unknown obligations if the liabilities could be determined from our partnership agreement. Liabilities to partners on account of their partnership interest and liabilities that are non-recourse to the partnership are not counted for purposes of determining whether a distribution is permitted.

 

The market price of our common units may be influenced by many factors.

 

Our common units are traded publicly on the NASDAQ Global Select Market under the symbol “EXLP.”

 

The market price of our common units may be influenced by many factors, some of which are beyond our control, including:

 

·          our quarterly distributions;

 

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·          our quarterly or annual earnings or those of other companies or partnerships in our industry;

 

·          changes in commodity prices;

 

·          changes in demand for natural gas in the U.S.;

 

·          loss of a large customer;

 

·          announcements by us or our competitors of significant contracts or acquisitions;

 

·          changes in accounting standards, policies, guidance, interpretations or principles;

 

·          tax legislation;

 

·          general economic conditions;

 

·          the failure of securities analysts to cover our common units or changes in financial estimates by analysts;

 

·          future sales of our common units; and

 

·          the other factors described in these Risk Factors.

 

Increases in interest rates could adversely impact our unit price, our ability to issue additional equity or incur debt to make acquisitions or for other purposes, and our ability to make distributions to our unitholders.

 

As with other yield-oriented securities, our unit price is impacted by the level of our cash distributions and implied distribution yield. The distribution yield is often used by investors to compare and rank related yield-oriented securities for investment decision-making purposes. Therefore, changes in interest rates, either positive or negative, may affect the yield requirements of investors who invest in our units, and a rising interest rate environment could have an adverse impact on our unit price, our ability to issue additional equity or incur debt to make acquisitions or for other purposes and our ability to make distributions to our unitholders.

 

Tax Risks to Common Unitholders

 

Our tax treatment depends on our status as a partnership for federal income tax purposes. We could lose our status as a partnership for a number of reasons, including not having enough “qualifying income.” If the Internal Revenue Service (“IRS”) were to treat us as a corporation for federal income tax purposes, our cash available for distribution would be substantially reduced.

 

The anticipated after-tax economic benefit of an investment in our common units depends largely on our being treated as a partnership for federal income tax purposes. The IRS has made no determination on our partnership status or any other tax matter affecting us.

 

Despite the fact that we are a limited partnership under Delaware law, a publicly traded partnership such as us will be treated as a corporation for federal income tax purposes unless 90% or more of its gross income from its business activities is “qualifying income” under Section 7704(d) of the Internal Revenue Code. “Qualifying income” includes income and gains derived from the exploration, development, production, processing, transportation, storage and marketing of natural gas and natural gas products or other passive types of income such as interest and dividends. Although we do not believe based upon our current operations that we are treated as a corporation, we could be treated as a corporation for federal income tax purposes or otherwise subject to taxation as an entity if our gross income is not properly classified as qualifying income, there is a change in our business or there is a change in current law.

 

If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, which is currently a maximum of 35%, and would likely pay state income tax at varying rates. Distributions to unitholders would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to our unitholders. Because a tax would be imposed upon us as a corporation, our cash available for distribution would be substantially reduced. Therefore, treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.

 

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The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes and differing interpretations, possibly on a retroactive basis.

 

The present U.S. federal income tax treatment of publicly traded partnerships, including us, or an investment in our common units may be modified by administrative, legislative or judicial interpretation at any time. For example, judicial interpretations of the U.S. federal income tax laws may have a direct or indirect impact on our status as a partnership and, in some instances, a court’s conclusions may heighten the risk of a challenge regarding our status as a partnership. Moreover from time to time, members of Congress may propose and consider substantive changes to the existing U.S. federal income tax laws that could affect publicly traded partnerships. One such legislative proposal would have eliminated the qualifying income exception to the treatment of all publicly traded partnerships as corporations, upon which we rely for our treatment as a partnership for U.S. federal income tax purposes. We are unable to predict whether any of these changes, or other proposals, will be reconsidered or will ultimately be enacted. Any modification to the U.S. federal income tax laws and interpretations thereof may or may not be applied retroactively and could make it more difficult or impossible to meet the “qualifying income” exception for us to be treated as a partnership for U.S. federal income tax purposes. Any such changes or differing judicial interpretations of existing laws could negatively impact the value of an investment in our common units. Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to taxation as a corporation or otherwise subjects us to additional entity-level taxation, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

 

If we were treated as a corporation for federal income tax purposes, we would pay federal income tax on our taxable income at the corporate tax rate, and would likely pay state income tax. Distributions to unitholders would generally be taxed again as corporate distributions, and no income, gains, losses or deductions would flow through to our unitholders. Because a tax would be imposed upon us as a corporation, our cash available for distribution would be substantially reduced. Therefore, treatment of us as a corporation would result in a material reduction in the anticipated cash flow and after-tax return to the unitholders, likely causing a substantial reduction in the value of our common units.

 

If we were subjected to additional entity-level taxation by individual states, it would reduce our cash available for distribution.

 

Changes in current state law may subject us to additional entity-level taxation by individual states. Because of widespread state budget deficits and other reasons, several states are evaluating ways to subject partnerships to entity-level taxation through the imposition of state income, franchise and other forms of taxation. Currently we are subject to income and franchise taxes in several states. Imposition of such taxes on us reduces the cash available for distribution to our unitholders and may adversely affect the value of our common units. Our partnership agreement provides that if a law is enacted or existing law is modified or interpreted in a manner that subjects us to additional amounts of entity-level taxation, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.

 

If the IRS contests the federal income tax positions we take, the market for our common units may be adversely affected, and the costs of any IRS contest will reduce our cash available for distribution.

 

The IRS has made no determination with respect to our treatment as a partnership for federal income tax purposes, the classification of any of the gross income from our business operations as “qualifying income” under Section 7704 of the Internal Revenue Code, or any other matter affecting us. The IRS may adopt positions that differ from the positions we take. It may be necessary to resort to administrative or court proceedings to sustain some or all of the positions we take, and a court may not agree with some or all of those positions. Any contest with the IRS may materially and adversely impact the market for our common units and the price at which they trade. In addition, the costs of any contest with the IRS will result in a reduction in cash available for distribution and thus will be borne indirectly by our unitholders and our general partner.

 

Unitholders are required to pay taxes on their share of our income even if they do not receive any cash distributions from us.

 

Because our unitholders are treated as partners to whom we will allocate taxable income, which could be different in amount than the cash we distribute, they will be required to pay any federal income taxes and, in some cases, state and local income taxes on their share of our taxable income even if they receive no cash distributions from us. Unitholders may not receive cash distributions from us equal to their share of our taxable income or even equal to the actual tax liability that results from that income.

 

Tax gain or loss on the disposition of our common units could be more or less than expected.

 

Unitholders who sell common units recognize a gain or loss equal to the difference between the amount realized and their tax basis in those common units. Because distributions in excess of their allocable share of our net taxable income decrease their tax basis in their common units, the amount, if any, of such prior excess distributions with respect to the common units they sell will, in effect, become taxable income to them if they sell such common units at a price greater than their tax basis in those common units, even if the price received is less than the original cost. Furthermore, a substantial portion of the amount realized, whether or not representing gain, may be taxed as ordinary income due to potential recapture items, including depreciation recapture. In addition, because the amount realized includes a unitholder’s share of our nonrecourse liabilities, unitholders who sell their units may incur a tax liability in excess of the amount of cash they receive from the sale.

 

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Tax-exempt entities and non-U.S. persons face unique tax issues from owning our common units that may result in adverse tax consequences to them.

 

Investment in common units by tax-exempt entities, such as employee benefit plans and individual retirement accounts (“IRAs”), and non-U.S. persons raises issues unique to them. For example, virtually all of our income allocated to organizations that are exempt from federal income tax, including IRAs and other retirement plans, will be unrelated business taxable income and will be taxable to them. Distributions to non-U.S. persons will be reduced by withholding taxes imposed at the highest applicable effective tax rate, and non-U.S. persons will be required to file U.S. federal tax returns and pay tax on their share of our taxable income. Tax-exempt entities or a non-U.S. persons should consult their tax advisors before investing in our common units.

 

We treat each purchaser of our common units as having the same tax benefits without regard to the actual common units purchased. The IRS may challenge this treatment, which could adversely affect the value of the common units.

 

Due to a number of factors, including our inability to match transferors and transferees of common units, we have adopted depreciation and amortization positions that may not conform to all aspects of existing Treasury Regulations. A successful IRS challenge to those positions could adversely affect the amount of tax benefits available to unitholders. It also could affect the timing of these tax benefits or the amount of gain from the sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to unitholders’ tax returns.

 

We prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The IRS may challenge this treatment, and, if successful, we would be required to change the allocation of items of income, gain, loss and deduction among our unitholders.

 

We prorate our items of income, gain, loss and deduction between transferors and transferees of our units each month based upon the ownership of our units on the first day of each month, instead of on the basis of the date a particular unit is transferred. The use of this proration method may not be permitted under existing Treasury regulations. The U.S. Treasury Department’s proposed Treasury Regulations allowing a similar monthly simplifying convention are not final and do not specifically authorize the use of the proration method we have adopted. If the IRS were to successfully challenge this method or new Treasury Regulations were issued, we could be required to change the allocation of items of income, gain, loss and deduction among our unitholders.

 

A unitholder whose units are the subject of a securities loan (e.g. a loan to a “short seller” to cover a short sale of units) may be considered to have disposed of those units. If so, he would no longer be treated for tax purposes as a partner with respect to those units during the period of the loan and may recognize gain or loss from the disposition.

 

Because there are no specific rules governing the federal income consequences of loaning a partnership interest, a unitholder whose units are the subject of securities loan may be considered to have disposed of the loaned units. In that case, the unitholder may no longer be treated as a partner for tax purposes with respect to those units and may recognize gain or loss from such disposition during the period of the loan. Moreover, during the period of such loan to the short seller, any of our income, gain, loss or deduction with respect to those units may not be reportable by the unitholder and any cash distributions received by the unitholder for those units could be fully taxable as ordinary income. Unitholders desiring to assure their status as partners and avoid the risk of gain recognition from a securities loan are urged to modify any applicable brokerage account agreements to prohibit their brokers from borrowing their units.

 

We have adopted certain valuation methodologies that could result in a shift of income, gain, loss and deduction between our general partner and the unitholders. The IRS may successfully challenge this treatment, which could adversely affect the value of our common units.

 

When we issue additional units or engage in certain other transactions, we determine the fair market value of our assets and allocate any unrealized gain or loss attributable to our assets to the capital accounts of our unitholders and our general partner. Our methodology may be viewed as understating the value of our assets. In that case, there may be a shift of income, gain, loss and deduction between certain unitholders and our general partner, which may be unfavorable to such unitholders. Moreover, under our valuation methods, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to our tangible assets and a lesser portion allocated to our intangible assets. The IRS may challenge our valuation methods, or our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets, and allocations of income, gain, loss and deduction between the general partner and certain of our unitholders.

 

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A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to our unitholders. It also could affect the amount of gain from our unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.

 

The sale or exchange of 50% or more of our capital and profits interests during any twelve-month period will result in the termination of our partnership for federal income tax purposes.

 

We will be considered to have constructively terminated as a partner for federal income tax purposes if there is a sale or exchange of 50% or more of the total interests in our capital and profits within a twelve-month period. For purposes of determining whether the 50% threshold has been met, multiple sales of the same unit will count only once. Our termination would, among other things, result in the closing of our taxable year for all unitholders, which would result in us filing two tax returns for one calendar year. However, pursuant to an IRS relief procedure, the IRS may allow, among other things, a constructively terminated partnership to provide a single Schedule K-1 for the calendar year in which a termination occurs. Our termination could also result in a deferral of depreciation deductions allowable in computing our taxable income. In the case of a unitholder reporting on a taxable year other than a calendar year ending December 31, the closing of our taxable year may also result in more than twelve months of our taxable income or loss being includable in his taxable income for the year of termination. Our termination currently would not affect our classification as a partnership for federal income tax purposes, but instead, we would be treated as a new partnership for tax purposes. If treated as a new partnership, we must make new tax elections and could be subject to penalties if we are unable to determine that a termination occurred.

 

Unitholders may become subject to international, state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire property.

 

In addition to federal income taxes, unitholders will likely be subject to other taxes, including international, state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we do business or own or acquire property now or in the future, even if they do not live in any of those jurisdictions. Unitholders will likely be required to file international, state and local income tax returns and pay state and local income taxes in some or all of these jurisdictions. Further, they may be subject to penalties for failure to comply with those requirements. We conduct business and/or own assets in the states of Alabama, Arkansas, California, Colorado, Illinois, Kansas, Kentucky, Louisiana, Michigan, Mississippi, Missouri, Montana, Nebraska, New Mexico, New York, North Dakota, Ohio, Oklahoma, Pennsylvania, Tennessee, Texas, Utah, West Virginia and Wyoming. Each of these states, other than Tennessee, Texas and Wyoming, currently imposes a personal income tax on individuals. A majority of these states impose an income tax on corporations and other entities that may be unitholders. As we make acquisitions or expand our business, we may conduct business or own assets in additional states that impose a personal income tax or that impose entity level taxes to which certain unitholders could be subject. It is each unitholder’s responsibility to file all applicable U.S. federal, international, state and local tax returns.

 

Item 1B.  Unresolved Staff Comments

 

None.

 

Item 2.  Properties

 

Our executive office is located at 16666 Northchase Drive, Houston, Texas 77060 and our telephone number is 281-836-7000. We do not own or lease any material facilities or properties. Pursuant to our Omnibus Agreement, we reimburse Exterran Holdings for the cost of our pro rata portion of the properties we utilize in connection with our business.

 

Item 3.  Legal Proceedings

 

In 2011, the Texas Legislature enacted changes related to the appraisal of natural gas compressors for ad valorem tax purposes by expanding the definitions of “Heavy Equipment Dealer” and “Heavy Equipment” effective from the beginning of 2012 (the “Heavy Equipment Statutes”). Under the revised statutes, we believe we are a Heavy Equipment Dealer, that our natural gas compressors are Heavy Equipment and that we, therefore, are required to file our ad valorem tax renditions under this new methodology. A large number of appraisal review boards denied our position, although some accepted it, and we filed 82 petitions for review in the appropriate district courts with respect to the 2012 tax year and 97 petitions for review in the appropriate district courts with respect to the 2013 tax year. Since we filed the petitions, many of the cases, pending in the same county, have been consolidated. Only five cases have advanced to the point of trial or submission of summary judgment motions, and only two cases have been decided, with both decisions rendered by the same presiding judge.

 

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On October 17, 2013, the 143rd Judicial District Court of Loving County, Texas ruled in EXLP Leasing LLC & EES Leasing LLC v. Loving County Appraisal District that EES and EXLP are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment, but the district court further held that the Heavy Equipment Statutes were unconstitutional as applied to EES’s and EXLP’s compressors. EES and EXLP have appealed the district court’s constitutionality holding to the Eighth Court of Appeals in El Paso, Texas. No hearing date for the appeal has yet been set.

 

On October 28, 2013, the 143rd Judicial District Court of Ward County, Texas ruled in EES Leasing LLC & EXLP Leasing LLC v. Ward County Appraisal District that EES and EXLP are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment, but the court again held that the Heavy Equipment Statutes were unconstitutional as applied to the EES’s and EXLP’s compressors. EES and EXLP have appealed the district court’s constitutionality holding to the Eighth Court of Appeals in El Paso, Texas, and the Ward County Appraisal District has cross-appealed the district court’s ruling that EES and EXLP are Heavy Equipment Dealers and that their compressors qualify as Heavy Equipment. No hearing date for the appeal has yet been set.

 

We have filed motions for summary judgment in three other state district court cases (EES Leasing v. Irion County Appraisal District pending in the 51st Judicial District Court of Irion County, Texas; EES Leasing LLC & EXLP Leasing LLC v. Harris County Appraisal District pending in the 189th Judicial District Court of Harris County, Texas; and EXLP Leasing LLC & EES Leasing LLC v. Galveston Central Appraisal District pending in the 10th Judicial District Court of Galveston County, Texas) but have not yet received the courts’ decisions. No trial date has been set with respect to the first two of these lawsuits. In the third lawsuit, trial is set for March 12, 2014.

 

We continue to believe that the revised statutes are constitutional as applied to natural gas compressors. Recognizing the similarity of the issues and that these cases will ultimately be resolved by the Texas appellate courts, we have reached, or intend to reach, agreements with appraisal districts to stay or abate other pending 2012 and 2013 district court cases. Please see Note 13 (“Commitments and Contingencies”) to the Financial Statements included in this report for a discussion of our ad valorem tax expense and benefit relating to the Heavy Equipment Statutes, which is incorporated by reference into this Item 3.

 

In the ordinary course of business, we are also involved in various other pending or threatened legal actions. While management is unable to predict the ultimate outcome of these actions, it believes that any ultimate liability arising from any of these other actions will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to make cash distributions to our unitholders. However, because of the inherent uncertainty of litigation, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our consolidated financial position, results of operations or cash flows, including our ability to make cash distributions to our unitholders.

 

Item 4.  Mine Safety Disclosures

 

Not applicable.

 

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Table of Contents

 

PART II

 

Item 5.  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Our common units trade on the NASDAQ Global Select Market under the symbol “EXLP”. On February 18, 2014, the closing price of a common unit was $29.28. At the close of business on February 11, 2014, based upon information received from our transfer agent and brokers and nominees, we had 14 registered common unitholders and approximately 14,200 street name holders. The following table sets forth the range of high and low sale prices for our common units and cash distributions declared per common unit for the periods indicated.

 

 

 

Price Range

 

Cash Distribution
Declared per

 

 

 

High

 

Low

 

Common Unit(1)

 

Year Ended December 31, 2012:

 

 

 

 

 

 

 

First Quarter

 

$

25.00

 

$

20.28

 

$

0.4975

 

Second Quarter

 

$

22.72

 

$

18.30

 

$

0.5025

 

Third Quarter

 

$

23.10

 

$

19.14

 

$

0.5075

 

Fourth Quarter

 

$

23.57

 

$

19.65

 

$

0.5125

 

Year Ended December 31, 2013:

 

 

 

 

 

 

 

First Quarter

 

$

26.45

 

$

20.50

 

$

0.5175

 

Second Quarter

 

$

31.44

 

$

26.11

 

$

0.5225

 

Third Quarter

 

$

32.39

 

$

26.77

 

$

0.5275

 

Fourth Quarter

 

$

31.48

 

$

25.61

 

$

0.5325

 

 


(1)                  Cash distributions declared for each quarter are paid in the following calendar quarter.

 

For disclosures regarding securities authorized for issuance under equity compensation plans, see Part III, Item 12 (“Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”).

 

Cash Distribution Policy

 

Within 45 days after the end of each quarter, we will distribute all of our available cash (as defined in our partnership agreement) to unitholders of record on the applicable record date. However, there is no guarantee that we will pay any specific distribution level on the units in any quarter. Even if our cash distribution policy is not modified or revoked, the amount of distributions paid under our policy and the decision to make any distribution is determined by our general partner, taking into consideration the terms of our partnership agreement. We will be prohibited from making any distributions to unitholders if doing so would cause an event of default, or an event of default exists, under our senior secured credit facility.

 

We make distributions of available cash (as defined in our partnership agreement) from operating surplus in the following manner:

 

·          first, 98% to the common unitholders, pro rata, and 2% to our general partner, until we distribute for each outstanding common unit an amount equal to the minimum quarterly distribution for that quarter;

 

·          second, 98% to common unitholders, pro rata, and 2% to our general partner, until each unit has received a distribution of $0.4025;

 

·          third, 85% to all common unitholders, pro rata, and 15% to our general partner, until each unit has received a distribution of $0.4375;

 

·          fourth, 75% to all common unitholders, pro rata, and 25% to our general partner, until each unit has received a total of $0.525; and

 

·          thereafter, 50% to all common unitholders, pro rata, and 50% to our general partner.

 

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Item 6.  Selected Financial Data

 

The table below shows selected financial data for Exterran Partners, L.P. for each of the five years in the period ended December 31, 2013, which has been derived from our audited Financial Statements. The following information should be read together with Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Financial Statements contained in this report (in thousands, except per unit data):

 

 

 

Years Ended December 31,

 

 

 

2013(1)

 

2012(1)

 

2011(1)

 

2010(1)

 

2009(1)

 

Statement of Operations Data

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

466,193

 

$

387,493

 

$

308,274

 

$

237,636

 

$

181,729

 

Gross margin(2)

 

264,148

 

204,333

 

145,349

 

113,394

 

98,249

 

Depreciation and amortization

 

103,711

 

88,298

 

67,930

 

52,518

 

36,452

 

Long-lived asset impairment(3)

 

5,350

 

29,560

 

1,060

 

24,976

 

3,151

 

Selling, general and administrative — affiliates

 

61,971

 

49,889

 

39,380

 

34,830

 

24,226

 

Interest expense

 

37,068

 

25,167

 

30,400

 

24,037

 

20,303

 

Other (income) expense, net

 

(9,481

)

(35

)

(392

)

(314

)

(1,208

)

Provision for income taxes

 

1,506

 

945

 

918

 

680

 

541

 

Net income (loss)

 

64,023

 

10,509

 

6,053

 

(23,333

)

14,784

 

Weighted average common units outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

47,651

 

41,371

 

31,390

 

21,360

 

13,461

 

Diluted

 

47,667

 

41,382

 

31,403

 

21,360

 

13,477

 

Weighted average subordinated units outstanding:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

3,747

 

5,731

 

6,325

 

Diluted

 

 

 

 

 

3,747

 

5,731

 

6,325

 

Income (loss) per common unit:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.18

 

$

0.14

 

$

0.09

 

$

(0.90

)

$

0.68

 

Diluted

 

$

1.18

 

$

0.14

 

$

0.09

 

$

(0.90

)

$

0.68

 

Income (loss) per subordinated unit:

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

 

 

 

$

0.09

 

$

(0.90

)

$

0.68

 

Diluted

 

 

 

 

 

$

0.09

 

$

(0.90

)

$

0.68

 

Other Financial Data:

 

 

 

 

 

 

 

 

 

 

 

EBITDA, as further adjusted(2)

 

$

238,012

 

$

180,034

 

$

139,290

 

$

104,807

 

$

83,840

 

Distributable cash flow(2)

 

$

152,976

 

$

117,966

 

$

90,284

 

$

66,831

 

$

49,809

 

Capital expenditures:

 

 

 

 

 

 

 

 

 

 

 

Expansion(4)

 

$

126,635

 

$

119,460

 

$

21,389

 

$

12,215

 

$

5,308

 

Maintenance(5)

 

41,401

 

38,368

 

28,861

 

15,898

 

12,585

 

Cash flows provided by (used in):

 

 

 

 

 

 

 

 

 

 

 

Operating activities

 

$

158,286

 

$

125,217

 

$

80,090

 

$

43,682

 

$

55,936

 

Investing activities

 

(117,132

)

(228,940

)

(106,463

)

(29,042

)

(7,422

)

Financing activities

 

(41,114

)

103,860

 

26,328

 

(14,793

)

(51,555

)

Cash distributions declared and paid per limited partner unit in respective periods

 

$

2.0800

 

$

2.0000

 

$

1.9200

 

$

1.8550

 

$

1.8500

 

 

 

 

December 31,

 

 

 

2013(1)

 

2012(1)

 

2011(1)

 

2010(1)

 

2009(1)

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

182

 

$

142

 

$

5

 

$

50

 

$

203

 

Working capital(6)

 

46,802

 

1,661

 

21,121

 

14,751

 

4,094

 

Total assets

 

1,368,063

 

1,163,536

 

991,005

 

813,345

 

717,226

 

Long-term debt

 

757,955

 

680,500

 

545,500

 

449,000

 

432,500

 

Partners’ capital

 

591,755

 

439,000

 

423,766

 

350,737

 

258,308

 

 


(1)         In March 2013, March 2012, June 2011, August 2010 and November 2009 we acquired from Exterran Holdings contract operations customer service agreements and a fleet of compressor units used to provide compression services under those agreements. An acquisition of a business from an entity under common control is generally accounted for in accordance with accounting principles generally accepted in the U.S. (“GAAP”) by the acquirer with retroactive application as if the acquisition date was the beginning of the earliest period included in the financial statements. Retroactive effect of these acquisitions was impracticable because such retroactive application would have required significant assumptions in a prior period that cannot be substantiated. Accordingly, our financial statements include the assets acquired, liabilities assumed, revenue and direct operating expenses associated with the acquisitions beginning on the date of each such acquisition.

 

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(2)         Gross margin, EBITDA, as further adjusted, and distributable cash flow are non-GAAP financial measures. They are defined, reconciled to net income (loss) and discussed further in “Non-GAAP Financial Measures” below.

 

(3)         During 2013, we evaluated the future deployment of our idle fleet and determined to retire and either sell or re-utilize the key components of approximately 110 idle compressor units, representing approximately 25,000 horsepower, previously used to provide services. As a result, we performed an impairment review and recorded a $5.4 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use.

 

During 2012, we evaluated the future deployment of our idle fleet and determined to retire and either sell or re-utilize the key components of approximately 260 idle compressor units, representing approximately 71,000 horsepower, previously used to provide services. As a result, we performed an impairment review and recorded a $22.2 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. In connection with our 2012 fleet review, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale. Based upon that review, we reduced the expected proceeds from disposition for most of the remaining units and increased the weighted average disposal period for the units from the assumptions used in prior periods. This resulted in an additional impairment of $7.4 million to reduce the book value of each unit to its estimated fair value.

 

During 2011, 2010 and 2009, we reviewed our idle compression fleet for units that were not of the type, configuration, make or model that are cost effective to maintain and operate. Our estimate of the impaired long-lived asset’s fair value was based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. The net book value of these assets exceeded the fair value by $1.1 million, $0.4 million and $3.2 million, respectively, during the years ended December 31, 2011, 2010 and 2009, and was recorded as a long-lived asset impairment. Additionally, during December 2010, we completed an evaluation of our longer-term strategies and determined to retire and sell approximately 370 idle compressor units, representing approximately 117,000 horsepower, previously used to provide services in our business. As a result of this decision to sell these compressor units, we performed an impairment review and based on that review, recorded a $24.6 million asset impairment to reduce the book value of each unit to its estimated fair value.

 

(4)         Expansion capital expenditures are made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue of existing or new assets, whether through construction, acquisition or modification.

 

(5)         Maintenance capital expenditures are made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets.

 

(6)        Working capital is defined as current assets minus current liabilities.

 

Non-GAAP Financial Measures

 

We define gross margin as total revenue less cost of sales (excluding depreciation and amortization expense). Gross margin is included as a supplemental disclosure because it is a primary measure used by our management to evaluate the results of revenue and cost of sales (excluding depreciation and amortization expense), which are key components of our operations. We believe gross margin is important because it focuses on the current operating performance of our operations and excludes the impact of the prior historical costs of the assets acquired or constructed that are utilized in those operations, the indirect costs associated with our SG&A activities, the impact of our financing methods and income taxes. Depreciation and amortization expense may not accurately reflect the costs required to maintain and replenish the operational usage of our assets and therefore may not portray the costs from current operating activity. As an indicator of our operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income (loss) as determined in accordance with GAAP. Our gross margin may not be comparable to a similarly titled measure of another company because other entities may not calculate gross margin in the same manner.

 

Gross margin has certain material limitations associated with its use as compared to net income (loss). These limitations are primarily due to the exclusion of interest expense, depreciation and amortization expense, SG&A expense and impairment charges. Each of these excluded expenses is material to our consolidated statements of operations. Because we intend to finance a portion of our operations through borrowings, interest expense is a necessary element of our costs and our ability to generate revenue. Additionally, because we use capital assets, depreciation expense is a necessary element of our costs and our ability to generate revenue, and SG&A expenses are necessary to support our operations and required partnership activities. To compensate for these limitations, management uses this non-GAAP measure as a supplemental measure to other GAAP results to provide a more complete understanding of our performance.

 

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Table of Contents

 

The following table reconciles our net income (loss) to gross margin (in thousands):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

Net income (loss)

 

$

64,023

 

$

10,509

 

$

6,053

 

$

(23,333

)

$

14,784

 

Depreciation and amortization

 

103,711

 

88,298

 

67,930

 

52,518

 

36,452

 

Long-lived asset impairment

 

5,350

 

29,560

 

1,060

 

24,976

 

3,151

 

Selling, general and administrative — affiliates

 

61,971

 

49,889

 

39,380

 

34,830

 

24,226

 

Interest expense

 

37,068

 

25,167

 

30,400

 

24,037

 

20,303

 

Other (income) expense, net

 

(9,481

)

(35

)

(392

)

(314

)

(1,208

)

Provision for income taxes

 

1,506

 

945

 

918

 

680

 

541

 

Gross margin

 

$

264,148

 

$

204,333

 

$

145,349

 

$

113,394

 

$

98,249

 

 

We define EBITDA, as further adjusted, as net income (loss) excluding income taxes, interest expense (including debt extinguishment costs and gain or loss on termination of interest rate swaps), depreciation and amortization expense, impairment charges, other charges, non-cash SG&A costs and any amounts by which cost of sales and SG&A costs are reduced as a result of caps on these costs contained in the Omnibus Agreement, which amounts are treated as capital contributions from Exterran Holdings for accounting purposes. We believe EBITDA, as further adjusted, is an important measure of operating performance because it allows management, investors and others to evaluate and compare our core operating results from period to period by removing the impact of our capital structure (interest expense from our outstanding debt), asset base (depreciation and amortization expense, impairment charges), tax consequences, caps on operating and SG&A costs, non-cash SG&A costs and reimbursements. Management uses EBITDA, as further adjusted, as a supplemental measure to review current period operating performance, comparability measures and performance measures for period to period comparisons. Our EBITDA, as further adjusted, may not be comparable to a similarly titled measure of another company because other entities may not calculate EBITDA in the same manner.

 

EBITDA, as further adjusted, is not a measure of financial performance under GAAP, and should not be considered in isolation or as an alternative to net income (loss), cash flows from operating activities and other measures determined in accordance with GAAP. Items excluded from EBITDA, as further adjusted, are significant and necessary components to the operations of our business, and, therefore, EBITDA, as further adjusted, should only be used as a supplemental measure of our operating performance.

 

The following table reconciles our net income (loss) to EBITDA, as further adjusted (in thousands):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

Net income (loss)

 

$

64,023

 

$

10,509

 

$

6,053

 

$

(23,333

)

$

14,784

 

Provision for income taxes

 

1,506

 

945

 

918

 

680

 

541

 

Depreciation and amortization

 

103,711

 

88,298

 

67,930

 

52,518

 

36,452

 

Long-lived asset impairment

 

5,350

 

29,560

 

1,060

 

24,976

 

3,151

 

Cap on operating and selling, general and administrative costs provided by Exterran Holdings

 

25,180

 

24,758

 

32,397

 

24,720

 

7,798

 

Non-cash selling, general and administrative costs — affiliates

 

1,174

 

797

 

532

 

1,209

 

811

 

Interest expense

 

37,068

 

25,167

 

30,400

 

24,037

 

20,303

 

EBITDA, as further adjusted

 

$

238,012

 

$

180,034

 

$

139,290

 

$

104,807

 

$

83,840

 

 

We define distributable cash flow as net income (loss) plus depreciation and amortization expense, impairment charges, non-cash SG&A costs, interest expense and any amounts by which cost of sales and SG&A costs are reduced as a result of caps on these costs contained in the Omnibus Agreement, which amounts are treated as capital contributions from Exterran Holdings for accounting purposes, less cash interest expense (excluding amortization of deferred financing fees, amortization of debt discount and non-cash transactions related to interest rate swaps) and maintenance capital expenditures, and excluding gains or losses on asset sales and other charges. We believe distributable cash flow is an important measure of operating performance because it allows management, investors and others to compare basic cash flows we generate (prior to the establishment of any retained cash reserves by our general partner) to the cash distributions we expect to pay our unitholders. Using distributable cash flow, management can quickly compute the coverage ratio of estimated cash flows to planned cash distributions. Our distributable cash flow may not be comparable to a similarly titled measure of another company because other entities may not calculate distributable cash flow in the same manner.

 

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Table of Contents

 

Distributable cash flow is not a measure of financial performance under GAAP, and should not be considered in isolation or as an alternative to net income (loss), cash flows from operating activities and other measures determined in accordance with GAAP. Items excluded from distributable cash flow are significant and necessary components to the operations of our business, and, therefore, distributable cash flow should only be used as a supplemental measure of our operating performance.

 

The following table reconciles our net income (loss) to distributable cash flow (in thousands, except ratios):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

2011

 

2010

 

2009

 

Net income (loss)

 

$

64,023

 

$

10,509

 

$

6,053

 

$

(23,333

)

$

14,784

 

Depreciation and amortization

 

103,711

 

88,298

 

67,930

 

52,518

 

36,452

 

Long-lived asset impairment

 

5,350

 

29,560

 

1,060

 

24,976

 

3,151

 

Cap on operating and selling, general and administrative costs provided by Exterran Holdings

 

25,180

 

24,758

 

32,397

 

24,720

 

7,798

 

Non-cash selling, general and administrative costs — affiliates

 

1,174

 

797

 

532

 

1,209

 

811

 

Interest expense

 

37,068

 

25,167

 

30,400

 

24,037

 

20,303

 

Expensed acquisition costs

 

575

 

695

 

514

 

356

 

803

 

Other expensed costs

 

246

 

 

 

 

 

Less: Gain on sale of property, plant and equipment

 

(10,140

)

(689

)

(919

)

(667

)

(2,011

)

Less: Cash interest expense

 

(32,810

)

(22,761

)

(18,822

)

(21,087

)

(19,697

)

Less: Maintenance capital expenditures

 

(41,401

)

(38,368

)

(28,861

)

(15,898

)

(12,585

)

Distributable cash flow

 

$

152,976

 

$

117,966

 

$

90,284

 

$

66,831

 

$

49,809

 

 

 

 

 

 

 

 

 

 

 

 

 

Distributions declared to all unitholders for the period, including incentive distributions rights

 

$

112,705

 

$

91,617

 

$

74,214

 

$

54,913

 

$

39,404

 

Distributable cash flow coverage(1)

 

1.36

x

1.29

x

1.22

x

1.22

x

1.26

x

 


(1)         Defined as distributable cash flow for the period divided by distributions declared to all unitholders for the period, including incentive distribution rights.

 

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Item 7.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Financial Statements, the notes thereto, and the other financial information appearing elsewhere in this report. The following discussion includes forward-looking statements that involve certain risks and uncertainties. See Part I (“Disclosure Regarding Forward-Looking Statements”) and Part I, Item 1A (“Risk Factors”) in this report.

 

Overview

 

We are a Delaware limited partnership formed in June 2006 to provide natural gas contract operations services to customers throughout the U.S. Our contract operations services primarily include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining equipment to provide natural gas compression services to our customers.

 

Our customers typically contract for our contract operations services on a site-by-site basis for a specific monthly service rate that is reduced if we fail to operate in accordance with the contract terms. Following the initial minimum term for our contract compression services, which is typically between six and twelve months, contract compression services generally continue until terminated by either party with 30 days’ advance notice. Our customers generally are required to pay our monthly service fee even during periods of limited or disrupted natural gas flows, which enhances the stability and predictability of our cash flows. See “General Terms of Our Contract Operations Customer Service Agreements,” in Part I, Item 1 (“Business”), for a more detailed description.

 

Generally, our overall business activity and revenue increase as the demand for natural gas increases. Demand for our compression services is linked more directly to natural gas consumption and production than to exploration activities, which helps limit our direct exposure to commodity price risk. Because we typically do not take title to the natural gas we compress, and the natural gas we use as fuel for our compressors is supplied by our customers, our direct exposure to commodity price risk is further reduced.

 

Industry Conditions and Trends

 

Our business environment and corresponding operating results are affected by the level of energy industry spending for the exploration, development and production of oil and natural gas reserves in the U.S. Spending by oil and natural gas exploration and production companies is dependent upon these companies’ forecasts regarding the expected future supply, demand and pricing of oil and natural gas products as well as their estimates of risk-adjusted costs to find, develop and produce reserves. Although we believe our business is typically less impacted by commodity prices than certain other oil and natural gas service providers, changes in natural gas exploration and production spending normally results in changes in demand for our services.

 

Natural gas consumption in the U.S. for the twelve months ended November 30, 2013 remained relatively flat compared to the twelve months ended November 30, 2012. The U.S. Energy Information Administration (“EIA”) forecasts that total U.S. natural gas consumption will decrease by 1.3% in 2014 compared to 2013 and increase by an average of 0.7% per year thereafter until 2040.

 

Natural gas marketed production in the U.S. for the twelve months ended November 30, 2013 increased by approximately 1.1% over the twelve months ended November 30, 2012. The EIA forecasts that total U.S. natural gas marketed production will increase by 2.2% in 2014 compared to 2013 and U.S. natural gas production will increase by an average of 1.5% per year thereafter until 2040.

 

Our Performance Trends and Outlook

 

Our results of operations depend upon the level of activity in the U.S. energy market. Oil and natural gas prices and the level of drilling and exploration activity can be volatile. For example, oil and natural gas exploration and development activity and the number of well completions typically decline when there is a significant reduction in oil and natural gas prices or significant instability in energy markets.

 

Our revenue, earnings and financial position are affected by, among other things, market conditions that impact demand and pricing for natural gas compression, our customers’ decisions between using our services or our competitors’ services, our customers’ decisions regarding whether to own and operate the equipment themselves, and the timing and consummation of acquisitions of additional contract operations customer service agreements and equipment from Exterran Holdings or others. As we believe there will continue to be a high level of activity in certain U.S. areas focused on the production of oil and natural gas liquids, we anticipate investing more capital in new fleet units in 2014 than we did in 2013.

 

In the second half of 2011, Exterran Holdings, which provides all operational staff, corporate staff and support services necessary to operate our business, embarked on a multi-year plan to improve the profitability of its operations, including the operations of our business. Exterran Holdings implemented certain key profitability initiatives associated with this plan in 2012 and implemented additional process initiatives intended to improve operating efficiency and reduce cost structure throughout 2013. These initiatives have positively impacted our business, and we expect additional positive impact in 2014.

 

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During 2013, we saw steady activity in certain shale plays and areas focused on the production of oil and natural gas liquids. This activity has increased the overall amount of compression horsepower in the industry; however, these increases continue to be offset by horsepower declines in more mature and predominantly dry gas markets, where we provide a significant amount of contract operations services. In early 2012, natural gas prices in the U.S. fell to their lowest levels in more than a decade, but recovered some of the 2012 decline during 2013. Historically, natural gas prices in the U.S. have been volatile. During periods of lower natural gas prices, natural gas production growth could be limited or decline in the U.S., particularly in dry gas areas. A 1% decrease in average operating horsepower of our contract operations fleet during the year ended December 31, 2013 would have resulted in a decrease of approximately $4.7 million and $2.6 million in our revenue and gross margin (defined as revenue less cost of sales, excluding depreciation and amortization expense), respectively. Gross margin is a non-GAAP financial measure. For a reconciliation of gross margin to net income (loss), its most directly comparable financial measure, calculated and presented in accordance with GAAP, please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”).

 

Exterran Holdings intends for us to be the primary long-term growth vehicle for its U.S. contract operations business and intends, but is not obligated, to offer us the opportunity to purchase the remainder of its U.S. contract operations business over time. Likewise, we are not required to purchase any additional portions of such business. The consummation of any future purchase of additional portions of Exterran Holdings’ U.S. contract operations business and the timing of any such purchase will depend upon, among other things, our ability to reach an agreement with Exterran Holdings regarding the terms of such purchase, which will require the approval of the conflicts committee of our board of directors. The timing of such transactions would also depend on, among other things, market and economic conditions and our access to additional debt and equity capital. Future acquisitions of assets from Exterran Holdings may increase or decrease our operating performance, financial position and liquidity. Unless otherwise indicated, this discussion of performance trends and outlook excludes any future potential transfers of additional contract operations customer service agreements and equipment from Exterran Holdings to us.

 

Certain Key Challenges and Uncertainties

 

Market conditions in the natural gas industry and competition in the natural gas compression industry represent key challenges and uncertainties. In addition to these, we believe the following represent some of the key challenges and uncertainties we will face in the near future:

 

Dependence on Cost Caps with Exterran Holdings.  Under the Omnibus Agreement, our obligation to reimburse Exterran Holdings for any cost of sales that it incurs in the operation of our business and any cash SG&A expense allocated to us is capped (after taking into account any such costs we incur and pay directly) through December 31, 2014. During 2013, 2012 and 2011, cost of sales was capped at $21.75 per operating horsepower per quarter, and is capped at $22.50 per operating horsepower per quarter from January 1, 2014 through December 31, 2014. SG&A costs were capped at $7.6 million per quarter from November 10, 2009 through June 9, 2011, $9.0 million per quarter from June 10, 2011 through March 7, 2012, $10.5 million per quarter from March 8, 2012 through March 31, 2013 and $12.5 million per quarter from April 1, 2013 through December 31, 2013, and are capped at $15.0 million per quarter from January 1, 2014 through December 31, 2014. Our cost of sales exceeded the cap provided in the Omnibus Agreement by $12.4 million, $16.6 million and $26.5 million during 2013, 2012, and 2011, respectively. Our SG&A expenses exceeded the cap provided in the Omnibus Agreement by $12.8 million, $8.2 million and $5.9 million during 2013, 2012 and 2011, respectively. Accordingly, our EBITDA, as further adjusted, and our distributable cash flow (please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”) for a discussion of EBITDA, as further adjusted, and distributable cash flow) would have been approximately $25.2 million, $24.8 million and $32.4 million lower during 2013, 2012 and 2011, respectively, without the benefit of the cost caps. As a result, without the benefit of the cost caps, our distributable cash flow coverage (distributable cash flow for the period divided by distributions declared to all unitholders for the period, including incentive distribution rights) would have been 1.13x, 1.02x and 0.78x during 2013, 2012 and 2011, respectively, rather than the actual distributable cash flow coverage (which includes the benefit of cost caps) of 1.36x, 1.29x and 1.22x during 2013, 2012, and 2011, respectively. These cost caps expire on December 31, 2014 and Exterran Holdings is under no obligation to extend them. The expiration of these caps, without an extension to them under the Omnibus Agreement, would likely reduce the amount of cash flow available to unitholders and, accordingly, may impair our ability to maintain or increase our distributions.

 

U.S. Market and Natural Gas Pricing.  During 2013, we saw steady activity in certain shale plays and areas focused on the production of oil and natural gas liquids. This activity has increased the overall amount of compression horsepower in the industry; however, these increases continue to be offset by horsepower declines in more mature and predominantly dry gas markets, where we provide a significant amount of contract operations services. In early 2012, natural gas prices in the U.S. fell to their lowest levels in more than a decade, but recovered some of the 2012 decline during 2013. Historically, natural gas prices in the U.S. have been volatile. During periods of lower natural gas prices, natural gas production growth could be limited or decline in the U.S., particularly in dry gas areas, and as a result, the demand for our natural gas compression services could be adversely affected. The recent investment of capital in new equipment by our competitors and other third parties could also create uncertainty in our business outlook. Many of our contracts with customers have short initial terms and are typically cancelable on short notice after the initial term, and we cannot be certain that these contracts will be extended or renewed after the end of the initial contractual term. Any such nonrenewals, or renewals at reduced rates, could adversely impact our results of operations and our distributable cash flow.

 

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Additional Purchases of Exterran Holdings’ Contract Operations Business By Us.  We plan to grow over time through accretive acquisitions of assets from Exterran Holdings, third-party compression providers and natural gas transporters or producers. The consummation of any future purchase of additional portions of Exterran Holdings’ business and the timing of any such purchase will depend upon, among other things, our ability to reach an agreement with Exterran Holdings regarding the terms of such purchase, which will require the approval of the conflicts committee of our board of directors. The timing of such transactions would also depend on, among other things, market and economic conditions and our access to additional debt and equity capital. Future acquisitions of assets from Exterran Holdings may increase or decrease our operating performance, financial position and liquidity.

 

Labor.  We have no employees. Exterran Holdings provides all operational staff, corporate staff and support services necessary to run our business, and therefore we depend on Exterran Holdings’ ability to hire, train and retain qualified personnel. Although Exterran Holdings has been able to satisfy personnel needs in these positions thus far, retaining employees in our industry is a challenge. Our ability to grow and to continue to make quarterly distributions will depend in part on Exterran Holdings’ success in hiring, training and retaining these employees.

 

Operating Highlights

 

The following table summarizes total available horsepower, total operating horsepower, average operating horsepower and horsepower utilization percentages (in thousands, except percentages):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

2011

 

Total Available Horsepower (at period end)(1)

 

2,417

 

2,084

 

1,873

 

Total Operating Horsepower (at period end)(1)

 

2,264

 

1,991

 

1,728

 

Average Operating Horsepower

 

2,155

 

1,883

 

1,549

 

Horsepower Utilization:

 

 

 

 

 

 

 

Spot (at period end)

 

94

%

96

%

92

%

Average

 

94

%

93

%

89

%

 


(1)                  Includes compressor units comprising approximately 109,000, 163,000 and 221,000 horsepower leased from Exterran Holdings as of December 31, 2013, 2012 and 2011, respectively. Excludes compressor units comprising approximately 8,000, 9,000 and 18,000 horsepower leased to Exterran Holdings as of December 31, 2013, 2012 and 2011, respectively (see Note 3 to the Financial Statements).

 

Summary of Results

 

Net income.  We recorded net income of $64.0 million, $10.5 million and $6.1 million during the years ended December 31, 2013, 2012 and 2011, respectively. The increase in net income during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to a $59.8 million increase in gross margin, a $24.2 million decrease in long-lived asset impairments and a $9.5 million increase in gain on sale of property, plant and equipment, partially offset by an $11.9 million increase in interest expense. The increase in net income during the year ended December 31, 2013 compared to the year ended December 31, 2012 was impacted by the assets acquired in the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition, which resulted in higher current year gross margin, depreciation and amortization expense and SG&A expense. The increase in net income during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily caused by improved gross margin, partially offset by higher depreciation and amortization expense and SG&A expense, all of which were primarily impacted by the assets acquired in the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition, and long-lived asset impairments of $29.6 million recorded during the year ended December 31, 2012.

 

EBITDA, as further adjusted.  Our EBITDA, as further adjusted, was $238.0 million, $180.0 million and $139.3 million during the years ended December 31, 2013, 2012 and 2011, respectively. The increase in EBITDA, as further adjusted, during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to a $59.8 million increase in gross margin, a $9.5 million increase in gain on sale of property, plant and equipment and the impact of the assets acquired in the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition, including improved gross margin, partially offset by higher SG&A expense. The increase in EBITDA, as further adjusted, during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily caused by improved gross margin, partially offset by higher SG&A expense, all of which were primarily impacted by the assets acquired in the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition. For a reconciliation of EBITDA, as further adjusted, to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”).

 

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Financial Results of Operations

 

Year Ended December 31, 2013 Compared to Year Ended December 31, 2012

 

The following table summarizes our revenue, gross margin, gross margin percentage, expenses and net income (dollars in thousands):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

Revenue

 

$

466,193

 

$

387,493

 

Gross margin(1)

 

264,148

 

204,333

 

Gross margin percentage

 

57

%

53

%

Expenses:

 

 

 

 

 

Depreciation and amortization

 

$

103,711

 

$

88,298

 

Long-lived asset impairment

 

5,350

 

29,560

 

Selling, general and administrative — affiliates

 

61,971

 

49,889

 

Interest expense

 

37,068

 

25,167

 

Other (income) expense, net

 

(9,481

)

(35

)

Provision for income taxes

 

1,506

 

945

 

Net income

 

$

64,023

 

$

10,509

 

 


(1)                  Defined as revenue less cost of sales, excluding depreciation and amortization expense. For a reconciliation of gross margin to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures.”)

 

Revenue.  The increase in revenue and average operating horsepower was primarily due to the inclusion of the results from the assets acquired in the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition, as well as from organic growth in operating horsepower. Average operating horsepower was approximately 2,155,000 and 1,883,000 during the years ended December 31, 2013 and 2012, respectively. The increase in revenue during the year ended December 31, 2013 compared to the year ended December 31, 2012 was also attributable to an increase in rates and a $6.5 million increase in revenue with no incremental cost due to the termination of contracts resulting from the exercise of purchase options by our customer on two natural gas processing plants, partially offset by a $4.5 million decrease in revenue due to the termination of the contracts associated with those plants during the second quarter of 2013.

 

Gross Margin.  The increases in gross margin and gross margin percentage during the year ended December 31, 2013 compared to the year ended December 31, 2012 were primarily due to the increases in revenue discussed above, improved management of field operating expenses from the implementation of profitability improvement initiatives by Exterran Holdings and a $3.2 million decrease in intercompany lease expense on equipment leased from Exterran Holdings.

 

Depreciation and Amortization.  The increase in depreciation and amortization expense during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to additional depreciation on compression equipment additions, including the assets acquired in the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition, partially offset by the impact of impairments recorded in 2012, which decreased depreciation and amortization expense during the year ended December 31, 2013.

 

Long-Lived Asset Impairment.  During the year ended December 31, 2013, we evaluated the future deployment of our idle fleet and determined to retire and either sell or re-utilize the key components of approximately 110 idle compressor units, representing approximately 25,000 horsepower, previously used to provide services. As a result, we performed an impairment review and recorded a $5.4 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use.

 

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During the year ended December 31, 2012, we evaluated the future deployment of our idle fleet and determined to retire and either sell or re-utilize the key components of approximately 260 idle compressor units, representing approximately 71,000 horsepower, previously used to provide services. As a result, we performed an impairment review and recorded a $22.2 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. The average age of the idle units we impaired during the second quarter of 2012 was 27 years.

 

In connection with our 2012 fleet review, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale. Based upon that review, we reduced the expected proceeds from disposition for most of the remaining units and increased the weighted average disposal period for the units from the assumptions used in prior periods. This resulted in an additional impairment of $7.4 million to reduce the book value of each unit to its estimated fair value.

 

SG&A — affiliates.  SG&A expenses are primarily comprised of an allocation of expenses, including costs for personnel support and related expenditures, from Exterran Holdings to us pursuant to the terms of the Omnibus Agreement. The increase in SG&A expense was primarily due to increased costs associated with the impact of the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition. SG&A expenses represented 13% of revenue for each of the years ended December 31, 2013 and 2012.

 

Interest Expense.  The increase in interest expense during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to an increase in the weighted average effective interest rate on our debt and a higher average balance of long-term debt. The increase in the weighted average effective rate on our debt was primarily due to the issuance of the 6% Notes in March 2013 and a charge of $0.7 million related to the write-off of unamortized deferred financing costs in conjunction with the March 2013 amendment to our Credit Agreement.

 

Other (Income) Expense, Net.  Other (income) expense, net, included $10.1 million of gain on sale of property, plant and equipment, of which $6.8 million resulted from the exercise of purchase options by our customer on two natural gas processing plants during the year ended December 31, 2013. Other (income) expense, net, included $0.7 million of gain on sale of property, plant and equipment during the year ended December 31, 2012. Additionally, other (income) expense, net, during the years ended December 31, 2013 and 2012 included $0.6 million of transaction costs associated with the March 2013 Contract Operations Acquisition and $0.7 million of transaction costs associated with the March 2012 Contract Operations Acquisition, respectively.

 

Provision for Income Taxes.  The increase in our provision for income taxes during the year ended December 31, 2013 compared to the year ended December 31, 2012 was primarily due to increased revenue subject to state-level taxation.

 

Year Ended December 31, 2012 Compared to Year Ended December 31, 2011

 

The following table summarizes our revenue, gross margin, gross margin percentage, expenses and net income (dollars in thousands):

 

 

 

Years Ended December 31,

 

 

 

2012

 

2011

 

Revenue

 

$

387,493

 

$

308,274

 

Gross margin(1)

 

204,333

 

145,349

 

Gross margin percentage

 

53

%

47

%

Expenses:

 

 

 

 

 

Depreciation and amortization

 

$

88,298

 

$

67,930

 

Long-lived asset impairment

 

29,560

 

1,060

 

Selling, general and administrative — affiliates

 

49,889

 

39,380

 

Interest expense

 

25,167

 

30,400

 

Other (income) expense, net

 

(35

)

(392

)

Provision for income taxes

 

945

 

918

 

Net income

 

$

10,509

 

$

6,053

 

 


(1)                  Defined as revenue less cost of sales, excluding depreciation and amortization expense. For a reconciliation of gross margin to net income (loss), its most directly comparable financial measure calculated and presented in accordance with GAAP, please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”).

 

Revenue.  The increase in revenue and average operating horsepower was primarily due to the inclusion of the results from the assets acquired in the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition, as well as from organic growth in operating horsepower. Average operating horsepower was approximately 1,883,000 and 1,549,000 during the years ended December 31, 2012 and 2011, respectively. The increase in revenue was also impacted by an increase in rates during the year ended December 31, 2012 compared to the year ended December 31, 2011.

 

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Gross Margin.  The increase in gross margin during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily due to the inclusion of results from the assets acquired in the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition. The increase in gross margin was also impacted by improved management of field operating expenses from the implementation of profitability improvement initiatives by Exterran Holdings, an increase in rates, a $4.3 million benefit from ad valorem taxes due to a change in tax law (see Note 13 to the Financial Statements), a $1.9 million reduction in use taxes and a $5.4 million decrease in intercompany lease expense during the year ended December 31, 2012 compared to the year ended December 31, 2011, partially offset by an increase in lube oil prices.

 

Depreciation and Amortization.  The increase in depreciation and amortization expense during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily due to additional depreciation on compression equipment additions, including the assets acquired in the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition.

 

Long-Lived Asset Impairment.  During 2012, we evaluated the future deployment of our idle fleet and determined to retire and either sell or re-utilize the key components of approximately 260 idle compressor units, representing approximately 71,000 horsepower, previously used to provide services. As a result, we performed an impairment review and recorded a $22.2 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use. The average age of the idle units we impaired during the second quarter of 2012 was 27 years.

 

In connection with our 2012 fleet review, we evaluated for impairment idle units that had been culled from our fleet in prior years and were available for sale. Based upon that review, we reduced the expected proceeds from disposition for most of the remaining units and increased the weighted average disposal period for the units from the assumptions used in prior periods. This resulted in an additional impairment of $7.4 million to reduce the book value of each unit to its estimated fair value.

 

During 2011, we reviewed our idle compression fleet for units that were not of the type, configuration, make or model that are cost effective to maintain and operate. As a result, we performed an impairment review and recorded a $1.1 million asset impairment to reduce the book value of each unit to its estimated fair value. The fair value of each unit was estimated based on either the expected net sale proceeds compared to other fleet units we recently sold and/or a review of other units recently offered for sale by third parties, or the estimated component value of the equipment we plan to use.

 

SG&A — affiliates.  SG&A expenses are primarily comprised of an allocation of expenses, including costs for personnel support and related expenditures, from Exterran Holdings to us pursuant to the terms of the Omnibus Agreement. The increase in SG&A expense was primarily due to increased costs associated with the impact of the March 2012 Contract Operations Acquisition and the June 2011 Contract Operations Acquisition. SG&A expenses represented 13% of revenue for each of the years ended December 31, 2012 and 2011.

 

Interest Expense.  The decrease in interest expense was primarily due to a decrease of $9.4 million in the amortization of terminated interest rate swaps, which was partially offset by a higher average balance of long-term debt, during the year ended December 31, 2012 compared to the year ended December 31, 2011. The terminated interest rate swaps are being amortized into interest expense over the original terms of the swaps. As of December 31, 2012, terminated interest rate swaps with an aggregate notional value of $255.0 million have been fully amortized; the remaining terminated interest rate swaps of $0.2 million will be amortized through July 2013.

 

Other (Income) Expense, Net.  Other (income) expense, net during the year ended December 31, 2012 included $0.7 million of transaction costs associated with the March 2012 Contract Operations Acquisition. Other (income) expense, net during the year ended December 31, 2011 included $0.5 million of transaction costs associated with the June 2011 Contract Operations Acquisition. Additionally, other (income) expense, net during the years ended December 31, 2012 and 2011 included $0.7 million and $0.9 million of gains on the sale of used compression equipment, respectively.

 

Provision for Income Taxes.  The increase in our provision for income taxes during the year ended December 31, 2012 compared to the year ended December 31, 2011 was primarily due to an increase in revenue subject to state-level taxation and the recognition of deferred state taxes resulting from taxable depreciation differences. This increase was offset by state tax benefits from refund claims filed or to be filed, net of unrecognized tax benefits.

 

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Liquidity and Capital Resources

 

The following tables summarize our sources and uses of cash during the years ended December 31, 2013 and 2012, and our cash and working capital as of the end of the periods presented (in thousands):

 

 

 

Years Ended December 31,

 

 

 

2013

 

2012

 

Net cash provided by (used in):

 

 

 

 

 

Operating activities

 

$

158,286

 

$

125,217

 

Investing activities

 

(117,132

)

(228,940

)

Financing activities

 

(41,114

)

103,860

 

Net change in cash and cash equivalents

 

$

40

 

$

137

 

 

 

 

December 31,

 

 

 

2013

 

2012

 

Cash and cash equivalents

 

$

182

 

$

142

 

Working capital

 

46,802

 

1,661

 

 

Operating Activities.  The increase in net cash provided by operating activities was primarily due to the increase in business levels resulting from the March 2013 Contract Operations Acquisition and the March 2012 Contract Operations Acquisition and improved profitability in our operations, which included improved management of field operating expenses and an increase in rates. These activities were partially offset by higher interest payments during the year ended December 31, 2013 compared to the year ended December 31, 2012.

 

Investing Activities.  The decrease in net cash used in investing activities was primarily attributable to $77.4 million of cash used during the year ended December 31, 2012 to pay a portion of the consideration for the March 2012 Contract Operations Acquisition and a $59.0 million increase in proceeds from sale of property, plant and equipment during the year ended December 31, 2013 compared to the year ended December 31, 2012. These activities were partially offset by a $10.2 million increase in capital expenditures and an increase of $10.5 million in amounts due from affiliates during the year ended December 31, 2013 compared to a decrease of $3.8 million in amounts due from affiliates during the year ended December 31, 2012. Capital expenditures during the year ended December 31, 2013 were $168.0 million, consisting of $126.6 million for fleet growth capital and $41.4 million for compressor maintenance activities.

 

Financing Activities.  The increase in net cash used in financing activities was primarily due to $114.5 million of net proceeds received from a public offering of common units during the year ended December 31, 2012, a decrease of $21.6 million in amounts due to affiliates during the year ended December 31, 2013 compared to an increase of $21.6 million in amounts due to affiliates during the year ended December 31, 2012, an increase in distributions to unitholders of $19.3 million for the year ended December 31, 2013 compared to the year ended December 31, 2012 and an increase in payments of debt issuance costs of $11.1 million during the year ended December 31, 2013 compared to the year ended December 31, 2012. These activities were partially offset by an increase of $47.4 million in net borrowings under our debt facilities during the year ended December 31, 2013 compared to the year ended December 31, 2012.

 

Working Capital.  The increase in working capital was primarily due to a decrease of $21.6 million in amounts due to affiliates, an increase of $14.6 million in accounts receivables, trade, and an increase of $10.5 million in amounts due from affiliates during the year ended December 31, 2013 compared to the year ended December 31, 2012. The amounts due to affiliates at December 31, 2012 were primarily due to short-term funding for capital expenditures.

 

Capital Requirements.  The natural gas compression business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Our capital spending is dependent on the demand for our services and the availability of the type of compression equipment required for us to render those services to our customers. Our capital requirements have consisted primarily of, and we anticipate will continue to consist of, the following:

 

·          maintenance capital expenditures, which are made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets; and

 

·          expansion capital expenditures, which are made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue generating capabilities of existing or new assets, whether through construction, acquisition or modification.

 

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Without giving effect to any equipment we may acquire pursuant to any future acquisitions, we currently plan to make approximately $45 million to $50 million in equipment maintenance capital expenditures during 2014. Exterran Holdings manages its and our respective U.S. fleets as one pool of compression equipment from which we can each readily fulfill our respective customers’ service needs. When we or Exterran Holdings are advised of a contract operations services opportunity, Exterran Holdings reviews both our and its fleet for an available and appropriate compressor unit. The majority of the idle compression equipment required for servicing these contract operations services has been and is currently held by Exterran Holdings. Under the Omnibus Agreement, the owner of the equipment being transferred is required to pay the costs associated with making the idle equipment suitable for the proposed customer and then has generally leased the equipment to the recipient of the equipment or exchanged the equipment for other equipment of the recipient. Because Exterran Holdings has owned the majority of such equipment, Exterran Holdings has generally had to bear a larger portion of the maintenance capital expenditures associated with making transferred equipment ready for service. For equipment that is then leased, the maintenance capital cost is a component of the lease rate that is paid under the lease. As we acquire more compression equipment, we expect that more of our equipment will be available to satisfy our or Exterran Holdings’ customer requirements. As a result, we expect that our maintenance capital expenditures will continue to increase (and that lease expense will be reduced).

 

In addition, our capital requirements include funding distributions to our unitholders. We anticipate such distributions will be funded through cash provided by operating activities and borrowings under our senior secured credit facility and that we will be able to generate cash or borrow adequate amounts of cash under our senior secured credit facility to meet our needs over the next twelve months. Given our objective of long-term growth through acquisitions, expansion capital expenditure projects and other internal growth projects, we anticipate that over time we will continue to invest capital to grow and acquire assets. We expect to actively consider a variety of assets for potential acquisitions and expansion projects. We expect to fund these future capital expenditures with borrowings under our senior secured credit facility and the issuance of additional debt and equity securities, as appropriate, given market conditions. The timing of future capital expenditures will be based on the economic environment, including the availability of debt and equity capital.

 

Our Ability to Grow Depends on Our Ability to Access External Expansion Capital.  We expect that we will rely primarily upon external financing sources, including our senior secured credit facility and the issuance of debt and equity securities, rather than cash reserves established by our general partner, to fund our acquisitions and expansion capital expenditures. Our ability to access the capital markets may be restricted at a time when we would like, or need, to do so, which could have an impact on our ability to grow.

 

We expect that we will distribute all of our available cash to our unitholders. Available cash is reduced by cash reserves established by our general partner to provide for the proper conduct of our business, including future capital expenditures. To the extent we are unable to finance growth externally and we are unwilling to establish cash reserves to fund future acquisitions, our cash distribution policy will significantly impair our ability to grow. Because we distribute all of our available cash, we may not grow as quickly as businesses that reinvest their available cash to expand ongoing operations. To the extent we issue additional units in connection with any acquisitions or expansion capital expenditures, the payment of distributions on those additional units may increase the risk that we will be unable to maintain or increase our per unit distribution level, which in turn may impact the available cash that we have to distribute for each unit. There are no limitations in our partnership agreement or in the terms of our senior secured credit facility on our ability to issue additional units, including units ranking senior to our common units.

 

Long-Term Debt.  In November 2010, we amended and restated our Credit Agreement to provide for a five-year $550.0 million senior secured credit facility, consisting of a $400.0 million revolving credit facility and a $150.0 million term loan facility. The revolving borrowing capacity under this facility increased to $550.0 million in March 2011 and to $750.0 million in March 2012. We amended our Credit Agreement in March 2013 to reduce the borrowing capacity under our revolving credit facility to $650.0 million and extend the maturity date of the term loan and revolving credit facilities to May 2018. As of December 31, 2013, we had undrawn and available capacity of $387.0 million under our revolving credit facility.

 

The revolving credit and term loan facilities bear interest at a base rate or LIBOR, at our option, plus an applicable margin. Depending on our leverage ratio, the applicable margin for the revolving and term loans varies (i) in the case of LIBOR loans, from 2.0% to 3.0% and (ii) in the case of base rate loans, from 1.0% to 2.0%. The base rate is the highest of the prime rate announced by Wells Fargo Bank, National Association, the Federal Funds Effective Rate plus 0.5% and one-month LIBOR plus 1.0%. At December 31, 2013, all amounts outstanding under these facilities were LIBOR loans and the applicable margin was 2.0%. The weighted average annual interest rate on the outstanding balance of these facilities at December 31, 2013, excluding the effect of interest rate swaps, was 2.2%.

 

Borrowings under the Credit Agreement are secured by substantially all of the U.S. personal property assets of us and our Significant Domestic Subsidiaries (as defined in the Credit Agreement), including all of the membership interests of our Domestic Subsidiaries (as defined in the Credit Agreement).

 

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The Credit Agreement contains various covenants with which we must comply, including, but not limited to, restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional indebtedness, engage in transactions with affiliates, merge or consolidate, sell assets, make certain investments and acquisitions, make loans, grant liens, repurchase equity and pay dividends and distributions. The Credit Agreement also contains various covenants requiring mandatory prepayments from the net cash proceeds of certain asset transfers. We must maintain various consolidated financial ratios, including a ratio of EBITDA (as defined in the Credit Agreement) to Total Interest Expense (as defined in the Credit Agreement) of not less than 2.75 to 1.0, a ratio of Total Debt (as defined in the Credit Agreement) to EBITDA of not greater than 5.25 to 1.0 (subject to a temporary increase to 5.5 to 1.0 for any quarter during which an acquisition meeting certain thresholds is completed and for the following two quarters after the acquisition closes) and a ratio of Senior Secured Debt (as defined in the Credit Agreement) to EBITDA of not greater than 4.0 to 1.0. As of December 31, 2013, we maintained a 7.5 to 1.0 EBITDA to Total Interest Expense ratio, a 3.1 to 1.0 Total Debt to EBITDA ratio and a 1.7 to 1.0 Senior Secured Debt to EBITDA ratio. A material adverse effect on our assets, liabilities, financial condition, business or operations that, taken as a whole, impacts our ability to perform our obligations under the Credit Agreement, could lead to a default under that agreement. A default under one of our debt agreements would trigger cross-default provisions under our other debt agreement, which would accelerate our obligation to repay our indebtedness under those agreements. As of December 31, 2013, we were in compliance with all financial covenants under the Credit Agreement.

 

In March 2013, we issued $350.0 million aggregate principal amount of the 6% Notes due April 2021. We used the net proceeds of $336.9 million, after original issuance discount and issuance costs, to repay borrowings outstanding under our revolving credit facility. The 6% Notes were issued at an original issuance discount of $5.5 million, which is being amortized using the effective interest method at an interest rate of 6.25% over their term. In January 2014, holders of the 6% Notes exchanged their 6% Notes for registered notes with the same terms.

 

The 6% Notes are guaranteed on a senior unsecured basis by all of our existing subsidiaries (other than EXLP Finance Corp., which is a co-issuer of the 6% Notes) and certain of our future subsidiaries. The 6% Notes and the guarantees, respectively, are our and the guarantors’ general unsecured senior obligations, rank equally in right of payment with all of our and the guarantors’ other senior obligations, and are effectively subordinated to all of our and the guarantors’ existing and future secured debt to the extent of the value of the collateral securing such indebtedness. In addition, the 6% Notes and guarantees are effectively subordinated to all existing and future indebtedness and other liabilities of any future non-guarantor subsidiaries. All of our subsidiaries are 100% owned, directly or indirectly, by us and guarantees by our subsidiaries are full and unconditional and constitute joint and several obligations. We have no assets or operations independent of our subsidiaries, and there are no significant restrictions upon the ability of our subsidiaries to distribute funds to us.

 

Prior to April 1, 2017, we may redeem all or a part of the 6% Notes at a redemption price equal to the sum of (i) the principal amount thereof, plus (ii) a make-whole premium at the redemption date, plus accrued and unpaid interest, if any, to the redemption date. In addition, we may redeem up to 35% of the aggregate principal amount of the 6% Notes prior to April 1, 2016 with the net proceeds of one or more equity offerings at a redemption price of 106.000% of the principal amount of the 6% Notes, plus any accrued and unpaid interest to the date of redemption, if at least 65% of the aggregate principal amount of the 6% Notes issued under the indenture remains outstanding after such redemption and the redemption occurs within 180 days of the date of the closing of such equity offering. On or after April 1, 2017, we may redeem all or a part of the 6% Notes at redemption prices (expressed as percentages of principal amount) equal to 103.000% for the twelve-month period beginning on April 1, 2017, 101.500% for the twelve-month period beginning on April 1, 2018 and 100.000% for the twelve-month period beginning on April 1, 2019 and at any time thereafter, plus accrued and unpaid interest, if any, to the applicable redemption date on the 6% Notes.

 

We entered into interest rate swap agreements to offset changes in expected cash flows due to fluctuations in the interest rates associated with our variable rate debt. At December 31, 2013, we were a party to interest rate swaps pursuant to which we make fixed payments and receive floating payments on a notional value of $250.0 million. Our interest rate swaps expire in May 2018. As of December 31, 2013, the weighted average effective fixed interest rate on our interest rate swaps was 1.7%. See Part II, Item 7A (“Quantitative and Qualitative Disclosures About Market Risk”) for further discussion of our interest rate swap agreements.

 

We may from time to time seek to retire or purchase our outstanding debt through cash purchases and/or exchanges for equity securities, in open market purchases, privately negotiated transactions or otherwise. Such repurchases or exchanges, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors. The amounts involved may be material.

 

Distributions to Unitholders.  Our partnership agreement requires us to distribute all of our “available cash” quarterly. Under our partnership agreement, available cash is defined generally to mean, for each fiscal quarter, (i) our cash on hand at the end of the quarter in excess of the amount of reserves our general partner determines is necessary or appropriate to provide for the conduct of our business, to comply with applicable law, any of our debt instruments or other agreements or to provide for future distributions to our unitholders for any one or more of the upcoming four quarters, plus, (ii) if our general partner so determines, all or a portion of our cash on hand on the date of determination of available cash for the quarter.

 

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On January 30, 2014, our board of directors approved a cash distribution of $0.5325 per limited partner unit, or approximately $28.8 million, including distributions to our general partner on its incentive distribution rights. The distribution covers the period from October 1, 2013 through December 31, 2013. The record date for this distribution was February 10, 2014 and payment was made on February 14, 2014.

 

Pursuant to the Omnibus Agreement, our obligation to reimburse Exterran Holdings for cost of sales and SG&A expenses is capped through December 31, 2014 (see Note 3 to the Financial Statements). Our cost of sales exceeded the cap provided in the Omnibus Agreement by $12.4 million, $16.6 million and $26.5 million during 2013, 2012, and 2011, respectively. Our SG&A expenses exceeded the cap provided in the Omnibus Agreement by $12.8 million, $8.2 million and $5.9 million during 2013, 2012 and 2011, respectively. Accordingly, our EBITDA, as further adjusted, and our distributable cash flow (please see Part II, Item 6 (“Selected Financial Data — Non-GAAP Financial Measures”) for a discussion of EBITDA, as further adjusted, and distributable cash flow) would have been approximately $25.2 million, $24.8 million and $32.4 million lower during 2013, 2012 and 2011, respectively, without the benefit of the cost caps. As a result, without the benefit of the cost caps, our distributable cash flow coverage (distributable cash flow for the period divided by distributions declared to all unitholders for the period, including incentive distribution rights) would have been 1.13x, 1.02x and 0.78x during 2013, 2012 and 2011, respectively, rather than the actual distributable cash flow coverage (which includes the benefit of cost caps) of 1.36x, 1.29x and 1.22x during 2013, 2012, and 2011, respectively.

 

Contractual Obligations.  The following table summarizes our cash contractual obligations as of December 31, 2013 (in thousands):

 

 

 

Payments Due by Period

 

 

 

Total

 

2014

 

2015-2016

 

2017-2018

 

Thereafter

 

Long-term debt(1)

 

 

 

 

 

 

 

 

 

 

 

Revolving credit facility due May 2018

 

$

263,000

 

$

 

$

 

$

263,000

 

$

 

Term loan facility due May 2018

 

150,000

 

 

 

150,000

 

 

6% senior notes due April 2021(2)

 

350,000

 

 

 

 

350,000

 

Total long-term debt

 

763,000

 

 

 

413,000

 

350,000

 

Estimated interest payments(3)

 

214,762

 

35,305

 

70,611

 

61,596

 

47,250

 

Total contractual obligations

 

$

977,762

 

$

35,305

 

$

70,611

 

$

474,596

 

$

397,250

 

 


(1)                  Amounts represent the expected cash payments for principal on our debt and do not include any deferred issuance costs or fair market valuations of our debt. For more information on our long-term debt, see Note 5 to the Financial Statements.

 

(2)                 These amounts include the full face value of the 6% Notes and are not reduced by the unamortized discount of $5.0 million as of December 31, 2013.

 

(3)                  Interest amounts calculated using the interest rates in effect as of December 31, 2013, including the effect of our interest rate swap agreements.

 

At December 31, 2013, $0.6 million of unrecognized tax benefits have been recorded as liabilities in accordance with the accounting standard for income taxes related to uncertain tax positions, and we are uncertain if or when such amounts may be settled. We have not recorded any liability for penalties and interest related to these unrecognized tax benefits.

 

Off-Balance Sheet Arrangements

 

We have no material off-balance sheet arrangements.

 

Effects of Inflation.  Our revenue and results of operations have not been materially impacted by inflation in the past three fiscal years.

 

Critical Accounting Estimates

 

This discussion and analysis of our financial condition and results of operations is based upon our Financial Statements, which have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. On an ongoing basis, we evaluate our estimates and accounting policies, including those related to bad debt, fixed assets, intangible assets, income taxes and contingencies. We base our estimates on historical experience and on other assumptions that we believe are reasonable under the circumstances. The results of this process form the basis of our judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions, and these differences can be material to our financial condition, results of operations and liquidity. We describe our significant accounting policies more fully in Note 1 to the Financial Statements.

 

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Allowances and Reserves

 

We maintain allowances for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The determination of the collectibility of amounts due from our customers requires us to use estimates and make judgments regarding future events and trends, including monitoring our customers’ payment history and current creditworthiness to determine that collectibility is reasonably assured, as well as consideration of the overall business climate in which our customers operate. Inherently, these uncertainties require us to make judgments and estimates regarding our customers’ ability to pay amounts due to us in order to determine the appropriate amount of valuation allowances required for doubtful accounts. We review the adequacy of our allowance for doubtful accounts quarterly. We determine the allowance needed based on historical write-off experience and by evaluating significant balances aged greater than 90 days individually for collectibility. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. During the year ended December 31, 2013, we recorded a bad debt benefit of approximately $25,000. During the years ended December 31, 2012 and 2011, we recorded bad debt expense of $0.5 million and $0.1 million, respectively.

 

Depreciation

 

Property, plant and equipment are carried at cost. Depreciation for financial reporting purposes is computed on the straight-line basis using estimated useful lives and salvage values. The assumptions and judgments we use in determining the estimated useful lives and salvage values of our property, plant and equipment reflect both historical experience and expectations regarding future use of our assets. The use of different estimates, assumptions and judgments in the establishment of property, plant and equipment accounting policies, especially those involving their useful lives, would likely result in significantly different net book values of our assets and results of operations.

 

Business Combinations and Goodwill

 

Goodwill and intangible assets acquired in connection with business combinations represent the excess of consideration over the fair value of tangible net assets acquired. Certain assumptions and estimates are employed in determining the fair value of assets acquired and liabilities assumed.

 

The carrying value of goodwill is reviewed annually or earlier if indicators of potential impairment exist. A qualitative assessment is performed to determine whether it is more likely than not that the fair value of the reporting unit is impaired. If it is more likely than not, we perform a goodwill impairment test. We determine the fair value of our reporting unit using both the expected present value of future cash flows and a market approach. Each approach is weighted 50% in determining our calculated fair value. The present value of future cash flows is estimated using our most recent forecast and the weighted average cost of capital. The market approach uses a market multiple on the reporting unit’s earnings before interest expense, income tax provision, depreciation and amortization expense. Significant estimates for the reporting unit included in our impairment analysis are our cash flow forecasts, our estimate of the market’s weighted average cost of capital and market multiples. Changes in forecasts, cost of capital and market multiples could affect the estimated fair value of our reporting unit and result in a goodwill impairment charge in a future period.

 

Long-Lived Assets

 

We review long-lived assets, including property, plant and equipment and identifiable intangibles that are being amortized, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The determination that the carrying amount of an asset may not be recoverable requires us to make judgments regarding long-term forecasts of future revenue and costs related to the assets subject to review. These forecasts are uncertain as they require significant assumptions about future market conditions. Significant and unanticipated changes to these assumptions could require a provision for impairment in a future period. Given the nature of these evaluations and their application to specific assets and specific times, it is not possible to reasonably quantify the impact of changes in these assumptions. An impairment loss exists when estimated undiscounted cash flows expected to result from the use of the asset and its eventual disposition are less than its carrying amount. When necessary, an impairment loss is recognized and represents the excess of the asset’s carrying value as compared to its estimated fair value and is charged to the period in which the impairment occurred.

 

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Income Taxes

 

As a partnership, all income, gains, losses, expenses, deductions and tax credits we generate generally flow through to our unitholders. However, some states impose an entity-level income tax on partnerships, including us. Our provision for income taxes, deferred tax liabilities and reserves for unrecognized tax benefits reflect management’s best assessment of estimated current and future taxes to be paid. Significant judgments and estimates are required in determining our provision for income taxes.

 

Deferred income taxes arise from temporary differences between the financial statements and tax basis of assets and liabilities. Changes in tax laws and rates could affect recorded deferred tax liabilities in the future. Management is not aware of any such changes that would have a material effect on our financial position, results of operations or ability to make cash distributions to our unitholders. The calculation of our tax liabilities involves dealing with uncertainties in the application of complex tax laws and regulations in various states.

 

The accounting standard for income taxes provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that the position will be sustained upon examination, including resolutions of any related appeals or litigation processes, on the basis of the technical merits. In addition, guidance is provided on measurement, derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adjust these liabilities when our judgment changes as a result of the evaluation of new information not previously available. Because of the complexity of some of these uncertainties, the ultimate resolution may result in a payment that is materially different from our current estimate of the tax liabilities. These differences will be reflected as increases or decreases to income tax expense in the period in which new information is available.

 

Contingencies

 

The impact of an uncertain tax position taken or expected to be taken on an income tax return must be recognized in the financial statements at the largest amount that is more likely than not to be sustained upon examination by the relevant taxing authority in accordance with the accounting standard for income taxes. We regularly assess and, if required, establish accruals for tax contingencies pursuant to the applicable accounting standards that could result from assessments of additional tax by taxing jurisdictions where we operate. Tax contingencies are subject to a significant amount of judgment and are reviewed and adjusted on a quarterly basis in light of changing facts and circumstances considering the outcome expected by management. As of December 31, 2013 and 2012, we had recorded approximately $5.3 million and $5.4 million (including penalties and interest), respectively, of accruals for tax contingencies. If our actual experience differs from the assumptions and estimates used for recording the liabilities, adjustments may be required and would be recorded in the period in which the difference becomes known.

 

Self-Insurance

 

Exterran Holdings insures our property and operations and allocates certain insurance costs to us. Exterran Holdings is self-insured up to certain levels for general liability, vehicle liability, group medical and workers’ compensation claims. We regularly review estimates of reported and unreported claims and provide for losses based on claims filed and an estimate for significant claims incurred but not reported. Although we believe the insurance costs allocated to us are adequate, it is reasonably possible our estimates of these liabilities will change over the near term as circumstances develop. Exterran Holdings currently has minimal insurance on our offshore assets.

 

Recent Accounting Pronouncements

 

See Note 12 to the Financial Statements.

 

Item 7A.  Quantitative and Qualitative Disclosures About Market Risk

 

Variable Rate Debt

 

We are exposed to market risk primarily associated with changes in interest rates under our financing arrangements. We use derivative financial instruments to minimize the risks and/or costs associated with financial activities by managing our exposure to interest rate fluctuations on a portion of our debt obligations. We do not use derivative financial instruments for trading or other speculative purposes.

 

As of December 31, 2013, after taking into consideration interest rate swaps, we had $163.0 million of outstanding indebtedness that was effectively subject to floating interest rates. A 1% increase in the effective interest rate on our outstanding debt subject to floating interest rates at December 31, 2013 would result in an annual increase in our interest expense of approximately $1.6 million.

 

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For further information regarding our use of interest rate swap agreements to manage our exposure to interest rate fluctuations on a portion of our debt obligations, see Note 8 to the Financial Statements.

 

Item 8.  Financial Statements and Supplementary Data

 

The financial statements and supplementary information specified by this Item are presented in Part IV, Item 15.

 

Item 9.  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

 

None.

 

Item 9A.  Controls and Procedures

 

Management’s Evaluation of Disclosure Controls and Procedures

 

As of the end of the period covered by this report, our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), which are designed to provide reasonable assurance that we are able to record, process, summarize and report the information required to be disclosed in our reports under the Exchange Act within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based on the evaluation, as of December 31, 2013, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective to provide reasonable assurance that the information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to management, and made known to our principal executive officer and principal financial officer, on a timely basis to ensure that it is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

 

Management’s Annual Report on Internal Control Over Financial Reporting

 

As required by Exchange Act Rules 13a-15(c) and 15d-15(c), our management, including the Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting. Management conducted an evaluation of the effectiveness of internal control over financial reporting based on the Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness as 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. Based on the results of management’s evaluation described above, management concluded that our internal control over financial reporting was effective as of December 31, 2013.

 

The effectiveness of internal control over financial reporting as of December 31, 2013 was audited by Deloitte & Touche LLP, an independent registered public accounting firm, as stated in its report found within this report.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Partners of

Exterran Partners, L.P.

Houston, Texas

 

We have audited the internal control over financial reporting of Exterran Partners, L.P. and subsidiaries (the “Partnership”) as of December 31, 2013, based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Partnership’s 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 Management’s Annual Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Partnership’s 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, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company’s internal control over financial reporting is a process designed by, or under the supervision of, the company’s principal executive and principal financial officers, or persons performing similar functions, and effected by the company’s board of directors, management, and other personnel 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 company’s 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 company’s assets that could have a material effect on the financial statements.

 

Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the 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, the Partnership maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on the criteria established in Internal Control — Integrated Framework (1992) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2013 of the Partnership and our report dated February 25, 2014 expressed an unqualified opinion on those financial statements and financial statement schedule.

 

/s/ DELOITTE & TOUCHE LLP

 

 

 

Houston, Texas

 

February 25, 2014

 

 

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Item 9B.  Other Information

 

None.

 

PART III

 

ITEM 10.  Directors, Executive Officers and Corporate Governance

 

Board of Directors

 

Because our general partner is a limited partnership, its general partner, Exterran GP LLC, conducts our business and operations. Exterran GP LLC’s board of directors and officers, which we refer to as our board of directors and our officers, make decisions on our behalf. Our general partner is not elected by our unitholders and is not subject to re-election on a regular basis in the future. Unitholders are not entitled to elect the directors of Exterran GP LLC or directly or indirectly participate in our management or operation. As a result, we do not hold annual unitholder meetings. Our general partner owes a fiduciary duty to our unitholders. Our general partner is liable, as our sole general partner, for all of our debts (to the extent not paid from our assets), except for indebtedness or other obligations that are made expressly non-recourse to it. Our general partner therefore may cause us to incur indebtedness or other obligations that are non-recourse to it.

 

NASDAQ does not require a listed limited partnership like us to have a majority of independent directors on our board of directors or to establish a compensation committee or a nominating committee. We have seven directors, three of whom — James G. Crump, G. Stephen Finley and Edmund P. Segner, III — have been determined by the board to be “independent directors” within the meaning of applicable NASDAQ rules and Rule 10A-3 of the Exchange Act. In determining the independence of each director, we have adopted standards that incorporate the NASDAQ and Exchange Act standards.

 

Our board of directors has standing audit, compensation and conflicts committees. Each committee’s written charter is available on our website at www.exterran.com and without charge to any unitholder upon written request to Investor Relations, 16666 Northchase Drive, Houston, Texas 77060.

 

Our board of directors met eight times during 2013. During 2013, each director attended at least 75% of the aggregate number of meetings of the board of directors and any committee of the board of directors on which such director served.

 

Our directors hold office until the earlier of their death, resignation, removal or disqualification or until their successors have been elected and qualified. Officers serve at the discretion of the board of directors. There are no family relationships among any of our directors or executive officers, and there are no arrangements or understandings between any of the directors or executive officers and any other persons pursuant to which a director or officer was selected as such.

 

Audit Committee.  The audit committee, which met four times during 2013, consists of Messrs. Crump (chair), Finley and Segner. The board of directors has determined that each of Messrs. Crump, Finley and Segner is an “audit committee financial expert” as defined in Item 407(d)(5)(ii) of SEC Regulation S-K, and that each is “independent” within the meaning of the applicable NASDAQ and Exchange Act rules regulating audit committee independence. The audit committee assists our board of directors in its oversight of the integrity of our financial statements and our compliance with legal and regulatory requirements and corporate policies and controls. The audit committee has the sole authority to retain and terminate our independent registered public accounting firm, approve all auditing services and related fees and terms and pre-approve any non-audit services to be performed by our independent registered public accounting firm. The audit committee is also responsible for confirming the independence and objectivity of our independent registered public accounting firm. Our independent registered public accounting firm has unrestricted access to the audit committee.

 

Compensation Committee.  The compensation committee, which met six times during 2013, consists of Messrs. Crump, Finley (chair) and Segner. The compensation committee discharges the board of directors’ responsibilities relating to compensation of our executives and independent directors, reviews and approves the manner in which Exterran Holdings allocates to us its compensation expense applicable to our executives and oversees the development and implementation of our compensation programs. The compensation committee also, in accordance with the SEC’s rules and regulations, produces the compensation discussion and analysis included in Item 11 (“Executive Compensation”) of this report.

 

Conflicts Committee.  The conflicts committee, which met seven times during 2013, consists of Messrs. Crump (chair), Finley and Segner. The purpose of the conflicts committee is to carry out the duties of the committee as set forth in our Partnership Agreement and the Omnibus Agreement, and any other duties delegated by our board of directors that may involve a conflict of interest. Any matters approved by the conflicts committee will be conclusively deemed to be fair and reasonable to us, approved by all of our partners and not a breach by our general partner of any duties it may owe us or our unitholders.

 

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Section 16(a) Beneficial Ownership Reporting Compliance

 

Under Section 16(a) of the Exchange Act, directors, officers and beneficial owners of 10 percent or more of our common units (“Reporting Persons”) are required to report to the SEC on a timely basis the initiation of their status as a Reporting Person and any changes with respect to their beneficial ownership of our common units. Based solely on a review of Forms 3, 4 and 5 (and any amendments thereto) furnished to us and the representations made to us, we have concluded that no Reporting Persons were delinquent with respect to their reporting obligations, as set forth in Section 16(a) of the Exchange Act, during 2013.

 

Code of Ethics

 

Exterran GP LLC has adopted a Code of Business Conduct and Ethics that applies to it and its subsidiaries and affiliates, including us, and to all of its and their respective employees, directors and officers, including its principal executive officer, principal financial officer and principal accounting officer. A copy of this code is available on our website at www.exterran.com or without charge upon written request to Investor Relations, 16666 Northchase Drive, Houston, Texas 77060.

 

Directors and Executive Officers

 

All of our executive officers allocate their time between managing our business and affairs and Exterran Holdings’ business and affairs. Exterran Holdings causes the executive officers to devote as much time to the management of our business and affairs as is necessary. A significant number of other employees of Exterran Holdings and its affiliates operate our business and provide us with general and administrative services.

 

Our current directors and executive officers are:

 

Name

 

Age

 

Title

D. Bradley Childers

 

49

 

President, Chief Executive Officer and Chairman of the Board

David S. Miller

 

50

 

Senior Vice President, Chief Financial Officer and Director

William M. Austin

 

67

 

Senior Vice President and Director

Robert E. Rice

 

48

 

Senior Vice President

Daniel K. Schlanger

 

40

 

Senior Vice President and Director

Donald C. Wayne

 

47

 

Senior Vice President and General Counsel

Kenneth R. Bickett

 

52

 

Vice President and Controller

James G. Crump

 

73

 

Director

G. Stephen Finley

 

63

 

Director

Edmund P. Segner, III

 

60

 

Director

 

D. Bradley Childers.  Mr. Childers was elected President and Chief Executive Officer and Chairman of the Board of Exterran GP LLC in December 2011, having served as interim Chief Executive Officer and interim Chairman of the Board since November 2011. Prior to that, Mr. Childers had served as Senior Vice President of Exterran GP LLC since June 2006 and as a director of Exterran GP LLC since May 2008. He also served as Senior Vice President of Exterran Holdings since August 2007 and as President, North America of Exterran Energy Solutions, L.P. from March 2008 to November 2011. Prior to the merger of Hanover Compressor Company and Universal Compression Holdings, Inc. in August 2007, Mr. Childers joined Universal in 2002 and served in a number of management positions, including Senior Vice President of Universal and President of the International Division of Universal Compression, Inc., Universal’s wholly-owned subsidiary. Prior to joining Universal, he held various positions with Occidental Petroleum Corporation (an international oil and gas exploration and production company) and its subsidiaries from 1994 to 2002, including as Vice President, Business Development at Occidental Oil and Gas Corporation, and as corporate counsel. Mr. Childers also serves as an officer and director of certain other Exterran Holdings majority-owned subsidiaries. Mr. Childers holds a B.A. from Claremont McKenna College and a J.D. from the University of Southern California.

 

Mr. Childers’ day to day leadership as our Chief Executive Officer and his role in forming the Partnership provide him with an intimate knowledge of our Partnership, including its strategies, operations and markets. His previous experience as President, North America of Exterran Energy Solutions, L.P. has provided him with intimate knowledge of our contract compression operations, as well as a unique understanding of market factors and operational challenges and opportunities. Mr. Childers’ business judgment, management experience and leadership skills are highly valuable in assessing our business strategies and accompanying risks. We believe this knowledge and experience make Mr. Childers well qualified to serve as a director of Exterran GP LLC.

 

David S. Miller.  Mr. Miller was elected Senior Vice President and Chief Financial Officer of Exterran GP LLC in April 2012 and as a director of Exterran GP LLC in March 2009. He served as Vice President and Chief Financial Officer, Eastern Hemisphere of Exterran Energy Solutions, L.P. from August 2010 to April 2012, and previously served as Vice President and Chief Financial Officer of Exterran GP LLC from March 2009 to August 2010. Prior to that, Mr. Miller served as Chief Operating Officer of JMI Realty, a private real estate investment and development company, from October 2005 to January 2009. From April 2002 to September 2005, Mr. Miller was a partner with SP Securities LLC, a private investment banking firm. Prior to joining SP Securities LLC, Mr. Miller served in positions of increasing responsibility with the Energy Investment Banking department of Merrill Lynch & Co, Inc. (a financial management and advisory firm) from May 1993 to March 2002. Mr. Miller holds a B.S. in finance from Southern Methodist University and an MBA from Northwestern University J.L. Kellogg Graduate School of Management.

 

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Through his role as our Senior Vice President and Chief Financial Officer, Mr. Miller brings extensive knowledge of our Partnership, including its capital structure and financing requirements. Mr. Miller also brings valuable financial expertise, including extensive experience with capital markets transactions, knowledge of the energy industry and familiarity with the natural gas compression industry from his prior role as an investment banker. We believe this knowledge and experience make Mr. Miller well qualified to serve as a director of Exterran GP LLC.

 

William M. Austin.  Mr. Austin was elected Director and Senior Vice President of Exterran GP LLC in April 2012. He also serves as Executive Vice President and Chief Financial Officer of Exterran Holdings, a position he has held since December 2011. Prior to joining Exterran, Mr. Austin served as President of Austin Lee Ventures LTD, an investment company, since April 2010. From June 2009 to April 2010, he served as Senior Vice President and CFO of Valerus Compression Services, L.P., a natural gas services, production and processing company. He was Senior Vice President and CFO of Key Energy Services, a publicly traded oilfield services firm, from January 2005 to February 2009. Prior to Key Energy Services, he worked in various senior operating and financial management positions across numerous industries, which included the following positions to assist with restructurings: Executive Vice President and then Chief Executive Officer of Cable & Wireless/Exodus Communications, Inc. (a provider of web-hosting services) from June 2001 to September 2002, which filed for protection under Chapter 11 of the Bankruptcy Code in September 2002, and Chief Restructuring Officer of Northwestern Corporation (a regional electrical and natural gas provider) from April 2003 to August 2004, prior to its bankruptcy filing in September 2004. Mr. Austin serves as a director of Express Energy LLC (a private oilfield services company). Mr. Austin served on the board and as chairman of the audit committee of IROC Energy Services Corp. (a TSX-listed oilfield services company operating in Canada) from November 2004 until it was acquired in April 2013, and as a director of myDIALS Inc. (a private company and a provider of business analytics tools) from 2009 to 2011. Mr. Austin holds a B.S in Electrical Engineering from Brown University, an M.S. in Computer Science from Stevens Institute of Technology and an MBA from Columbia University. Mr. Austin also serves as an officer and director of certain other Exterran Holdings majority-owned subsidiaries.

 

Through his role as Exterran Holdings’ Chief Financial Officer, Mr. Austin brings extensive knowledge of our Partnership, including its capital structure and financing requirements. Mr. Austin also brings valuable financial expertise, having served in key management and financial roles in a variety of industries. Further, his role in connection with company restructurings brings extensive experience in implementing internal cost discipline and appropriate debt management. We believe this knowledge and experience make Mr. Austin well qualified to serve as a director of Exterran GP LLC.

 

Robert E. Rice.  Mr. Rice was elected Senior Vice President of Exterran GP LLC in December 2011, and at that time he was also appointed Senior Vice President of Exterran Holdings, Inc. and President, North America of Exterran Energy Solutions, L.P. Previously, Mr. Rice was Regional Vice President for the U.S. Gulf Coast Region of Exterran Energy Solutions, L.P. Prior to the merger of Hanover and Universal, Mr. Rice held the following positions at Hanover: Vice President, Gulf Coast Business Unit, from September 2003 to August 2007; Vice President, Health, Safety & Environmental, from October 2002 to September 2003; and Director, Corporate Development, January 2002 to October 2002. During his career, Mr. Rice has been based in Argentina and Australia and has developed detailed experience in analyzing, structuring and growing businesses in domestic and international energy markets. Mr. Rice also served as a Flight Test Engineer with the United States Air Force. Mr. Rice holds a B.S. in electrical engineering from Louisiana Tech University.

 

Daniel K. Schlanger.  Mr. Schlanger has served as Senior Vice President of Exterran GP LLC since June 2006, and has served as a director of Exterran GP LLC since October 2006. From June 2006 to March 2009, he also served as Chief Financial Officer of Exterran GP LLC. He also currently serves as Senior Vice President, Operations Services of Exterran Holdings and Exterran Energy Solutions, L.P. Prior to the merger of Hanover and Universal, Mr. Schlanger served as Vice President — Corporate Development of Universal. From August 1996 through May 2006, Mr. Schlanger was employed as an investment banker with Merrill Lynch & Co., where he focused on the energy sector. Mr. Schlanger also serves as an officer of certain other Exterran Holdings majority-owned subsidiaries. Mr. Schlanger holds a B.S. in economics from the University of Pennsylvania.

 

From his position as Senior Vice President, Operations Services of Exterran Holdings, Mr. Schlanger has unique insight into our operational challenges and opportunities. Also, through his prior role as our Chief Financial Officer and his role in forming the Partnership, Mr. Schlanger brings extensive knowledge of our Partnership, including its capital structure and financing requirements. Mr. Schlanger also brings financial expertise, including experience with capital markets transactions, knowledge of the energy industry and familiarity with master limited partnerships from his prior role as an investment banker. We believe this knowledge and experience make Mr. Schlanger well qualified to serve as a director of Exterran GP LLC.

 

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Donald C. Wayne.  Mr. Wayne was elected Senior Vice President and General Counsel of Exterran GP LLC in May 2008, having served as Vice President, General Counsel and Secretary since August 2006. He also serves as Senior Vice President, General Counsel and Secretary of Exterran Holdings. Prior to the merger of Hanover and Universal, Mr. Wayne served as Vice President, General Counsel and Secretary of Universal, a position he assumed upon joining Universal in August 2006. Prior to joining Universal, he served as Vice President, General Counsel and Corporate Secretary of U.S. Concrete, Inc. (a producer of ready-mixed concrete and concrete-related products) from 1999 to August 2006. Prior to joining U.S. Concrete in 1999, Mr. Wayne served as an attorney with the law firm of Akin, Gump, Strauss, Hauer & Feld, L.L.P. Mr. Wayne also serves as an officer and director of certain other Exterran Holdings majority-owned subsidiaries. Mr. Wayne holds a B.A. from Tufts University and a J.D. and an MBA from Washington University (St. Louis).

 

Kenneth R. Bickett.  Mr. Bickett is Vice President and Controller of Exterran GP LLC, positions he assumed in December 2011. Mr. Bickett held the titles of Vice President, Finance and Accounting of Exterran GP LLC from April 2009 to December 2011, having served as Vice President and Controller of Exterran GP LLC from June 2006 to April 2009. He also serves as Vice President and Controller of Exterran Holdings. Prior to the merger of Hanover and Universal, Mr. Bickett served as Vice President, Accounting and Corporate Controller of Universal, a position he held since joining Universal in July 2005. Prior to joining Universal, he served as Vice President and Assistant Controller for Reliant Energy, Inc. (an electricity and energy services provider). Prior to joining Reliant Energy in 2002, Mr. Bickett was employed by Azurix Corp. (a water and wastewater utility and services company) since 1998, where he most recently served as Vice President and Controller. Mr. Bickett also serves as an officer of certain other Exterran Holdings majority-owned subsidiaries. Mr. Bickett is a Certified Public Accountant and holds a B.S. in accounting from the University of Kentucky.

 

James G. Crump.  Mr. Crump was appointed as a director of Exterran GP LLC in October 2006. Mr. Crump began his career at Price Waterhouse in 1962 and became a partner in 1974. From 1977 until the merger of Price Waterhouse and Coopers Lybrand in 1998, Mr. Crump held numerous management and leadership roles. From 1998 until his retirement in 2001, Mr. Crump served as Global Energy and Mining Cluster Leader, as a member of the U.S. Management Committee and the Global Management Committee and as Houston Office Managing Partner. Mr. Crump served as chairman of the audit committee and a member of the conflicts committee of the board of directors of Copano Energy, L.L.C. (a natural gas gathering and processing company) from November 2004 until Copano was acquired by Kinder Morgan Energy Partners in May 2013. He is a director of the Lamar University Foundation and the Culinary Endorsement Scholarship, Inc. (both non-profit organizations). Mr. Crump holds a B.B.A. in accounting from Lamar University.

 

With a nearly 40-year career focused on providing independent public accounting services to the energy industry, Mr. Crump contributes a broad-based understanding of the oil and gas industry and of complex accounting and financial matters. We believe this knowledge and experience make Mr. Crump well qualified to serve as a director of Exterran GP LLC.

 

G. Stephen Finley.  Mr. Finley was elected as a director of Exterran GP LLC in November 2006. Mr. Finley served in various positions of increasing responsibility at Baker Hughes Incorporated (a provider of drilling, formation evaluation, completion and production products and services to the worldwide oil and gas industry) from 1982 until his retirement in 2006, including as Senior Vice President — Finance and Administration and Chief Financial Officer from April 1999 through April 2006. Mr. Finley currently serves as chairman of the audit committee and as a member of the compensation committee and the nominating and corporate governance committee of the board of directors of Newpark Resources, Inc. (a provider of integrated site, environmental and drilling fluid services to the oil and gas exploration and production industry) and on the board of Microseismic, Inc. (a private oilfield services company providing real-time monitoring and mapping of hydraulic fracture operations in unconventional oil and gas plays). From December 2006 to November 2011, Mr. Finley served on the board of Total Safety U.S., Inc. (a privately held company and global provider of integrated safety strategies and solutions for hazardous environments). From June 2006 to June 2008, Mr. Finley served on the board of Ocean Rig ASA (a Norway-based drilling contractor). Mr. Finley holds a B.S. from Indiana State University.

 

Mr. Finley contributes extensive financial acumen and an understanding of the oil and gas services industry, including oilfield services companies, through his 24 years of service with Baker Hughes, including seven years as Chief Financial Officer, and also serves on the audit and compensation committees of the board of directors of another energy services company. We believe this knowledge and experience make Mr. Finley well qualified to serve as a director of Exterran GP LLC.

 

Edmund P. Segner, III.  Mr. Segner was elected as a director of Exterran GP LLC in May 2009. Mr. Segner is a Professor in the Practice of Engineering Management in the Department of Civil and Environmental Engineering at Rice University (Houston). In November 2008, Mr. Segner retired from EOG Resources, Inc. (EOG), a publicly traded independent oil and gas exploration and production company. Among the positions he held at EOG was President and Chief of Staff and Director from 1999 to 2007. From March 2003 through June 2007, he also served as EOG’s principal financial officer. Mr. Segner served on the board of directors of Universal from 2000 to 2002. Mr. Segner currently serves as chairman of the reserves and environment, health and safety committee and is a member of the audit and compensation committees of Bill Barrett Corporation (a company engaged in exploration and development of natural gas and oil reserves in the Rocky Mountain region of the U.S.). Mr. Segner also serves as the audit committee chair and serves on the nominating and governance committee of Laredo Petroleum, Inc. (a company focused on the exploration, development and acquisition of oil and natural gas properties in the Permian and Mid-Continent regions of the U.S.), and on the conflicts committee of Midcoast Energy Partners, L.P. (a master limited partnership engaged in the natural gas and natural gas liquids midstream business in the U.S.). He served as chairman of the audit committee and as a member of the finance committee of the board of Seahawk Drilling, Inc. (an owner and operator of offshore oil and gas platforms and a provider of shallow water contract drilling services to the oil and natural gas exploration industry) from August 2009 to October 2011. Mr. Segner is a member of the Society of Petroleum Engineers and currently serves on the board of trustees of the Nature Conservancy of Texas (a non-profit nature conservation organization). Mr. Segner is a Certified Public Accountant and holds a B.S. in civil engineering from Rice University and an M.A. in economics from the University of Houston.

 

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Mr. Segner brings technical experience and financial acumen to the board of directors. Having served in a senior management position for an oil and gas company, Mr. Segner also possesses a thorough understanding of the energy industry and operational challenges unique to this industry. In addition, as a former president of a public company and as a director of other public companies, Mr. Segner has valuable experience with other functions pertinent to our board, including compensation, financing matters and the evaluation of acquisition opportunities. We believe this knowledge and experience make Mr. Segner well qualified to serve as a director of Exterran GP LLC.

 

Item 11.  Executive Compensation

 

Compensation Discussion and Analysis

 

Overview

 

As is commonly the case for many publicly traded limited partnerships, we have no employees. Under the terms of our partnership agreement, we are ultimately managed by Exterran GP LLC, the general partner of Exterran General Partner, L.P., our general partner (which we may refer to as our general partner or Exterran GP LLC). We refer to Exterran GP LLC’s management and executive officers as “our management” and “our executive officers” and Exterran GP LLC’s board of directors and compensation committee as “our board of directors” and “our compensation committee.”

 

The following discussion addresses the 2013 compensation for our named executive officers (collectively, the “Named Executive Officers”), who are:

 

·       D. Bradley Childers, President and Chief Executive Officer of Exterran GP LLC and Exterran Holdings;

 

·                    David S. Miller, Senior Vice President and Chief Financial Officer of Exterran GP LLC;

 

·                    Robert E. Rice, Senior Vice President of Exterran GP LLC and Exterran Holdings and President, North America of Exterran Energy Solutions, L.P.;

 

·                    Daniel K. Schlanger, Senior Vice President of Exterran GP LLC and Senior Vice President, Operations Services of Exterran Holdings; and

 

·                    Donald C. Wayne, Senior Vice President and General Counsel of Exterran GP LLC and Exterran Holdings.

 

Compensation Expense Allocations

 

Under the Omnibus Agreement, most costs associated with Exterran Holdings’ provision of services to us, including compensation of our Named Executive Officers, are allocated to us on a monthly basis in the manner that our general partner deems reasonable. During 2013, those allocations were generally made using a two-step process:

 

·                    First, Exterran Holdings allocated an appropriate portion of its total SG&A expenses among its business segments, including to the U.S. portion of its North America contract operations segment, based on revenue.

 

·                    Second, Exterran Holdings allocated to us a prorated portion of the SG&A expenses initially allocated to the U.S. portion of Exterran Holdings’ North America contract operations segment based upon the ratio of our total compression equipment horsepower to the sum of Exterran Holdings’ total U.S. compression equipment horsepower and our total compression equipment horsepower.

 

Under the Omnibus Agreement, the amount for which we were obligated to reimburse Exterran Holdings for SG&A expenses allocated to us, including compensation costs, could not exceed $10.5 million per quarter, after taking into account any such costs we incur and pay directly (the “SG&A Cap”), for the period from January 1, 2013 through March 31, 2013. In connection with the March 2013 Contract Operations Acquisition, effective April 1, 2013, the SG&A Cap under the terms of the Omnibus Agreement was increased to $12.5 million per quarter. The reimbursement of compensation costs allocated by Exterran Holdings to us for the compensation of our Named Executive Officers (which excludes the non-cash costs related to our phantom unit awards) is subject to the SG&A Cap. See Part III, Item 13 (“Certain Relationships and Related Transactions, and Director Independence”) of this report for additional discussion of relationships and transactions we have with Exterran Holdings and the terms of the Omnibus Agreement.

 

During the year ended December 31, 2013, Exterran Holdings allocated to us the following percentages of Exterran Holdings’ compensation expenses incurred to provide the Named Executive Officers’ total compensation, including base salary, annual performance-based incentive compensation, Exterran Holdings’ stock and option awards, our phantom unit awards and other benefits:

 

Executive Officer

 

Percent of Named Executive Officer’s 2013
Total Compensation Allocated to the
Partnership
(%)

 

Current Named Executive Officers

 

 

 

D. Bradley Childers

 

14

 

David S. Miller

 

14

 

Robert E. Rice

 

23

 

Daniel K. Schlanger

 

 

Donald C. Wayne

 

14

 

 

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Our Compensation Committee’s Structure and Responsibilities

 

As described above, because most of our Named Executive Officers are also officers of Exterran Holdings and generally spend a majority of their time working on matters for Exterran Holdings rather than us, their compensation structure is established by the compensation committee of the board of directors of Exterran Holdings (the “Exterran Holdings compensation committee”). Our compensation committee’s primary responsibilities are to:

 

·                    Discharge the board of directors’ responsibilities relating to our executives’ compensation;

 

·                    Review and approve the manner in which Exterran Holdings allocates to us the compensation expense applicable to our Named Executive Officers;

 

·                    Oversee the Exterran Partners, L.P. Long-Term Incentive Plan (the “Partnership Plan”) and make awards thereunder;

 

·                    Review and approve compensation programs for our independent directors; and

 

·                    Produce an annual report relating to this compensation discussion and analysis for inclusion in our Annual Report on Form 10-K in accordance with the rules and regulations of the SEC.

 

Our compensation committee is comprised entirely of independent directors within the meaning of applicable NASDAQ rules. The current members of our compensation committee are Messrs. Finley (chair), Crump and Segner.

 

Compensation Philosophy and Objectives

 

The primary objectives of Exterran Holdings’ executive compensation program are to:

 

·       Pay competitively - The Exterran Holdings compensation committee believes that, to attract, retain and motivate an effective management team with the level of expertise and experience needed to achieve consistent growth, profitability and return for Exterran Holdings’ stockholders and our equity holders, our total compensation should be competitive with that of companies similar in size to Exterran Holdings across a variety of industries and within the oilfield services sector, as further described below in “How the Exterran Holdings Compensation Committee Determines Executive Compensation.”

 

·       Pay for performance — Exterran Holdings’ and our emphasis on performance-based compensation is an important component of our overall compensation philosophy.  Cash bonuses and performance awards based on Exterran Holdings’ annual performance combined with Exterran Holdings and our equity awards that vest over several years balance short-term and long-term business objectives.  On the average, approximately 74% of our Named Executive Officers’ targeted total direct compensation (base salary plus targeted annual and long-term incentive award levels) for 2013 was performance-based pay.

 

·       Align management’s interests with equityholders’ interests — Exterran Holdings’ and our emphasis on equity-based compensation and ownership encourages executives to act strategically to drive sustainable long-term performance and enhance long-term equityholder value.

 

How the Exterran Holdings Compensation Committee Determines Executive Compensation

 

The Exterran Holdings compensation committee is responsible for establishing and overseeing compensation programs that are consistent with Exterran Holdings’ compensation philosophy. In carrying out this role, the Exterran Holdings compensation committee considers the following:

 

·                    Current and past total compensation, including a review of base salary, short-term incentive pay and the value of long-term incentive awards received;

 

·                    Data and analysis provided by the Exterran Holdings compensation committee’s compensation consultant, as further detailed below;

 

·                    The Chief Executive Officer’s recommendations (other than with respect to his own compensation);

 

·                    Exterran Holdings’ company and operating unit performance (where applicable), as well as each executive’s impact on performance;

 

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·                    Each executive’s relative scope of responsibility and potential;

 

·                    Individual performance and demonstrated leadership;

 

·                    Internal pay equity considerations; and

 

·                    Any other factors that the Exterran Holdings compensation committee deems relevant.

 

No specific formula is used to determine the weight of any factor; rather, compensation is established based on the Exterran Holdings compensation committee’s assessment of all relevant information.

 

Compensation Consultant Data and Analysis

 

For 2013, the Exterran Holdings compensation committee engaged Pearl Meyer & Partners (“Pearl Meyer”), an independent third-party compensation consultant, to:

 

·                  provide a competitive review of executive compensation, including base salary, annual incentives, long-term incentives and total direct compensation, compared with independent and objective market data; and

 

·                  provide information on how trends, new rules, regulations and laws impact executive and director compensation practice and administration.

 

For 2013, Pearl Meyer provided an analysis of data derived from (i) proxy statements filed by the members of Exterran Holdings’ peer group, as further described below, and (ii) surveys of the compensation practices of companies in the oilfield services industry, the broader energy industry and across a variety of industries, in each case with annual revenues of approximately $3.0 billion.(1)  In performing its analysis, Pearl Meyer generally placed more weight on the proxy compensation data than on the information derived from the compensation surveys.

 

In consultation with Pearl Meyer, the Exterran Holdings compensation committee selected Exterran Holdings’ 2013 peer group as follows:

 

Basic Energy Services, Inc.

Flowserve Corporation

Patterson-UTI Energy, Inc.

 

 

 

Cameron International Corporation

Gardner Denver, Inc.

Regency Energy Partners, L.P.

 

 

 

Chicago Bridge & Iron Company N.V.

Key Energy Services, Inc.

RPC, Inc.

 

 

 

DCP Midstream Partners

McDermott International, Inc.

Superior Energy Services, Inc.

 

 

 

Dresser-Rand Group Inc.

Oceaneering International, Inc.

Willbros Group, Inc.

 

 

 

 

Oil States International, Inc.

 

 

Because many of Exterran Holdings’ direct competitors are not publicly traded or are not of a comparable size, its peer group includes a diversity of oilfield services and related companies with a range of revenues and with both domestic and international operations.  The Exterran Holdings compensation committee believes this peer group includes companies with which Exterran Holdings competes for technical and managerial talent and provides an appropriate reference point for assessing the competitiveness of Exterran Holdings’ compensation program. The Exterran Holdings compensation committee annually reviews the composition of the peer group, based on input from its compensation consultant, and modifies it as circumstances, including industry consolidation and other competitive forces, warrant.  In consultation with Pearl Meyer, the Exterran Holdings compensation committee made several changes to the peer group for 2013, including the removal of Complete Production Services, Inc. due to its 2012 acquisition, the removal of FMC Technologies, Inc. because its revenue and market cap were greater than the majority of Exterran Holdings’ peer companies, and the removal of Noble Corporation and Rowan Companies, Inc., both of which are offshore drilling contractors (and thus engage in a business dissimilar to Exterran Holdings’) and have redomiciled to Europe over recent years. To balance out these removals, the Exterran Holdings compensation committee added Basic Energy Services, Inc., Flowserve Corporation, Oceaneering International, Inc., RPC, Inc. and Willbros Group, Inc., all of which are either oilfield services companies or engaged in another similar business and are of comparable size to Exterran Holdings in terms of revenue.

 

For 2013, the Exterran Holdings compensation committee used Pearl Meyer’s analysis to help structure a competitive executive compensation program, position executive compensation within a target range, and make individual compensation decisions based on

 


(1)  No information was provided as to any individual company’s responses to the survey questions, and no individual component company that contributed to these surveys was evaluated by or considered by the Exterran Holdings compensation committee for purposes of determining executive compensation.

 

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comparable positions at those companies with which Exterran Holdings competes for talent, as follows:

 

 

 

2013 Target Level

 

2013 Actual Compensation Positioning

Target Cash Compensation(1)

 

50th percentile

 

Averaged around the 50th percentile for all Named Executive Officers, including the Chief Executive Officer.

Target Total Direct Compensation(2)

 

50th percentile

 

Between the 25th and the 50th percentile for the Chief Executive Officer. Averaged around the 50th percentile for all other Named Executive Officers.

 


(1)                                 Calculated for each Named Executive Officer as the sum of his base salary earned for 2013 and his 2013 target short-term incentive compensation.

 

(2)                                 Calculated for each Named Executive Officer as the sum of his target cash compensation for 2013 and the grant date fair value of all equity-based awards granted to him during 2013.

 

While the Exterran Holdings compensation committee took into consideration the analysis provided, Pearl Meyer did not make any specific recommendation as to the Named Executive Officers’ compensation levels or performance targets for 2013.

 

Following review and consultation with Pearl Meyer, the Exterran Holdings compensation committee has determined that Pearl Meyer is independent and that no conflict of interest, either currently or during 2013, results from this engagement.  In arriving at this conclusion, the Exterran Holdings compensation committee considered the following:

 

·       Pearl Meyer did not provide any services to Exterran Holdings, us or management other than services requested by or with the approval of the Exterran Holdings compensation committee, and these services were limited to executive and director compensation consulting;

 

·       Pearl Meyer maintains a conflicts policy that includes specific policies and procedures designed to ensure independence, and has provided this policy to the Exterran Holdings compensation committee;

 

·       The fees paid by Exterran Holdings to Pearl Meyer during 2013 were less than 1% of Pearl Meyer’s total revenue for 2013;

 

·       No Pearl Meyer consultant that  worked on Exterran Holdings matters had any business or personal relationship with any member of the Exterran Holdings compensation committee;

 

·       Neither Pearl Meyer nor any Pearl Meyer consultant had any business or personal relationship with any executive officer of Exterran Holdings; and

 

·       No Pearl Meyer consultant that worked on Exterran Holdings matters held an equity interest in Exterran Holdings.

 

The Exterran Holdings compensation committee continues to monitor the independence of its compensation consultant on a periodic basis.

 

Chief Executive Officer Recommendations

 

The most significant aspects of management’s, including the Chief Executive Officer’s, role in the compensation-setting process are:

 

·                    recommending compensation programs, compensation policies, compensation levels and incentive opportunities that are consistent with Exterran Holdings’ and our business strategies;

 

·                    compiling, preparing and distributing materials for the Exterran Holdings compensation committee’s review and consideration;

 

·                    recommending corporate performance goals on which performance-based compensation will be based; and

 

·                    assisting in the evaluation of employee performance.

 

The Chief Executive Officer annually reviews the performance of each of the other executive officers and recommends salary adjustments, annual cash incentives and long-term incentive awards, which the Exterran Holdings compensation committee considers along with the other factors discussed above.

 

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Elements of Compensation

 

Exterran Holdings’ compensation program is designed (i) to align our executive officers’ pay with individual and company and partnership performance in order to achieve growth, profitability and return for our equityholders, and (ii) to attract and retain talented executives who are critical to Exterran Holdings’ and our short- and long-term success. The key elements of our Named Executive Officers’ compensation and the primary objectives of each are:

 

·                    Base salary attracts and retains talented executives, recognizes individual roles and responsibilities, and provides stable income;

 

·                    Annual performance-based incentive compensation promotes short-term performance objectives and rewards executives for their contributions toward achieving those objectives;

 

·                    Long-term incentive compensation aligns executives’ interests with equityholders’ interests, emphasizes long-term financial and operational performance, and helps retain key executives;

 

·                    Retirement savings, health and welfare benefits provide retirement income and protection against the financial hardship that can result from illness, disability or death; and

 

·                    Severance benefit and change of control arrangements aid in attracting and retaining executive talent, particularly during any potential transition period due to a change in control.

 

Each of these elements of compensation is further described below.

 

Base Salary

 

The Exterran Holdings compensation committee has determined that, to attract external executive talent and support the development and retention of current executives, base pay should be competitive, as described above. In February 2013, the Exterran Holdings compensation committee reviewed the base salaries of our Named Executive Officers based upon the considerations discussed above under “How the Exterran Holdings Compensation Committee Determines Executive Compensation” and determined to make the adjustments shown below, effective as of March 2013.  Our Named Executive Officers’ 2013 base salaries (both before and after the March 2013 adjustments) were:

 

 

 

 

 

2013 Base Salary ($)

 

Executive Officer

 

Title

 

Pre-adjustment

 

Post-
adjustment

 

D. Bradley Childers

 

President and Chief Executive Officer

 

500,000

 

650,000

 

David S. Miller

 

Senior Vice President and Chief Financial Officer

 

280,000

 

288,400

 

Robert E. Rice

 

Senior Vice President

 

315,000

 

340,000

 

Daniel K. Schlanger

 

Senior Vice President

 

355,000

 

365,000

 

Donald C. Wayne

 

Senior Vice President and General Counsel

 

338,000

 

350,000

 

 

When Mr. Childers was promoted to Chief Executive Officer in December 2011, the Exterran Holdings compensation committee targeted his 2012 cash compensation between the 25th and 50th percentiles to allow for future increases commensurate with his experience and achievements in the role. Accordingly, in February 2013, the Exterran Holdings compensation committee determined to increase Mr. Childers’ base salary by approximately 30%, both in recognition of his substantial contributions to company performance in 2012 and to bring his base salary more closely in line with comparable positions at those companies with which Exterran Holdings competes for talent.

 

Annual Performance-Based Incentive Compensation

 

During the first quarter of each year, the Exterran Holdings compensation committee adopts a program to provide the short-term cash incentive element of Exterran Holdings’ and our Named Executive Officers’ compensation for that year.  Accordingly, in February 2013, the Exterran Holdings compensation committee adopted the short-term incentive program for 2013 (the “2013 Incentive Program”). Each Named Executive Officer’s cash incentive target was a specified percentage of his base salary earned in 2013.  In determining the cash incentive opportunity for each Named Executive Officer, the Exterran Holdings compensation committee considered the factors discussed above under “How the Exterran Holdings Compensation Committee Determines

 

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Executive Compensation.  Under the 2013 Incentive Program, each Named Executive Officer’s cash incentive target was:

 

Executive Officer

 

Title

 

2013 Cash
Incentive Target
(% of earned
base salary)

 

2013 Cash
Incentive Target
($)

 

D. Bradley Childers

 

President and Chief Executive Officer

 

100

 

615,385

 

David S. Miller

 

Senior Vice President and Chief Financial Officer

 

50

 

143,231

 

Robert E. Rice

 

Senior Vice President