ITEM 1. Business
References in this report to “USA Compression,” “we,” “our,” “us,” “the Partnership” or like terms refer to USA Compression Partners, LP and its wholly owned subsidiaries, including USA Compression Partners, LLC (“USAC Operating”) and USAC OpCo 2, LLC (“OpCo 2” and together with USAC Operating, the “Operating Subsidiaries”). References to “USA Compression Holdings” refer to USA Compression Holdings, LLC, the owner of USA Compression GP, LLC, our general partner. References to our “general partner” refer to USA Compression GP, LLC. References to USAC Management refer to USA Compression Management Services, LLC, a wholly owned subsidiary of our general partner. References to “Riverstone” refer to Riverstone/Carlyle Global Energy and Power Fund IV, L.P., and affiliated entities, including Riverstone Holdings, LLC.
Overview
We are a growth oriented Delaware limited partnership and, based on management’s significant experience in the industry, we believe that we are one of the largest independent providers of compression services in the U.S. in terms of total compression unit horsepower. We have been providing compression services since 1998. As of December 31, 2013, we had 1,202,374 horsepower in our fleet and approximately 180,000 horsepower on order for expected delivery primarily in the first half of 2014. Our primary focus is to provide compression services to our customers in connection with infrastructure applications. Natural gas compression is a mechanical process whereby natural gas is compressed to a smaller volume, resulting in higher pressure. This process has various applications, including both allowing for the transportation of the natural gas through the domestic pipeline system and enhancing crude oil production through artificial lift processes. As such, our compression services play a critical role in the production and transportation of both natural gas and crude oil.
We provide compression services in a number of shale plays throughout the U.S., including the Marcellus, Eagle Ford, Utica, Mississippi Lime, Granite Wash, Woodford, Barnett, Permian Basin, Haynesville and Fayetteville shales. Because the demand for our services is driven by production of natural gas and crude oil, we have focused our activities in areas of attractive growth, which are generally found in these shale and unconventional resource plays. Further, we believe production in these areas will increase in the future. According to the Annual Energy Outlook 2013 (the “2013 Outlook”) prepared by the Energy Information Agency (“EIA”), natural gas production from shale formations is expected to increase from 34% of total U.S. natural gas production in 2011 to 50% of total U.S. natural gas production in 2040. In addition, the EIA forecasts in its 2013 Outlook that total domestic crude oil production will increase by 33% from 2011 to 2019, and more importantly, forecasts tight oil production to increase by 128% over the same time period. Not only are the production and transportation volumes in these and other shale plays increasing, the geological and reservoir characteristics are also particularly attractive for compression services. The changes in production volume and pressure of shale plays over time result in a wider range of compression requirements than in conventional basins. We believe we are well-positioned to meet these changing operating conditions as a result of the flexibility of our compression units. While our business focuses largely on compression services in shale plays, we also provide compression services in more mature conventional basins, including crude oil wells targeted by horizontal drilling techniques. Wells in conventional basins typically require increasing amounts of compression as they age and pressures decline. In addition, the continued development of horizontal drilling, particularly in crude oil wells, has allowed producers to produce incremental volumes of crude oil on attractive economic terms. Our gas lift fleet, critical to producing oil from horizontal wells, serves this growing market demand.
We operate a modern fleet of compression units, with an average age of approximately four years. We acquire our compression units from third-party fabricators who build the units to our specifications, utilizing specific original equipment manufacturers and assembling the units in a manner that provides us the ability to meet certain operating condition thresholds. Our standard new-build compression units are generally configured for multiple compression stages allowing us to operate our units across a broad range of operating conditions. As of December 31, 2013, we estimate that approximately 89% of our revenue generating horsepower was deployed in infrastructure applications, including large-volume gathering systems, processing facilities, transportation applications and crude oil gas lift. The design flexibility of our units, particularly in midstream applications, allows us to enter into longer-term contracts where appropriate and reduces the redeployment risk of our horsepower in the field. Our modern and standardized fleet, decentralized field level operating structure and technical proficiency in predictive and preventive maintenance and overhaul operations have enabled us to achieve average service run times consistently above the levels required by our customers.
As part of our services, we engineer, design, operate, service and repair our compression units and maintain related support inventory and equipment. The compression units in our modern fleet are designed to be easily adaptable to fit our customers’ dynamic compression requirements. By focusing on the needs of our customers and by providing them with reliable and flexible compression services in geographic areas of attractive growth, we are able to generate stable cash flows for our unitholders. From 2003 through 2013, our average horsepower utilization was over 90%, occurring throughout periods of volatile natural gas prices.
We provide compression services to our customers under fixed-fee contracts, with initial contract terms of up to five years for midstream applications and six to twelve months for crude oil gas lift applications. We typically continue to provide compression services to our customers beyond their initial contract terms, either through contract renewals or on a month-to-month basis. We generally enter into take-or-pay contracts whereby our customers are required to pay our monthly fee even during periods of limited or disrupted throughput, which enhances the stability and predictability of our cash flows. We are not directly exposed to commodity price risk because we do not take title to the natural gas we compress and because the natural gas used as fuel by our compression units is supplied by our customers without cost to us.
Business Strategies
Our principal business objective is to increase the quarterly cash distributions that we pay to our unitholders over time while ensuring the ongoing stability and growth of our business. We expect to achieve this objective by executing on the following strategies:
· Capitalize on the increased need for natural gas compression in conventional and unconventional plays. We expect additional demand for compression services to result from the continuing shift of natural gas production to domestic shale plays as well as the declining production pressures of aging conventional basins. In addition, the continued development of horizontal drilling in crude oil production and the demand for artificial lift techniques represents an attractive growth area. Our fleet of modern, flexible compression units, which are capable of being rapidly deployed and redeployed and many of which are designed to operate in multiple compression stages, will enable us to capitalize on these opportunities both in emerging shale plays as well as conventional fields.
· Continue to execute on attractive organic growth opportunities. Between 2003 and 2013, we grew the horsepower in our fleet of compression units and our compression revenues at a compound annual growth rate of 24%, primarily through organic growth. We believe organic growth opportunities will continue to be our most attractive source of near-term growth. We seek to achieve continued organic growth by (i) increasing our business with existing customers, (ii) obtaining new customers in our existing areas of operations and (iii) expanding our operations into new geographic areas.
· Partner with customers who have significant compression needs. We actively seek to identify customers with major acreage positions in active and growing areas. We work with these customers to jointly develop long-term and adaptable solutions designed to optimize their lifecycle compression costs. We believe this is important in determining the overall economics of producing, gathering and transporting natural gas. Our proactive and collaborative approach positions us to serve as our customers’ compression provider of choice.
· Pursue accretive acquisition opportunities. While our principal growth strategy will be to continue to grow organically, we may pursue accretive acquisition opportunities, including the acquisition of complementary businesses, participation in joint ventures or purchase of compression units from existing or new customers in conjunction with providing compression services to them. We will consider opportunities that (i) are in our existing geographic areas of operations or new, high-growth regions, (ii) meet internally established economic thresholds and (iii) may be financed on reasonable terms.
· Maintain financial flexibility. We intend to maintain financial flexibility to be able to take advantage of growth opportunities. Historically, we have utilized our cash flow from operations, borrowings under available debt facilities and operating leases to fund capital expenditures to expand our compression services business. This approach has allowed us to significantly grow our fleet and the amount of cash we generate, while maintaining our debt at levels we believe are manageable for our business. We believe our financial flexibility positions us to take advantage of future growth opportunities without incurring debt beyond appropriate levels.
Our Operations
Compression Services
We provide compression services for a monthly service fee. As part of our services, we engineer, design, operate, service and repair our fleet of compression units and maintain related support inventory and equipment. We have consistently provided average service run times above the levels required by our customers. In general, our team of field service technicians service our compression fleet and do not service third party owned equipment. We seek to enter into service contracts with each of our customers. In connection with the S&R Acquisition (as defined below), we acquired contracts related to the active compressors in the fleet that were styled as rentals. We are in the process of converting these agreements into service contracts. We do not own any compression fabrication facilities.
Our Compression Fleet
The fleet of compression units that we own and use to provide compression services consists of specially engineered compression units that utilize standardized components, principally engines manufactured by Caterpillar, Inc. and compressor frames and cylinders manufactured by Ariel Corporation. Our units can be rapidly and cost effectively modified for specific customer applications. Approximately 97% of our fleet horsepower at December 31, 2013 was purchased new and the average age of our compression units was approximately four years. Our modern, standardized compressor fleet primarily consists of the Caterpillar 3500 and 3600 engine classes, which range from 630 to 4,700 horsepower per unit. These larger horsepower units, defined as 400 horsepower per unit or greater, represented approximately 81.2% of our total horsepower (including compression units on order) as of December 31, 2013. In addition, a portion of our fleet consists of smaller horsepower units ranging from 84 horsepower to 240 horsepower that are primarily used in our gas lift operations. We believe the young age and overall composition of our compressor fleet results in fewer mechanical failures, lower fuel usage (a direct cost savings for our customers), and reduced environmental emissions.
The following table provides a summary of our compression units by horsepower as of December 31, 2013 (including additional new compression unit horsepower on order for delivery between January 2014 and November 2014):
(1) As of December 31, 2013, we had on order 179,857 horsepower, of which 149,092 horsepower is expected to be delivered between January 2014 and June 2014, and 30,765 horsepower is expected to be delivered between July 2014 and November 2014.
(2) Comprised of 2,461 compression units, including 266 new compression units on order.
The following table sets forth certain information regarding our compression fleet as of the dates and for the periods indicated:
(1) Fleet horsepower is horsepower for compression units that have been delivered to us (and excludes units on order). As of December 31, 2013, we had approximately 180,000 horsepower on order with expected delivery primarily in the first half of 2014.
(2) Total available horsepower is revenue generating horsepower under contract for which we are billing a customer, horsepower in our fleet that is under contract but is not yet generating revenue, horsepower not yet in our fleet that is under contract not yet generating revenue and that is subject to a purchase order, and idle horsepower. Total available horsepower excludes new horsepower on order for which we do not have a compression services contract.
(3) Revenue generating horsepower is horsepower under contract for which we are billing a customer.
(4) Calculated as the average of the month-end horsepower per revenue generating horsepower for each of the months in the period.
(5) Calculated as the average of the month-end horsepower per revenue generating compression unit for each of the months in the period.
(6) Horsepower utilization is calculated as (i)(a) revenue generating horsepower plus (b) horsepower in our fleet that is under contract, but is not yet generating revenue plus (c) horsepower not yet in our fleet that is under contract not yet generating revenue and that is subject to a purchase order, divided by (ii) total available horsepower less idle horsepower that is under repair. Horsepower utilization based on revenue generating horsepower and fleet horsepower at each applicable period end was 89.0%, 86.4%, 89.9% and 87.5%, for the years ended December 31, 2013, 2012, 2011 and 2010, respectively.
(7) Calculated as the average utilization for the months in the period based on utilization at the end of each month in the period.
A growing number of our compression units have electronic control systems that enable us to monitor our units remotely by satellite or other means to supplement our technicians’ on-site monitoring visits. Our compression units are designed to automatically shut down if operating conditions deviate from a pre-determined range. While we retain the care, custody, ongoing maintenance and control of our compression units, we allow our customers, subject to a defined protocol, to start, stop, accelerate and slow down compression units in response to field conditions.
We adhere to routine, preventive and scheduled maintenance cycles. Each of our compression units is subjected to rigorous sizing and diagnostic analyses, including lubricating oil analysis and engine exhaust emission analysis. We have proprietary field service automation capabilities that allow our service technicians to electronically record and track operating, technical, environmental and commercial information at the discrete unit level. These capabilities allow our field technicians to identify potential problems and act on them before such problems result in downtime.
Generally, we expect each of our compression units to undergo a major overhaul between service deployment cycles once every eight to ten years for our larger horsepower units (400 horsepower or greater) and on average every five years for smaller horsepower units. A major overhaul involves the periodic rebuilding of the unit to materially extend its economic useful life or to enhance the unit’s ability to fulfill broader or more diversified compression applications. Because our compression fleet is comprised of units of varying horsepower that have been placed into service with staggered initial on-line dates, we are able to schedule overhauls in a way to avoid excessive maintenance capital expenditures and minimize the revenue impact of downtime.
We believe that our customers, by outsourcing their compression requirements, can achieve higher compression runtimes, which translates into increased volume of either natural gas or crude oil production and therefore increases revenues. Utilizing our compression services also allows our customers to reduce their operating, maintenance and equipment costs by allowing us to efficiently manage their changing compression needs. In many of our service contracts, we guarantee our customers availability ranging from 95% to 98%, depending on field level requirements. For service contracts that do not have a stated availability guarantee, we work with those customers to ensure that our compression services meet their operational needs.
General Compression Service Contract Terms
The following discussion describes the material terms generally common to our compression service contracts. We generally enter into a new contract with respect to each distinct application for which we will provide compression services.
Term and termination. Our contracts typically have an initial term between one and five years for midstream applications and between six and twelve months for gas lift applications. After the expiration of the applicable term the contract continues on a month-to-month or longer basis until terminated by us or our customers upon notice as provided for in the applicable contract.
Availability. Our contracts often provide a guarantee of specified availability. We define availability as the percentage of time in a given period that our compression services are being provided or are capable of being provided. Availability is reduced by instances of “down-time” that are attributable to anything other than events of force majeure or acts or failures to act by the customer. “Down-time” under our contracts usually begins when our services stop being provided and when we receive notice of the problem. Down-time due to scheduled maintenance is also excluded from our availability commitment. Our failure to meet a stated availability guarantee may result in a service fee credit to the customer. As a consequence of our availability guarantee, we are incentivized to perform predictive and preventive maintenance on our fleet as well as promptly respond to a problem to meet our contractual commitments and ensure our customers the compression availability on which their business and our service relationship is based.
Fees and expenses. Our customers pay a fixed monthly fee for our services. We bill our customers 30 days in advance, except for many of our gas lift compression customers (which are billed at the beginning of the service month), and they are required to pay upon receipt of the invoice. We are not responsible for acts of force majeure, and our customers generally are required to pay our monthly fee even during periods of limited or disrupted throughput. We are generally responsible for the costs and expenses associated with operation and maintenance of our compression equipment, such as providing necessary lubricants, although certain fees and expenses are the responsibility of our customers under the terms of their contracts. For example, all fuel gas is provided by our customers without cost to us, and in many cases customers are required to provide all water and electricity, while lubricants in certain cases may be provided by the customer. We are also reimbursed by our customers for certain ancillary expenses such as trucking and crane operation, depending on the terms agreed to in the applicable contract, resulting in no gross operating margin.
Service standards and specifications. We commit to provide compression services under service contracts that typically provide that we will supply all compression equipment, tools, parts, field service support and engineering. Our contracts do not govern the compression equipment we will use; instead, in conjunction with our customer, we determine what equipment is necessary to perform our contractual commitments.
Title; Risk of loss. We own all compression equipment we use to provide compression services, and we normally bear the risk of loss or damage to our equipment and tools and injury or death to our personnel.
Insurance. Our contracts typically provide that both we and our customers are required to carry general liability, workers’ compensation, employers’ liability, automobile and excess liability insurance.
Marketing and Sales
Our marketing and client service functions are performed on a coordinated basis by our sales and field technicians. Salespeople and field technicians qualify, analyze and scope new compression applications as well as regularly visit our customers to ensure customer satisfaction, to determine a customer’s current needs related to services currently being provided and to determine the customer’s future compression services requirements. This ongoing communication allows us to quickly identify and respond to our customers’ compression requirements. We currently focus on geographic areas where we can achieve economies of scale through high density operations.
Customers
Our customers consist of more than 250 companies in the energy industry, including major integrated oil companies, public and private independent exploration and production companies and midstream companies. Our largest customer for the years ended December 31, 2013 and 2012 was Southwestern Energy Corporation and its subsidiaries, or Southwestern Energy. Southwestern Energy accounted for 14.3% of our revenue for the year ended December 31, 2013 and 14.5% of our revenue for the year ended December 31, 2012. Our ten largest customers accounted for 49% and 54% of our revenue for the years ended December 31, 2013 and 2012, respectively.
Suppliers and Service Providers
The principal manufacturers of components for our natural gas compression equipment include Caterpillar, Inc., or Caterpillar, Cummins Inc., or Cummins, and Arrow Engine Company, or Arrow (for engines), Air-X-Changers and Air Cooled Exchangers (for coolers), and Ariel Corporation, GE Oil & Gas Gemini products and Arrow (for compressor frames and cylinders). We also rely primarily on three vendors, A G Equipment Company, Standard Equipment Corp. and S&R Compression, LLC (“S&R”), to package and assemble our compression units. Although we rely primarily on these suppliers, we believe alternative sources for natural gas compression equipment are generally available if needed. However, relying on alternative sources may increase our costs and change the
standardized nature of our fleet. We have not experienced any material supply problems to date, although lead-times for Caterpillar engines and Ariel compressor frames have in the past been in excess of one year due to increased demand and supply allocations imposed on equipment packagers and end-users by Caterpillar. Please read “- Item 1A.
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 were to occur, our business, financial condition or results of operations could be materially and adversely affected. In that case, we might not be able to pay our minimum quarterly distribution on our common units or grow such distributions and the trading price of our common units could decline.
Risks Related to Our Business
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 make cash distributions at our current distribution rate to holders of our common units and subordinated units.
In order to make cash distributions at our current distribution rate of $0.48 per unit per quarter, or $1.92 per unit per year, we will require available cash of $18.7 million per quarter, or $74.6 million per year, based on the number of common units, subordinated units and the 2.0% general partner interest currently outstanding at February 18, 2014. Under our cash distribution policy, the amount of cash we can distribute to our unitholders 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 level of production of, demand for, and price of natural gas and crude oil, particularly the level of production in the locations where we provide compression services;
· the fees we charge, and the margins we realize, from our compression services;
· the cost of achieving organic growth in current and new markets;
· the level of competition from other companies; and
· prevailing global and regional economic and regulatory conditions, and their impact on our customers.
In addition, the actual amount of cash we will have available for distribution will depend on other factors, including:
· the levels of our maintenance capital expenditures and expansion capital expenditures;
· the level of our operating costs and expenses;
· our debt service requirements and other liabilities;
· fluctuations in our working capital needs;
· restrictions contained in our revolving credit facility;
· the cost of acquisitions, if any;
· fluctuations in interest rates;
· our ability to borrow funds and access capital markets; and
· the amount of cash reserves established by our general partner.
A long-term reduction in the demand for, or production of, natural gas or crude oil in the locations where we operate could adversely affect the demand for our services or the prices we charge for our services, which could result in a decrease in our revenues and cash available for distribution to our unitholders.
The demand for our compression services depends upon the continued demand for, and production of, natural gas and crude oil. Demand may be affected by, among other factors, natural gas prices, crude oil prices, weather, availability of alternative energy sources, governmental regulation and general demand for energy. Any prolonged, substantial reduction in the demand for natural gas or crude oil would, in all likelihood, depress the level of production activity and result in a decline in the demand for our compression services, which would reduce our cash available for distribution. Lower natural gas prices or crude oil prices over the long term could result in a decline in the production of natural gas or crude oil, respectively, resulting in reduced demand for our compression services. Additionally, an increasing percentage of natural gas and crude oil production comes from unconventional sources, such as shales, tight sands and coalbeds. Such sources can be less economically feasible to produce in low natural gas price environments, in part due to costs related to compression requirements, and a reduction in demand for natural gas or gas lift for crude oil may cause such sources of natural gas or crude oil to be uneconomic to drill and produce, which could in turn negatively impact the demand for our services. In addition, governmental regulation and tax policy may impact the demand for natural gas or crude oil or impact the economic feasibility of development of new fields or production of existing fields.
We have several key customers. The loss of any of these customers would result in a decrease in our revenues and cash available for distribution to our unitholders.
We provide compression services under contracts with several key customers. The loss of one of these key customers may have a greater effect on our financial results than for a company with a more diverse customer base. Our largest customer for the years ended December 31, 2013 and 2012 was Southwestern Energy Company and its subsidiaries, or Southwestern Energy. Southwestern Energy accounted for 14.3% of our revenue for the year ended December 31, 2013 and 14.5% of our revenue for the year ended December 31, 2012. Our ten largest customers accounted for 49% and 54% of our revenue for the years ended December 31, 2013 and 2012, respectively. The loss of all or even a portion of the compression services we provide to our key customers, as a result of competition or otherwise, could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.
The erosion of the financial condition of our customers could adversely affect our business.
During times when the natural gas or oil markets weaken, our customers are more likely to experience financial difficulties and the lack of availability of debt or equity financing, which could result in a reduction in our customers’ spending for our services. For example, our customers could seek to preserve capital by using lower cost providers, not renewing month-to-month contracts or determining not to enter into any new compression service contracts. Reduced demand for our services could adversely affect our business, results of operations, financial condition and cash flows. In addition, in the event of the financial failure of a customer, we could experience a loss of all or a portion of our outstanding accounts receivable associated with that customer.
We face significant competition that may cause us to lose market share and reduce our ability to make distributions to our unitholders.
The compression business is highly competitive. Some of our competitors have a broader geographic scope, as well as greater financial and other resources than we do. 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 and our customers. 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 be unable to compete effectively. Some of these competitors may expand or construct newer, more powerful or more flexible compression fleets that would create additional competition for us. All of these competitive pressures could have a material adverse effect on our business, results of operations, financial condition and reduce our ability to make cash distributions to our unitholders.
Our customers may choose to vertically integrate their operations by purchasing and operating their own compression fleet, expanding the amount of compression units they currently own or using alternative technologies for enhancing crude oil production.
Our customers that are significant producers, processors, gatherers and transporters of natural gas and crude oil may choose to vertically integrate their operations by purchasing and operating their own compression fleets in lieu of using our compression services. Currently, the availability of attractive financing terms from financial institutions and equipment manufacturers facilitates this possibility by making the purchase of individual compression units increasingly affordable to our customers. In addition, there are many technologies available for the artificial enhancement of crude oil production and our customers may elect to use these alternative technologies instead of the
gas lift compression services we provide. Such vertical integration, increases in vertical integration or use of alternative technologies could result in decreased demand for our compression services, which may have a material adverse effect on our business, results of operations, financial condition and reduce our ability to make cash distributions to our unitholders.
A significant portion of our services are provided to customers on a month-to-month basis, and we cannot be sure that our customers will continue to utilize these services that have continued beyond the primary term.
As of December 31, 2013, approximately 38% of our compression services on a horsepower basis (and 43% on a revenue basis for the year ended December 31, 2013) were provided on a month-to-month basis to customers who continue to utilize our services following expiration of the primary term of their contracts with us. These customers can generally terminate their month-to-month compression services contracts on 30-days’ written notice. If a significant number of these customers were to terminate their month-to-month services, or attempt to renegotiate their month-to-month contracts at substantially lower rates, it could have a material adverse effect on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.
We may be unable to grow our cash flows if we are unable to expand our business, which could limit our ability to increase distributions to our unitholders.
A principal focus of our strategy is to continue to grow the per unit distribution on our common units by expanding our business. Our future growth will depend upon a number of factors, some of which we cannot control. These factors include our ability to:
· develop new business and enter into service contracts with new customers;
· retain our existing customers and maintain or expand the services we provide them;
· recruit and train qualified personnel and retain valued employees;
· expand our geographic presence;
· effectively manage our costs and expenses, including costs and expenses related to growth;
· consummate accretive acquisitions;
· obtain required debt or equity financing for our existing and new operations; and
· meet customer specific contract requirements or pre-qualifications.
If we do not achieve our expected growth, we may not be able to pay the aggregate minimum quarterly distribution on our common units and subordinated units and the 2.0% general partner interest, in which event the market price of our common units will likely decline materially.
We may be unable to grow successfully through acquisitions, and we may not be able to integrate effectively the businesses we may acquire, which may impact our operations and limit our ability to increase distributions to our unitholders.
From time to time, we may choose to make business acquisitions to pursue market opportunities, increase our existing capabilities and expand into new areas of operations. On August 30, 2013, we completed the acquisition of all of the compression and related assets of S&R. We will continue to review acquisition opportunities in the future, but we may not be able to identify attractive acquisition opportunities or successfully acquire identified targets. In addition, we may not be successful in integrating any future acquisitions into our existing operations, which may result in unforeseen operational difficulties or diminished financial performance or require a disproportionate amount of our management’s attention. Even if we are successful in integrating future acquisitions into our existing operations, we may not derive the benefits, such as operational or administrative synergies, that we expected from such acquisitions, which may result in the commitment of our capital resources without the expected returns on such capital. Furthermore, competition for acquisition opportunities may escalate, increasing our cost of making acquisitions or causing us to refrain from making acquisitions. Our inability to make acquisitions, or to integrate acquisitions successfully into our existing operations, may adversely impact our operations and limit our ability to increase distributions to our unitholders.
Our ability to grow in the future is dependent on our ability to access external expansion capital.
Our partnership agreement requires us to distribute all of our available cash after expenses and prudent operating reserves to our unitholders. We expect that we will rely primarily upon external financing sources, including borrowings under our revolving credit facility and the issuance of debt and equity securities, to fund expansion capital expenditures. However, we may not be able to obtain equity or debt financing on terms favorable to us, or at all. To the extent we are unable to efficiently finance growth externally, our ability to increase distributions to our uniholders could be significantly impaired. In addition, 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 other 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. There are no limitations in our partnership agreement on our ability to issue additional units, including units ranking senior to the common units. The incurrence of borrowings or other debt by us to finance our growth strategy would result in interest expense, which in turn would affect the available cash that we have to distribute to our unitholders.
Our debt levels may limit our flexibility in obtaining additional financing, pursuing other business opportunities and paying distributions.
We have an $850 million revolving credit facility that matures on December 13, 2018. In addition, we have the option to increase the amount of total commitments under the revolving credit facility by $100 million, subject to receipt of lender commitments and satisfaction of other conditions. As of December 31, 2013, we had outstanding borrowings of $420.9 million and available borrowings of $264.6 million, based on our borrowing base. Our ability to incur additional debt is subject to limitations in our revolving credit facility. Our level of debt could have important consequences to us, including the following:
· our ability to obtain additional financing, if necessary, for working capital, capital expenditures, acquisitions or other purposes may be impaired or such financing may not be available on favorable terms;
· we will need a portion of our cash flow to make payments on our indebtedness, reducing the funds that would otherwise be available for operating activities, future business opportunities and distributions; and
· our debt level will make us more vulnerable, than our competitors with less debt, to competitive pressures or a downturn in our business or the economy generally.
Our ability to service our debt will depend upon, among other things, our future financial and operating performance, which will be affected by prevailing economic conditions and financial, business, regulatory and other factors, some of which are beyond our control. In addition, our ability to service our debt under the revolving credit facility could be impacted by market interest rates, as all of our outstanding borrowings are subject to interest rates that fluctuate with movements in interest rate markets. A substantial increase in the interest rates applicable to our outstanding borrowings could have a material impact on our cash available for distribution. If our operating results are not sufficient to service our current or future indebtedness, we could be forced to take actions such as reducing distributions, reducing or delaying our business activities, acquisitions, investments or capital expenditures, selling assets, restructuring or refinancing our debt or seeking additional equity capital. We may be unable to effect any of these actions on satisfactory terms, or at all.
Restrictions in our revolving credit facility may limit our ability to make distributions to our unitholders and may limit our ability to capitalize on acquisition and other business opportunities.
The operating and financial restrictions and covenants in our revolving credit facility and any future financing agreements could restrict our ability to finance future operations or capital needs or to expand or pursue our business activities. Our amended and restated credit agreement restricts or limits our ability to (subject to exceptions):
· grant liens;
· make certain loans or investments;
· incur additional indebtedness or guarantee other indebtedness;
· enter into transactions with affiliates;
· merge or consolidate;
· sell our assets; or
· make certain acquisitions.
Furthermore, our revolving credit facility contains certain operating and financial covenants. Our ability to comply with these covenants and restrictions may be affected by events beyond our control, including prevailing economic, financial and industry conditions. If market or other economic conditions deteriorate, our ability to comply with these covenants may be impaired. If we violate any of the restrictions, covenants, ratios or tests in our revolving credit facility, a significant portion of our indebtedness may become immediately due and payable, our lenders’ commitment to make further loans to us may terminate, and we may be prohibited from making distributions to our unitholders. We might not have, or be able to obtain, sufficient funds to make these accelerated payments. Any subsequent replacement of our revolving credit facility or any new indebtedness could have similar or greater restrictions. Please read Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Liquidity and Capital Resources-Description of Revolving Credit Facility.”
An impairment of goodwill or other intangible assets could reduce our earnings.
We have recorded $208.1 million of goodwill and $85.9 million of other intangible assets as of December 31, 2013. Goodwill is recorded when the purchase price of a business exceeds the fair market value of the tangible and separately measurable intangible net assets. Generally accepted accounting principles (“GAAP”) requires us to test goodwill for impairment on an annual basis or when events or circumstances occur indicating that goodwill might be impaired. Any event that causes a reduction in demand for our services could 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 goodwill or other intangible assets. If we determine that any of our goodwill or other intangible assets are impaired, we will be required to take an immediate charge to earnings with a corresponding reduction of partners’ capital resulting in an increase in balance sheet leverage as measured by debt to total capitalization. There was no impairment recorded for goodwill or other intangible assets for the years ended December 31, 2013 and 2012.
Our ability to manage and grow our business effectively may be adversely affected if we lose management or operational personnel.
We depend on the continuing efforts of our executive officers. The departure of any of our executive officers could have a significant negative effect on our business, operating results, financial condition and on our ability to compete effectively in the marketplace.
Additionally, our ability to hire, train and retain qualified personnel will continue to be important and could become more challenging as we grow and if energy industry market conditions continue to be positive. When general industry conditions are good, the competition for experienced operational and field technicians increases as other energy and manufacturing companies’ needs for the same personnel increases. Our ability to grow or even to continue our current level of service to our current customers could be adversely impacted if we are unable to successfully hire, train and retain these important personnel.
We depend on a limited number of suppliers and are vulnerable to product shortages and price increases, which could have a negative impact on our results of operations.
The substantial majority of the components for our natural gas compression equipment are supplied by Caterpillar, Cummins and Arrow (for engines), Air-X-Changers and Air Cooled Exchangers (for coolers), and Ariel Corporation, GE Oil & Gas Gemini products and Arrow (for compressor frames and cylinders). Our reliance on these suppliers involves several risks, including price increases and a potential inability to obtain an adequate supply of required components in a timely manner. We also rely primarily on three vendors, A G Equipment Company, Standard Equipment Corp. and S&R, to package and assemble our compression units. We do not
have long-term contracts with these suppliers or packagers, and a partial or complete loss of any of these sources could have a negative impact on our results of operations and could damage our customer relationships. Some of these suppliers manufacture the components we purchase in a single facility and any damage to that facility could lead to significant delays in delivery of completed units.
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 health and safety 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 conduct operations in a wide variety of locations across the continental U.S. These operations require U.S. federal, state or local environmental permits or other authorizations. Our operations may require new or amended facility permits or licenses from time to time with respect to storm water discharges, waste handling or air emissions relating to equipment operations, which subject us to new or revised permitting conditions that may be onerous or costly to comply with. Additionally, the operation of compression units may 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 wide variety of locations 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. We could be subject to penalties for any noncompliance 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 compression services or inactive compression unit 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 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.
New regulations, proposed regulations and proposed modifications to existing regulations under the Clean Air Act, or CAA, if implemented, could result in increased compliance costs.
In August 2010, the U.S. Environmental Protection Agency, or the EPA, published new regulations under the CAA to control emissions of hazardous air pollutants from existing stationary reciprocating internal combustion engines. In June, 2012, the EPA proposed amendments to the final rule in response to several petitions for reconsideration, and EPA finalized the proposed amendments in January, 2013. The final rule was effective in April, 2013, and imposes varying compliance deadlines based on engine ratings and type of site, with the latest deadlines falling during October 2013. The rule requires us to undertake certain expenditures and activities, including purchasing and installing emissions control equipment on a portion of our engines located at major sources of hazardous air pollutants, following prescribed maintenance practices for engines (which are consistent with our existing practices), and implementing additional emissions testing and monitoring. If we were unable to maintain compliance with the final rule, our business, financial condition, results of operations or ability to make cash distributions to our unitholders could be impacted.
In April 2012, the EPA finalized rules that establish new air emission controls for oil and natural gas production and natural gas processing operations. Specifically, the EPA’s rule package included New Source Performance Standards to address emissions of sulfur dioxide and volatile organic compounds, or VOCs, and a separate set of emission standards to address hazardous air pollutants frequently associated with oil and natural gas production and processing activities. The rules establish specific new requirements regarding emissions from compressors and controllers at natural gas processing plants, dehydrators, storage tanks and other production equipment as well as the first federal air standards for natural gas wells that are hydraulically fractured. In addition, the rules establish leak detection requirements for natural gas processing plants at 500 ppm. In August 2013, the EPA issued a final update to the VOC performance standards for storage tanks used in crude oil and natural gas production and transmission. These rules may require a number of modifications to our operations, including the installation of new equipment to control emissions from our compressors at initial startup. Compliance with such rules could result in significant costs, including increased capital expenditures and operating costs, and could adversely impact our business.
In addition, the Texas Commission on Environmental Quality, or the TCEQ, has finalized revisions to certain air permit programs that significantly increase the air permitting requirements for new and certain existing oil and gas production and gathering sites for 15 counties in the Barnett Shale production area. The final rule establishes new emissions standards for engines, which could impact the operation of specific categories of engines by requiring the use of alternative engines, compression packages or the installation of aftermarket emissions control equipment. The rule became effective for the Barnett Shale production area in April 2011, with the lower emissions standards becoming applicable between 2015 and 2030 depending on the type of engine and the permitting requirements. The cost to comply with the revised air permit programs is not expected to be material at this time. However, the TCEQ has stated it will consider expanding application of the new air permit program statewide. At this point, we cannot predict the cost to comply with such requirements if the geographic scope is expanded.
These new regulations and proposals, when finalized, and any other new regulations requiring the installation of more sophisticated pollution control equipment could have a material adverse impact on our business, results of operations, financial condition and ability to make cash distributions to our unitholders.
Climate change legislation and regulatory initiatives could result in increased compliance costs.
Methane, a primary component of natural gas, and carbon dioxide, a byproduct of the burning of natural gas, are examples of greenhouse gases. In recent years, the U.S. Congress has considered legislation to reduce emissions of greenhouse gases. 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 are expected to be proposed that may be relevant to greenhouse gas emissions issues. However, almost half of the states have begun to address greenhouse gas emissions, primarily through the planned development of emission inventories or regional greenhouse gas cap and trade programs. Depending on the particular program, we could be required to control greenhouse gas emissions or to purchase and surrender allowances for greenhouse gas emissions resulting from our operations.
Independent of Congress, the EPA is beginning to adopt regulations controlling greenhouse gas emissions under its existing CAA authority. For example, in December 2009, the EPA officially published its findings that emissions of carbon dioxide, methane, and other greenhouse gases endanger human health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. These findings by the EPA allowed the agency to proceed with the adoption and implementation of regulations that restrict emissions of greenhouse gases under existing provisions of the CAA. In 2009, the EPA adopted rules regarding regulation of greenhouse emissions from motor vehicles. In addition, on September 2009, the EPA issued a final rule requiring the reporting of greenhouse gas emissions in the United States beginning in 2011 for emissions occurring in 2010 from specified large greenhouse gas emission sources. On November 2010, the EPA published a final rule expanding its existing greenhouse gas emissions reporting rule for petroleum and natural gas facilities, including natural gas transmission compression facilities that emit 25,000 metric tons or more of carbon dioxide equivalent per year. The rule, which went into effect on December 2010, requires reporting of greenhouse gas emissions by such regulated facilities to the EPA by September 2012 for emissions during 2011 and annually thereafter. In 2010, the EPA also issued a final rule, known as the “Tailoring Rule,” that makes certain large stationary sources and modification projects subject to permitting requirements for greenhouse gas emissions under the CAA.
Both the Tailoring Rule and the EPA’s endangerment finding were challenged in federal court and were upheld by the D.C. Court of Appeals. On October 15, 2013, the United States Supreme Court agreed to hear arguments regarding the Tailoring Rule during its 2013-2014 session. However, the Court refused to consider other issues such as whether greenhouse gases endanger public health. A decision is expected in this case by the end of June 2014.
Finally, on January 8, 2014, the EPA published standards of performance for greenhouse gas emissions from power plants. The proposal sets forth a performance standard for integrated gasification combined cycled units and utility boilers based on the use of partial carbon capture and sequestration technology. The proposal also sets limits for stationary natural gas combustion turbines based on the use of natural gas combined cycle technology.
Although it is not currently possible to predict with specificity how any proposed or future greenhouse gas legislation or regulation 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 and results of operations.
Increased regulation of hydraulic fracturing could result in reductions or delays in natural gas production by our customers, which could adversely impact our revenue.
A significant portion of our customers’ natural gas production is from unconventional sources that require hydraulic fracturing as part of the completion process. Hydraulic fracturing involves the injection of water, sand and chemicals under pressure into the formation to stimulate gas production. Legislation to amend the Safe Drinking Water Act, or SDWA, to repeal the exemption for hydraulic fracturing from the definition of “underground injection” and require federal permitting and regulatory control of hydraulic fracturing, as well as legislative proposals to require disclosure of the chemical constituents of the fluids used in the fracturing process, were proposed in recent sessions of Congress. The U.S. Congress continues to consider legislation to amend the SDWA. Scrutiny of hydraulic fracturing activities continues in other ways, with the EPA having commenced a multi-year study of the potential environmental impacts of hydraulic fracturing, the results of which are anticipated to be available in 2014. The EPA also has recently announced that it believes hydraulic fracturing using fluids containing diesel fuel can be regulated under the SDWA notwithstanding the SDWA’s general exemption for hydraulic fracturing. Several states have also proposed or adopted legislative or regulatory restrictions on hydraulic fracturing. We cannot predict if additional legislation will ever be enacted and if so, what its provisions would be. If additional levels of regulation, restriction and permits were required through the adoption of new laws and regulations at the federal or state level, that could lead to delays, increased operating costs and process prohibitions that could reduce demand for our compression services, which could have a material adverse effect on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.
We do not insure against all potential losses and could be seriously harmed by unexpected liabilities.
Our operations are subject to inherent risks such as equipment defects, malfunction and failures, and natural disasters that can result in uncontrollable flows of gas or well fluids, fires and explosions. These risks could expose us to substantial liability for personal injury, death, property damage, pollution and other environmental damages. Our insurance may be inadequate to cover our liabilities. Further, insurance covering the risks we 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 adversely affected. Please read Part I, Item 1, “Business-Our Operations-Environmental and Safety Regulations” for a description of how we are subject to federal, state and local laws and regulations governing the discharge of materials into the environment or otherwise relating to protection of human health and environment.
Terrorist attacks, the threat of terrorist attacks, hostilities in the Middle East, or other sustained military campaigns may adversely impact our results of operations.
The long-term impact of terrorist attacks, such as the attacks that occurred on September 11, 2001, and the magnitude of the threat of future terrorist attacks on the energy industry in general and on us in particular are not known at this time. Uncertainty surrounding hostilities in the Middle East or other sustained military campaigns may affect our operations in unpredictable ways, including disruptions of natural gas supplies and markets for natural gas and natural gas liquids and the possibility that infrastructure facilities could be direct targets of, or indirect casualties of, an act of terror. Changes in the insurance markets attributable to terrorist attacks may make certain types of insurance more difficult for us to obtain. Moreover, the insurance that may be available to us may be significantly more expensive than our existing insurance coverage. Instability in the financial markets as a result of terrorism or war could also affect our ability to raise capital.
If we fail to develop or maintain an effective system of internal controls, we may not be able to report our financial results accurately or prevent fraud, which would likely have a negative impact on the market price of our common units.
In connection with the closing of our initial public offering, we became subject to the public reporting requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Effective internal controls are necessary for us to provide reliable financial reports, prevent fraud and to operate successfully as a publicly traded partnership. Our efforts to develop and maintain our internal controls may not be successful, and we may be unable to maintain effective controls over our financial processes and reporting in the future or to comply with our obligations under Section 404 of the Sarbanes Oxley Act of 2002, or Section 404. For example, Section 404(a) requires us, among other things, to review and report annually on the effectiveness of our internal control over financial reporting. We were required to comply with Section 404(a) for our fiscal year ended December 31, 2013. In addition, our independent registered public accountants will be required to assess the effectiveness of internal control over financial reporting at the end of the fiscal year after we are no longer an “emerging growth company” under the Jumpstart Our Business Startups Act, which may be for up to five fiscal years after the completion of our initial public offering in January 2013. Any failure to develop, implement or maintain effective internal controls or to improve our internal controls could harm our operating results or cause us to fail to meet our reporting obligations. Given the difficulties inherent in the design and operation of internal controls over financial reporting, we can provide no assurance as to our independent registered public accounting firm’s conclusions about the effectiveness of our internal controls, and we may incur significant costs in our efforts to comply with Section 404. Ineffective internal controls will subject us to regulatory scrutiny and a loss of confidence in our reported financial information, which could have an adverse effect on our business and would likely have a negative effect on the trading price of our common units.
Risks Inherent in an Investment in Us
Holders of our common units have limited voting rights and are not entitled to elect our general partner or its directors.
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 will have no right on an annual or ongoing basis to elect our general partner or its board of directors. USA Compression Holdings is the sole member of our general partner and will have the right to appoint our general partner’s entire board of directors, including its independent directors. If the unitholders are dissatisfied with the performance of our general partner, they will have little ability to remove our general partner. As a result of these limitations, the price at which the common units will trade could be diminished because of the absence or reduction of a takeover premium in the trading price. 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 limiting the unitholders’ ability to influence the manner or direction of management.
USA Compression Holdings owns and controls our general partner, which has sole responsibility for conducting our business and managing our operations. Our general partner and its affiliates, including USA Compression Holdings, have conflicts of interest with us and limited fiduciary duties and they may favor their own interests to the detriment of us and our common unitholders.
USA Compression Holdings, which is principally owned and controlled by Riverstone, owns and controls our general partner and appointed all of the officers and directors of our general partner, some of whom are also officers and directors of USA Compression Holdings. Although our general partner has a fiduciary duty to manage us in a manner that is beneficial to us and our unitholders, the directors and officers of our general partner have a fiduciary duty to manage our general partner in a manner that is beneficial to its owners. Conflicts of interest will arise between USA Compression Holdings, Riverstone and 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 USA Compression Holdings and the other owners of USA Compression Holdings over our interests and the interests of our common unitholders. These conflicts include the following situations, among others:
· neither our partnership agreement nor any other agreement requires USA Compression Holdings to pursue a business strategy that favors us;
· our general partner is allowed to take into account the interests of parties other than us, such as USA Compression Holdings, in resolving conflicts of interest;
· our partnership agreement limits the liability of and reduces the fiduciary duties owed by our general partner, and also restricts the remedies available to our unitholders for actions that, without the limitations, might constitute breaches of fiduciary duty;
· except in limited circumstances, our general partner has the power and authority to conduct our business without unitholder approval;
· our general partner determines the amount and timing of asset purchases and sales, borrowings, issuance of additional partnership interests and the creation, reduction or increase of reserves, each of which can affect the amount of cash that is distributed to our unitholders;
· our general partner determines the amount and timing of any capital expenditures and whether a capital expenditure is classified as 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 and to our general partner and the ability of the subordinated units to convert to common units;
· our general partner determines which costs incurred by it are reimbursable by us;
· our general partner may cause us to borrow funds in order to permit the payment of cash distributions, even if the purpose or effect of the borrowing is to make a distribution on the subordinated units, to make incentive distributions or to accelerate the expiration of the subordination period;
· our partnership agreement permits us to classify up to $36.6 million as operating surplus, even if it is generated from asset sales, non-working capital borrowings or other sources that would otherwise constitute capital surplus. This cash may be used to fund distributions on our subordinated units or to our general partner in respect of the general partner interest or the incentive distribution rights;
· 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;
· our general partner may exercise its right to call and purchase all of the common units not owned by it and its affiliates if they own more than 80% of the common units;
· our general partner controls the enforcement of the obligations that it and its affiliates owe to us;
· our general partner decides whether to retain separate counsel, accountants or others to perform services for us; and
· our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to our general partner’s incentive distribution rights without the approval of the conflicts committee of the board of directors of our general partner or our unitholders. This election may result in lower distributions to our common unitholders in certain situations.
Our general partner intends to limit its liability regarding our obligations.
Our general partner intends to limit its liability under contractual arrangements so that the counterparties to such arrangements have recourse only against our assets, and not against our general partner or its assets. Our general partner may therefore cause us to incur indebtedness or other obligations that are nonrecourse to our general partner. Our partnership agreement provides that any action taken by our general partner to limit its liability is not a breach of our general partner’s fiduciary duties, even if we could have obtained more favorable terms without the limitation on liability. In addition, we are obligated to reimburse or indemnify our general partner to the extent that it incurs obligations on our behalf. Any such reimbursement or indemnification payments would 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 and subordinated units.
Our partnership agreement contains provisions that modify and reduce the fiduciary standards to which our general partner would otherwise be held by state fiduciary duty law. 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, or otherwise free of fiduciary duties to us and our unitholders. This entitles our general partner to consider only the interests and factors that it desires and relieves it of any duty or obligation to give any consideration to any interest of, or factors affecting, us, our affiliates or our limited partners. Examples of decisions that our general partner may make in its individual capacity include:
· how to allocate business opportunities among us and its affiliates;
· whether to exercise its limited call right;
· how to exercise its voting rights with respect to the units it owns;
· whether to elect to reset target distribution levels; and
· whether or not to consent to any merger or consolidation of the partnership or amendment to the partnership agreement.
By purchasing a common unit, a common unitholder agrees to become bound by the provisions in the partnership agreement, including the provisions discussed above.
Even if holders of our common units are dissatisfied, they cannot remove our general partner without USA Compression Holdings’ consent.
The unitholders are currently unable to remove our general partner 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 662/3% of all outstanding common and subordinated units voting together as a single class is required to remove our general partner. USA Compression Holdings owns an aggregate of 50.9% of our outstanding common and subordinated units. Also, if our general partner is removed without cause during the subordination period and no units held by the holders of the
subordinated units or their affiliates (including the general partner and its affiliates) are voted in favor of that removal, all subordinated units will automatically be converted into common units. A removal of our general partner under these circumstances would adversely affect our common units by prematurely eliminating their distribution and liquidation preference over our subordinated units, which would otherwise have continued until we had met certain distribution and performance tests. Cause is narrowly defined to mean that a court of competent jurisdiction has entered a final, non-appealable judgment finding our general partner liable for actual fraud or willful misconduct in its capacity as our general partner. Cause does not include most cases of charges of poor management of the business.
Our partnership agreement 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 restrict the remedies available to unitholders for actions taken by our general partner that might otherwise constitute breaches of fiduciary duty under state fiduciary duty law. For example, our partnership agreement:
· provides that whenever our general partner makes a determination or takes, or declines to take, any other action in its capacity as our general partner, our general partner is required to make such determination, or take or decline to take such other action, in good faith, and will not be subject to any other or different standard imposed by our partnership agreement, Delaware law, or any other law, rule or regulation, or at equity;
· 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 such decisions are made in good faith, meaning that it believed that the decisions were in the best interest of our partnership;
· provides that our general partner and its officers and directors will not be liable for monetary damages to us, our limited partners or their assignees resulting from any act or omission unless there has been a final and non-appealable judgment entered by a court of competent jurisdiction determining that our general partner or its officers and directors, as the case may be, 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 our general partner will not be in breach of its obligations under the partnership agreement or its fiduciary duties to us or our unitholders if a transaction with an affiliate or the resolution of a conflict of interest is:
(a) approved by the conflicts committee of the board of directors of our general partner, although our general partner is not obligated to seek such approval;
(b) approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner and its affiliates;
(c) on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or
(d) fair and reasonable to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.
In connection with a situation involving a transaction with an affiliate or a conflict of interest, any determination by our general partner must be made in good faith. If an affiliate transaction or the resolution of a conflict of interest is not approved by our common unitholders or the conflicts committee and the board of directors of our general partner determines that the resolution or course of action taken with respect to the affiliate transaction or conflict of interest satisfies either of the standards set forth in subclauses (c) and (d) above, then it will conclusively be deemed that, in making its decision, the board of directors acted in good faith.
Our general partner may elect to cause us to issue common units to it in connection with a resetting of the target distribution levels related to its incentive distribution rights, without the approval of the conflicts committee of its board of directors or the holders of our common units. This could result in lower distributions to holders of our common units.
Our general partner has the right, at any time when there are no subordinated units outstanding and it has received incentive distributions at the highest level to which it is entitled (48.0%) for each of the prior four consecutive fiscal quarters, to reset the initial target distribution levels at higher levels based on our distributions at the time of the exercise of the reset election. Following a reset election by our general partner, the minimum quarterly distribution will be adjusted to equal the reset minimum quarterly distribution, and the target distribution levels will be reset to correspondingly higher levels based on percentage increases above the reset minimum quarterly distribution.
If our general partner elects to reset the target distribution levels, it will be entitled to receive a number of common units and to maintain its general partner interest. The number of common units to be issued to our general partner will equal the number of common units which would have entitled the holder to an average aggregate quarterly cash distribution in the prior two quarters equal to the average of the distributions to our general partner on the incentive distribution rights in the prior two quarters. Our general partner’s general partner interest in us (currently 2.0%) will be maintained at the percentage that existed immediately prior to the reset election. We anticipate that our general partner would exercise this reset right in order to facilitate acquisitions or internal growth projects that would not be sufficiently accretive to cash distributions per common unit without such conversion. It is possible, however, that our general partner could exercise this reset election at a time when it is experiencing, or expects to experience, declines in the cash distributions it receives related to its incentive distribution rights and may, therefore, desire to be issued common units rather than retain the right to receive incentive distributions based on the initial target distribution levels. As a result, a reset election may cause our common unitholders to experience a reduction in the amount of cash distributions that our common unitholders would have otherwise received had we not issued new common units to our general partner in connection with resetting the target distribution levels.
Our partnership agreement restricts the voting rights of unitholders owning 20% or more of our common units.
Unitholders’ voting rights are further restricted by a provision of our partnership agreement 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, their direct transferees and their indirect transferees approved by our general partner (which approval may be granted in its sole discretion) and persons who acquired such units with the prior approval of our general partner, cannot vote on any matter.
Our general partner interest or the control of our general partner may be transferred to a third party without unitholder consent.
Our general partner 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 USA Compression Holdings to transfer all or a portion of its ownership interest in our general partner to a third party. The new owner of our general partner would then be in a position to replace the board of directors and officers of our general partner with its own designees and thereby exert significant control over the decisions made by the board of directors and officers.
An increase in interest rates may cause the market price of our common units to decline.
Like all equity investments, an investment in our common units is subject to certain risks. In exchange for accepting these risks, investors may expect to receive a higher rate of return than would otherwise be obtainable from lower-risk investments. Accordingly, as interest rates rise, the ability of investors to obtain higher risk-adjusted rates of return by purchasing government backed debt securities may cause a corresponding decline in demand for riskier investments generally, including yield based equity investments such as publicly traded partnership interests. Reduced demand for our common units resulting from investors seeking other more favorable investment opportunities may cause the trading price of our common units to decline.
We may issue additional units without your approval, which would dilute your 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 by us of additional common units, including pursuant to our Dividend Reinvestment Plan (“DRIP”), or other equity securities of equal or senior rank, will have the following effects:
· our existing unitholders’ proportionate ownership interest in us will decrease;
· the amount of cash available for distribution on each unit may decrease;
· because a lower percentage of total outstanding units will be subordinated units during the subordination period, the risk that a shortfall in the payment of the minimum quarterly distribution will be borne by our common unitholders will increase;
· the ratio of taxable income to distributions may increase;
· the relative voting strength of each previously outstanding unit may be diminished; and
· the market price of the common units may decline.
USA Compression Holdings may sell units in the public or private markets, and such sales could have an adverse impact on the trading price of the common units.
USA Compression Holdings holds an aggregate of 5,337,977 common units and 14,048,588 subordinated units. All of the subordinated units will convert into common units at the end of the subordination period and may convert earlier under certain circumstances. In addition, USA Compression Holdings may acquire additional common units in connection with our DRIP. We have agreed to provide USA Compression Holdings with certain registration rights for any common and subordinated units it owns. The sale of these 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 call right that may require you to sell your 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, which it may assign to any of its affiliates or to us, but not the obligation, to acquire all, but not less than all, of the common units held by unaffiliated persons at a price that is not less than their then-current market price, as calculated pursuant to the terms of our partnership agreement. As a result, you may be required to sell your common units at an undesirable time or price. You may also incur a tax liability upon a sale of your units. USA Compression Holdings owns an aggregate of approximately 22.2% of our outstanding common units. At the end of the subordination period, assuming no additional issuances of common units (other than upon the conversion of the subordinated units), USA Compression Holdings will own an aggregate of approximately 50.9% of our outstanding common units.
Your 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. You could be liable for any and all of our obligations as if you were a general partner if a court or government agency were to determine that:
· we were conducting business in a state but had not complied with that particular state’s partnership statute; or
· your 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 constitute “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, or the Delaware Act, we may not make a distribution to you 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 an 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 both for the obligations of the assignor to make contributions to the partnership that were known to the substituted limited partner at the time it became a limited partner and for those obligations that were unknown if the liabilities could have been determined from the partnership agreement. Neither liabilities to partners on account of their partnership interest nor liabilities that are non-recourse to the partnership are counted for purposes of determining whether a distribution is permitted.
The NYSE does not require a publicly traded partnership like us to comply with certain of its corporate governance requirements.
Our common units are listed on the NYSE. Because we are a publicly traded partnership, the NYSE does not require us to have a majority of independent directors on our general partner’s board of directors or to establish a compensation committee or a nominating and corporate governance committee. Accordingly, unitholders do not have the same protections afforded to investors in certain corporations that are subject to all of the NYSE corporate governance requirements. Please read Part III, Item 10 (“Directors, Executive Officers and Corporate Governance”).
Pursuant to certain federal securities laws, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes Oxley Act of 2002 for so long as we are an emerging growth company.
We are required to disclose changes made in our internal control over financial reporting on a quarterly basis, and we are required to assess the effectiveness of our controls annually. However, for as long as we are an “emerging growth company” under federal securities laws, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404. We could be an emerging growth company for up to five years from the date of our initial public offering, which occurred on January 18, 2013. Even if we conclude that our internal control over financial reporting is effective, our independent registered public accounting firm may still decline to attest to our assessment or may issue a report that is qualified if it is not satisfied with our controls or the level at which our controls are documented, designed, operated or reviewed, or if it interprets the relevant requirements differently from us.
Tax Risks to Common Unitholders
Our tax treatment depends on our status as a partnership for federal income tax purposes. If the IRS were to treat us as a corporation for federal income tax purposes, which would subject us to entity level taxation, then our cash available for distribution to our unitholders would be substantially reduced.
The anticipated after-tax economic benefit of an investment in the common units depends largely on our being treated as a partnership for federal income tax purposes. We have not requested a ruling from the IRS on this or any other tax matter affecting us.
Despite the fact that we are a limited partnership under Delaware law, it is possible in certain circumstances for a partnership such as ours to be treated as a corporation for federal income tax purposes. Although we do not believe based upon our current operations that we are or will be so treated, a change in our business or a change in current law could cause us to be treated as a corporation for federal income tax purposes or otherwise subject us to taxation as an entity.
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 and local income tax at varying rates. Distributions would generally be taxed again as corporate dividends (to the extent of our current and accumulated earnings and profits), and no income, gains, losses, deductions or credits would flow through to you. Because a tax would be imposed upon us as a corporation, our cash available for distribution to our unitholders would be substantially reduced. Therefore, if we were treated as a corporation for federal income tax purposes, there would be a material reduction in the anticipated cash flow and after-tax return to our unitholders, likely causing a substantial reduction in the value of our common units.
If we were subjected to a material amount of additional entity level taxation by individual states, it would reduce our cash available for distribution to our unitholders.
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. For example, we are required to pay Texas franchise tax each year at a maximum effective rate of 0.7% of our gross income apportioned to Texas in the prior year. Imposition of any similar taxes by any other state may substantially reduce the cash available for distribution to our unitholders and, therefore, negatively impact the value of an investment in our common units.
The tax treatment of publicly traded partnerships or an investment in our common units could be subject to potential legislative, judicial or administrative changes or differing interpretations, possibly applied on a retroactive basis.
The present 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 the U.S. Congress propose and consider substantive changes to the existing federal income tax laws that would affect the tax treatment of certain 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 or any other proposals, will be reintroduced, introduced or will ultimately be enacted. Any such changes or differing judicial interpretations of existing laws could be applied retroactively and 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 entity level taxation for federal, state or local income tax purposes, the minimum quarterly distribution amount and the target distribution amounts may be adjusted to reflect the impact of that law on us.
Our unitholders’ share of our income will be taxable to them for federal income tax purposes even if they do not receive any cash distributions from us.
Because a unitholder will be treated as a partner to whom we will allocate taxable income that could be different in amount than the cash we distribute, a unitholder’s allocable share of our taxable income will be taxable to it, which may require the payment of federal income taxes and, in some cases, state and local income taxes, on its share of our taxable income even if it receives no cash distributions from us. Our 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.
If the IRS contests the federal income tax positions we take, the market for our common units may be adversely impacted and the cost of any IRS contest will reduce our cash available for distribution to our unitholders.
We have not requested a ruling from the IRS with respect to our treatment as a partnership for federal income tax purposes or any other matter affecting us. The IRS may adopt positions that differ from the conclusions of our counsel expressed in this report or from the positions we take, and the IRS’s positions may ultimately be sustained.
It may be necessary to resort to administrative or court proceedings to sustain some or all of our counsel’s conclusions or the positions we take. A court may not agree with some or all of our counsel’s conclusions or the positions we take. Any contest with the IRS, and the outcome of any IRS contest, may have a materially adverse impact on the market for our common units and the price at which they trade. In addition, our costs of any contest with the IRS will be borne indirectly by our unitholders and our general partner because the costs will reduce our cash available for distribution.
Tax gain or loss on the disposition of our common units could be more or less than expected.
If our unitholders sell common units, they will recognize a gain or loss for federal income tax purposes 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 a unitholder sells will, in effect, become taxable income to the unitholder if it sells such common units at a price greater than its tax basis in those common units, even if the price received is less than its original cost. Furthermore, a substantial portion of the amount realized on any sale of common units, 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, a unitholder that sells common units may incur a tax liability in excess of the amount of cash received from the sale.
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 (known as 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 subject to withholding taxes imposed at the highest tax rate applicable to such non-U.S. persons, and each non-U.S. person will be required to file U.S. federal income tax returns and pay tax on its share of our taxable income. If you are a tax-exempt entity or a non-U.S. person, you should consult a tax advisor before investing in our common units.
We will treat each purchaser of 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.
Because we cannot match transferors and transferees of common units and because of other reasons, we will adopt 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 you. Our counsel is unable to opine as to the validity of such filing positions. It also could affect the timing of these tax benefits or the amount of gain from your sale of common units and could have a negative impact on the value of our common units or result in audit adjustments to your tax returns.
We prorate our items of income, gain, loss and deduction for federal income tax purposes 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, which could change the allocation of items of income, gain, loss and deduction among our unitholders.
We will prorate our items of income, gain, loss and deduction for federal income tax purposes 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 challenge our proration method or new Treasury regulations were issued, we may be required to change the allocation of items of income, gain, loss and deduction among our unitholders.
A unitholder whose common units are the subject of a securities loan (e.g., a loan to a “short seller” to effect a short sale of common units) may be considered as having disposed of those common units. If so, he would no longer be treated for federal income tax purposes as a partner with respect to those common 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 tax consequences of loaning a partnership interest, a unitholder whose common units are the subject of a securities loan may be considered as having disposed of the loaned common units, he may no longer be treated for federal income tax purposes as a partner with respect to those common units during the period of the loan to the short seller and the unitholder may recognize gain or loss from such disposition. Moreover, during the period of the loan, any of our income, gain, loss or deduction with respect to those common units may not be reportable by the unitholder and any cash distributions received by the unitholder as to those common 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 consult a tax advisor to discuss whether it is advisable to modify any applicable brokerage account agreements to prohibit their brokers from loaning their common units.
We will adopt certain valuation methodologies and monthly conventions for federal income tax purposes that may result in a shift of income, gain, loss and deduction between our general partner and our unitholders. The IRS may challenge this treatment, which could adversely affect the value of the common units.
When we issue additional units or engage in certain other transactions, we will 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 taxable income, gain, loss and deduction between our general partner and certain of our unitholders.
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 taxable 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 technically terminated 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 interest will be counted only once. Our technical 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 (and our unitholders could receive two Schedules K-1 if relief was not available, as described below) for one calendar year and could 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, 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. A technical 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 such 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. The IRS has announced a publicly traded partnership technical termination relief program whereby a publicly traded partnership that technically terminated may request publicly traded partnership technical termination relief which, if granted by the IRS, among other things would permit the partnership to provide only one Schedule K-1 to unitholders for the year notwithstanding two partnership tax years.
As a result of investing in our common units, you will likely become subject to state and local taxes and return filing requirements in jurisdictions where we operate or own or acquire properties.
In addition to federal income taxes, our unitholders will likely be subject to other taxes, including state and local taxes, unincorporated business taxes and estate, inheritance or intangible taxes that are imposed by the various jurisdictions in which we conduct business or control property now or in the future, even if they do not live in any of those jurisdictions. Our unitholders will likely be required to file state and local income tax returns and pay state and local income taxes in some or all of these various jurisdictions. Further, our unitholders may be subject to penalties for failure to comply with those requirements. We currently conduct business in thirteen states. Many of these states currently impose a personal income tax on individuals. Many of these states also impose an income tax on corporations and other entities. As we make acquisitions or expand our business, we may control assets or conduct business in additional states or foreign jurisdictions that impose a personal income tax. It is your responsibility to file all foreign, federal, state and local tax returns.
ITEM 1B.
ITEM 1B. Unresolved Staff Comments
None.
ITEM 2.
ITEM 2. Properties
We do not currently own or lease any material facilities or properties for storage or maintenance of our compression units. As of December 31, 2013, our headquarters consisted of 11,307 square feet of leased space located at 100 Congress Avenue, Austin, Texas 78701.
ITEM 3.
ITEM 3. Legal Proceedings
None.
ITEM 4.
ITEM 4. Mine Safety Disclosures
None.
PART II
ITEM 5.
ITEM 5. Market For Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Our Partnership Interests
As of February 18, 2014, we had outstanding 24,034,240 common units, 14,048,588 subordinated units, a 2% general partner interest and incentive distribution rights, or IDRs. As of February 18, 2014, USA Compression Holdings, LLC owned approximately 22.2% of our outstanding common units and 100% of our subordinated units. Our general partner currently owns a 2.0% general partner interest in us and all of our IDRs. As discussed below under “Selected Information from Our Partnership Agreement- General Partner Interest and IDRs,” the IDRs represent the right to receive increasing percentages, up to a maximum of 48%, of the cash we distribute from operating surplus (as defined below) in excess of $0.4888 per unit per quarter. Our common units, which represent limited partner interests in us, are listed on the New York Stock Exchange (“NYSE”) under the symbol “USAC.”
Our common units have been traded on the NYSE since January 15, 2013, and therefore, we have not set forth quarterly information with respect to the high and low prices for our common units for periods prior to that date. The following table sets forth high and low sales prices per common unit and cash distributions per common unit to common unitholders for the periods indicated. The last reported sales price for our common units on February 18, 2014, was $26.23.
(1) Beginning on January 15, 2013 the first day our common units were traded on the NSYE.
(2) Prorated to reflect 72 days of a quarterly cash distribution rate of $0.435 per unit.
Holders
At the close of business on February 18, 2014, we had 27 holders of record of our common units. The number of record holders does not include holders of shares in “street names” or persons, partnerships, associations, corporations or other entities identified in security position listings maintained by depositories.
Selected Information from our Partnership Agreement
Set forth below is a summary of the significant provisions of our partnership agreement that relate to cash distributions, minimum quarterly distributions and IDRs.
Available Cash
Our partnership agreement requires that, within 45 days after the end of each quarter, we distribute all of our available cash (as defined in our partnership agreement) to unitholders of record on the applicable record date. Our partnership agreement generally defines available cash, for each quarter, as cash on hand at the end of a quarter less the amount of reserves established by our general partner to provide for the proper conduct of our business, comply with applicable law, our revolving credit facility or other agreements; and provide fund for distributions to our unitholders for any one or more of the next four quarters plus cash on hand resulting from working capital borrowings made after the end of the quarter. Working capital borrowings are borrowings made under a credit facility, commercial paper facility or other similar financing arrangement, and in all cases are used solely for working capital purposes or to pay distributions to partners and with the intent of the borrower to repay such borrowings within twelve months from sources other than working capital borrowings.
Minimum Quarterly Distribution
Our partnership agreement provides that, during the subordination period, the common units will have the right to receive distributions of available cash from operating surplus each quarter in an amount equal to $0.425 per common unit, which amount is defined in our partnership agreement as the minimum quarterly distribution, plus any arrearages in the payment of the minimum quarterly distribution on the common units from prior quarters, before any distributions of available cash from operating surplus may be made on the subordinated units. These units are deemed “subordinated” because for a period of time, referred to as the subordination period, the subordinated units will not be entitled to receive any distributions until the common units have received the minimum quarterly distribution plus any arrearages from prior quarters. Furthermore, no arrearages will be paid on the subordinated units. The practical effect of the subordinated units is to increase the likelihood that during the subordination period there will be available cash to be distributed on the common units. On January 23, 2014, the Partnership announced a cash distribution of $0.48 per unit on its common and subordinated units. This fourth quarter distribution corresponds to an annualized distribution rate of $1.92 per unit. The distribution was paid on February 14, 2014 to unitholders of record as of the close of business on February 4, 2014. USA Compression Holdings, and Argonaut Private Equity, L.L.C. (“Argonaut”) and certain other related unitholders elected to reinvest all of this distribution with respect to their units pursuant to the Partnership’s Distribution Reinvestment Plan (“DRIP”). Following the issuance of common units under the DRIP, USAC Compression Holdings owned 50.9% of the Partnership’s outstanding limited partner interests, and Argonaut and the related parties participating in the DRIP, owned 19.4% of the Partnership’s outstanding limited partner interests.
General Partner Interest and IDRs
Our partnership agreement provides that our general partner initially will be entitled to 2.0% of all distributions that we make. Our general partner has the right, but not the obligation, to contribute a proportionate amount of capital to us to maintain its 2.0% general partner interest if we issue additional units. Our general partner’s 2.0% interest, and the percentage of our cash distributions to which it is entitled, will be proportionately reduced if we issue additional units in the future (other than the issuance of common units upon conversion of outstanding subordinated units or the issuance of common units upon a reset of the incentive distribution rights) and our general partner does not contribute a proportionate amount of capital to us in order to maintain its 2.0% general partner interest. Our partnership agreement does not require that the general partner fund its capital contribution with cash and our general partner may fund its capital contribution by the contribution to us of common units or other property.
Incentive distribution rights represent the right to receive increasing percentages (13.0%, 23.0% and 48.0%) of quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and the target distribution levels have been achieved. Our general partner currently holds the incentive distribution rights, but may transfer these rights separately from its general partner interest.
Issuer Purchases of Equity Securities
None.
Sales of Unregistered Securities; Use of Proceeds from Sale of Securities
On January 18, 2013, we completed our IPO of common units pursuant to a Registration Statement on Form S-1, as amended (Reg. No. 333-174803), that was declared effective on January 14, 2013. Under the registration statement, we sold an aggregate of 11,000,000 common units at a price to the public of $18.00 per common unit. Barclays Capital Inc. and Goldman, Sachs & Co. acted as joint book-running managers of the offering. The offering closed on January 18, 2013. As a result of our IPO, we raised a total of $198.0 million in gross proceeds, and approximately $180.5 million in net proceeds after deducting underwriting discounts and commissions of $12.2 million, structuring fees of $0.7 million and offering expenses of $4.6 million.
On August 30, 2013, in connection with the acquisition from S&R of certain assets and liabilities related to the business of providing compression services to third parties engaged in the exploration, production, gathering, processing, transportation or distribution of oil and gas (the “S&R Acquisition”), the Partnership issued 7,425,261 common units to certain accredited investors (the “Holders”) who are members or beneficial owners of S&R or its controlling member, Argonaut Private Equity, L.L.C. (“Argonaut”).
The common units issued in connection with the S&R Acquisition were issued in a private placement in reliance upon an exemption from the registration requirements of the Securities Act, pursuant to Section 4(a)(2) thereof. In connection with the S&R Acquisition, we entered into a registration rights agreement with Argonaut and the other Holders pursuant to which we agreed to register the common units issued in connection with the S&R Acquisition. On February 3, 2014, we filed a Registration Statement on Form S-3 (File No. 333-193724) (the “S-3 Registration Statement”). Until such time as the S-3 Registration Statement is declared effective by the SEC, the common units issued in connection with the S&R Acquisition may not be offered or sold in the United States absent an applicable exemption from the registration requirements of the Securities Act and applicable state securities laws.
Equity Compensation Plan
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” of this report.
ITEM 6.
ITEM 6. Selected Financial Data
SELECTED HISTORICAL FINANCIAL DATA
In the table below we have presented certain selected financial data for USA Compression Partners, LP for each of the five years in the period ended December 31, 2013, which has been derived from our audited consolidated 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 Item 7
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 consolidated 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 growth oriented Delaware limited partnership and, based on management’s significant experience in the industry, we believe that we are one of the largest independent providers of compression services in the U.S. in terms of total compression unit horsepower. We have been providing compression services since 1998. As of December 31, 2013, we had 1,202,374 horsepower in our fleet and approximately 180,000 horsepower on order for expected delivery primarily in the first half of 2014. Our primary focus is to provide compression services to our customers in connection with infrastructure applications. Natural gas compression is a mechanical process whereby natural gas is compressed to a smaller volume, resulting in higher pressure. This process has various applications, including both allowing for the transportation of the natural gas through the domestic pipeline system and enhancing crude oil production through artificial lift processes. As such, our compression services play a critical role in the production and transportation of both natural gas and crude oil.
We provide compression services in a number of shale plays throughout the U.S., including the Marcellus, Eagle Ford, Utica, Mississippi Lime, Granite Wash, Woodford, Barnett, Permian Basin, Haynesville and Fayetteville shales. Because the demand for our services is driven by production of natural gas and crude oil, we have focused our activities in areas of attractive growth, which are generally found in these shale and unconventional resource plays. Further, we believe production in these areas will increase in the future. According to the 2013 Outlook prepared by the EIA, natural gas production from shale formations is expected to increase from 34% of total U.S. natural gas production in 2011 to 50% of total U.S. natural gas production in 2040. In addition, the EIA forecasts in its 2013 Outlook that total domestic crude oil production will increase by 33% from 2011 to 2019, and more importantly, forecasts tight oil production to increase by 128% over the same time period. Not only are the production and transportation volumes in these and other shale plays increasing, the geological and reservoir characteristics are also particularly attractive for compression services. The changes in production volume and pressure of shale plays over time result in a wider range of compression requirements than in conventional basins. We believe we are well-positioned to meet these changing operating conditions as a result of the flexibility of our compression units. While our business focuses largely on compression services in shale plays, we also provide compression services in more mature conventional basins, including crude oil wells targeted by horizontal drilling techniques. Wells in conventional basins typically require increasing amounts of compression as they age and pressures decline. In addition, the continued development of horizontal drilling, particularly in crude oil wells, has allowed producers to produce incremental volumes of crude oil on attractive economic terms. Our gas lift fleet, critical to producing oil from horizontal wells, serves this growing market demand.
We operate in a single business segment, the compression service business. We provide our customers with compression services to maximize their natural gas and crude oil production, throughput and cash flow. We provide domestic compression services to major oil companies and independent producers, processors, gatherers and transporters of natural gas and crude oil using our modern, flexible fleet of compression units, which have been designed to be rapidly deployed and redeployed throughout the country. As part of our services, we engineer, design, operate, service and repair our compression units and maintain related support inventory and equipment.
We provide compression services to our customers under fixed-fee contracts, with initial contract terms of up to five years for midstream applications and six to twelve months for crude oil gas lift applications. We typically continue to provide compression services to our customers beyond their initial contract terms, either through contract renewals or on a month-to-month basis. For the year ended December 31, 2013, approximately 38% of our compression services on a horsepower basis (and 43% on a revenue basis) were provided to customers under contracts continuing on a month to month basis. We generally enter into take-or-pay contracts whereby our customers are required to pay our monthly fee even during periods of limited or disrupted throughput, which enhances the stability and predictability of our cash flows. We are not directly exposed to commodity price risk
because we do not take title to the natural gas we compress and because the natural gas used as fuel by our compression units is supplied by our customers without cost to us. Our indirect exposure to short-term volatility in natural gas and crude oil commodity prices is mitigated by the long-term nature of the majority of our contracts. As of December 31, 2013, we estimate that approximately 89% of our revenue generating horsepower was deployed in infrastructure applications, including large volume gathering systems, processing facilities, transportation applications and crude oil gas lift.
General Trends and Outlook
Following a period of decreasing market rates in 2009 and 2010, when we elected to sign shorter-term contracts to limit our long-term exposure to lower market rates, rates have improved and generally stabilized starting in 2011 and continue improving throughout 2013. We have experienced some pricing pressure on certain of our midstream compression units during 2013. However, over the long term, we expect that continued improved pricing will ultimately improve our average monthly revenue per revenue generating horsepower as contracts that we entered into in 2009 and early 2010 expire and we enter into new contracts at higher rates. In our gas lift fleet, we have continued to experience strong market demand and, as a result, attractive pricing. We intend to grow the number of midstream and gas lift units in our fleet. While larger horsepower units used in midstream applications in general allow us to generate higher gross operating margins than gas lift units, they also generate lower average monthly revenue per revenue generating horsepower.
Our ability to increase our revenues is dependent in large part on our ability to add new revenue generating compression units to our fleet and increase the utilization of idle compression units. During 2011, we began to see an increase in overall natural gas activity in the U.S. and experienced an increase in demand for our compression services that has continued through 2012 and 2013. The generally strong activity in crude oil production in our core gas lift regions has also contributed to increased demand for our services. Revenue generating horsepower increased by 34.8% from December 31, 2012 to December 31, 2013, in part due to the S&R Acquisition. Average revenue generating horsepower increased by 20.3%, primarily due to growth in our core midstream compression business along with the S&R Acquisition, from the year ended December 31, 2012 to the year ended December 31, 2013. We believe the natural gas activity levels in the U.S. will continue to increase in the foreseeable future, particularly in shale plays, with respect to natural gas, as well as crude oil. We anticipate this activity will result in higher demand for our compression services, which we believe should result in increasing revenues. However, the expected increase in overall natural gas and crude oil activity and demand for our compression services may not occur for a variety of reasons. Please read Part I, Item 1A. “Risk Factors - Risks Related to Our Business - A long-term reduction in the demand for, or production of, natural gas or crude oil in the locations where we operate could adversely affect the demand for our services or the prices we charge for our services, which could result in a decrease in our revenues and cash available for distribution to our unitholders.”
Factors That Affect Our Future Results
Customers
We provide compression services to major oil companies and independent producers, processors, gatherers and transporters of natural gas and crude oil, and operate in a number of U.S. natural gas shale plays, including the Fayetteville, Marcellus, Woodford, Barnett, Eagle Ford, Utica, Permian Basin and Haynesville shales. Our customers use our services primarily in large volume gathering systems, processing facilities and transportation applications as well as in gas-lift compression for crude oil wells. Regardless of the application for which our services are provided, our customers rely upon the availability of the equipment used to provide compression services and our expertise to help generate the maximum throughput of product, reduce fuel costs and reduce emissions. While we are currently focused on our existing service areas, our customers have compression demands in other areas of the U.S. in conjunction with their field development projects. We continually consider expansion of our areas of operation in the U.S. based upon the level of customer demand. Our modern, flexible fleet of compression units, which have been designed to be rapidly deployed and redeployed throughout the country, provides us with continuing opportunities to expand into other areas with both new and existing customers. From April 2008 through December 2013, we redeployed approximately 66,900 horsepower of our compression units from our Central operating region to our Northeast operating region, which includes the Marcellus shale, to meet increasing customer demand in that geographic area.
Many of our customers have access to low-cost capital, made available by banks and equipment manufacturers, and have elected to access this capital to add compression units to their owned compression fleets. Additional purchases of compression equipment by our customers may result in reduced demand for our compression services by these customers, which could materially reduce our results of operations and ability to make cash distributions to our unitholders.
Supply and Demand for Natural Gas and Crude Oil
We believe that as a clean alternative to other fuels, natural gas will continue to be a fuel of choice for many years to come for many industries and consumers. The EIA forecasts in its 2013 Outlook that natural gas production in the U.S. is expected to increase by approximately 44% from 2011 to 2040. We believe this long-term increasing demand for natural gas will create increasing demand for compression services, for both existing natural gas fields as they age and for the development of new natural gas fields. Additionally, the shift to production of natural gas from shale, tight gas and coal bed formations that often have lower producing pressures than conventional reservoirs, results in a further increase in compression needs. In the short-term, changes in natural gas pricing, based primarily upon the supply of natural gas, will affect the development activities of natural gas producers based upon the costs associated with finding and producing natural gas in the particular natural gas and oil fields in which they are active. Although short-term declines in natural gas prices have a short-term negative effect on the development activity in natural gas fields, periods of lower development activity tend to place emphasis on improving production efficiency. As a result of our commitment to providing a high level of availability of the equipment used to provide compression services, we believe our service run times position us to satisfy the needs of our customers.
The continued development of horizontal drilling, particularly in crude oil wells, has allowed producers to produce incremental volumes of crude oil from tight oil formations on attractive economic terms. The EIA forecasts in its 2013 Outlook that total domestic crude oil production will increase by 33% from 2011 to 2019, and more importantly, forecasts tight oil production to increase by 128% over the same time period. Gas lift and other artificial lift technologies are critical to the enhancement of production of oil from horizontal wells operating in tight shale plays. Gas lift is a process by which natural gas is injected into the production tubing, thus reducing the hydrostatic pressure and allowing the oil to flow at a higher rate. We believe that our flexible fleet of smaller horsepower units that are primarily utilized in gas lift applications will enable us to capitalize on this growing market demand.
Access to External Expansion Capital
In determining the amount of cash available for distribution, the board of directors of our general partner will determine the amount of cash reserves to set aside for our operations, including reserves for future working capital, maintenance capital expenditures, expansion capital expenditures and other matters, which will impact the amount of cash we are able to distribute to our unitholders. However, we expect that we will rely primarily upon external financing sources, including borrowings under our revolving credit facility and issuances of debt and equity securities, rather than cash reserves, to fund our expansion capital expenditures. To the extent we are unable to finance growth externally and are unwilling to establish cash reserves to fund future expansions, our cash available for distribution will not significantly increase. In addition, 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 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. There are no limitations in our partnership agreement or in the terms of our revolving credit facility on our ability to issue additional units, including units ranking senior to the common units.
Operating Highlights
The following table summarizes certain horsepower and horsepower utilization percentages for the periods presented.
(1) Fleet horsepower is horsepower for compression units that have been delivered to us (and excludes units on order). As of December 31, 2013, we had approximately 180,000 horsepower on order for delivery which is expected to be delivered primarily in the first half of 2014.
(2) Total available horsepower is revenue generating horsepower under contract for which we are billing a customer, horsepower in our fleet that is under contract but is not yet generating revenue, horsepower not yet in our fleet that is under contract not yet generating revenue and that is subject to a purchase order, and idle horsepower. Total available horsepower excludes new horsepower on order for which we do not have a compression services contract.
(3) Revenue generating horsepower is horsepower under contract for which we are billing a customer.
(4) Calculated as the average of the month-end revenue generating horsepower for each of the months in the period.
(5) Calculated as the average of the month-end horsepower per revenue generating compression unit for each of the months in the period.
(6) Horsepower utilization is calculated as (i)(a) revenue generating horsepower plus (b) horsepower in our fleet that is under contract, but is not yet generating revenue plus (c) horsepower not yet in our fleet that is under contract not yet generating revenue and that is subject to a purchase order, divided by (ii) total available horsepower less idle horsepower that is under repair. Horsepower utilization based on revenue generating horsepower and fleet horsepower at each applicable period end was 89.0%, 86.4% and 89.9%, for the years ended December 31, 2013, 2012 and 2011, respectively.
(7) Calculated as the average utilization for the months in the period based on utilization at the end of each month in the period.
The increase in fleet horsepower as of December 31, 2013 compared to December 31, 2012 is attributable to the compression units added to our fleet to meet the incremental demand by new and current customers and the S&R Acquisition. Revenue generating horsepower increased by 34.8% from December 31, 2012 to December 31, 2013 primarily due to organic growth in our core midstream fleet and acquiring compression units under contract in connection with the S&R Acquisition. The average horsepower per revenue generating compression unit decreased from 791 to 720, or (9.0)%, over that same period, due to the smaller horsepower gas lift units that were added to the fleet in the S&R Acquisition. The increase in fleet horsepower as of December 31, 2012 compared to December 31, 2011 is attributable to the compression units added to our fleet to meet the incremental demand by new and current customers. Revenue generating horsepower increased by 22.3% from December 31, 2011 to December 31, 2012, primarily due to organic growth and increasing customer demand. The average horsepower per revenue generating compression unit increased from 692 to 791 between 2011 and 2012, primarily due to our focus during that period on the addition of large horsepower compression units.
(1) Gross operating margin is a non-GAAP financial measure. We calculate gross operating margin as revenue less cost of operations, exclusive of depreciation and amortization expense. We believe that gross operating margin is useful as a supplemental measure of our operating profitability. Gross operating margin should not be considered an alternative to, or more meaningful than, operating income or any other measure of financial performance presented in accordance with GAAP. Moreover, gross operating margin as presented may not be comparable to similarly titled measures of other companies. Because we capitalize assets, depreciation and amortization of equipment is a necessary element of our costs. To compensate for the limitations of gross operating margin as a measure of our performance, we believe that it is important to consider operating income determined under GAAP, as well as gross operating margin, to evaluate our operating profitability. For more information, please read “Item 6 - Selected Historical Financial Data - Non-GAAP Financial Measures.”
The following table reconciles gross operating margin to operating income, its most directly comparable GAAP financial measure, for each of the periods presented:
(2) Gross operating margin percentage and Adjusted EBITDA percentage are calculated as a percentage of revenue.
(3) For a reconciliation of Adjusted EBITDA, a non-GAAP financial measure, to net income and cash flows from operating activities, its most directly comparable GAAP financial measures, see “Item 6 - Selected Historical Financial Data-Non-GAAP Financial Measures.”
Gross operating margin, as a percentage of total revenues, increased to 68.5% in 2013 from 68.2% in 2012. The increase in gross operating margin was primarily attributable to a 28.7% increase in total revenues when comparing the periods, partially offset by an increase of 27.3% in cost of operations. Average revenue generating horsepower increased from 749,821 in 2012 to 902,168 in 2013, an increase of 20.3%, primarily due to compression units added to our fleet to meet the incremental demand by new and current customers and the S&R Acquisition. Average revenue per revenue generating horsepower per month increased to $14.15 in 2013 from $13.39 in 2012, an increase of 5.7%. The increase in average revenue per revenue generating horsepower per month was primarily due to higher revenue per horsepower per month from the gas lift compression units that were acquired from S&R. The increase in cost of operations is primarily attributable to (1) a $2.8 million increase in lubrication oil expenses due to a 21.7% increase in gallons consumed, offset by a 3.9% decrease in the average supplier price per gallon, (2) a $4.3 million increase in direct labor expenses, (3) a $0.9 million increase in training and safety expense, (4) a $0.4 million increase in maintenance parts and (5) a $0.6 million increase related to vehicle tools and gasoline. These factors are attributable primarily to the increase in our fleet size due to organic growth and four months of operations related to the assets acquired in the S&R Acquisition. In addition, business and property insurance increased by $0.4 million primarily due to certain insurance claims on our compression units and the increase in the size of our fleet.
Gross operating margin, as a percentage of total revenues, increased to 68.2% in 2012 from 59.9% in 2011. The increase in gross operating margin percentage was primarily attributable to a 20.3% increase in total revenues when comparing the periods, and a 4.6% decrease in cost of operations. Average revenue generating horsepower increased from 570,900 in 2011 to 749,821 in 2012, an increase of 31.3%, primarily due to organic growth and increasing customer demand. Average revenue per revenue generating horsepower per month declined to $13.39 in 2012 from $14.07 in 2011, a decrease of 4.8%. The decline in average revenue per revenue generating horsepower per month related primarily to the 14.3% increase in average horsepower per revenue generating compression unit to 791 for 2012 from 692 in 2011, resulting from our focus on the addition of large horsepower compression units to our fleet. The decrease in cost of operations is attributable to a $4.1 million decrease in equipment operating lease expense, as the Caterpillar operating lease schedules were terminated on December 15, 2011. Partially offsetting the decrease related to the Caterpillar operating lease were certain cost increases, including (1) a $1.1 million increase in lubrication oil expenses due to both a 7.1% increase in the average supplier price per gallon and a 12.7% increase in gallons consumed, (2) a $1.0 million increase in direct labor expenses and (3) a $0.3 million increase related to vehicle tools and gasoline, all of which were attributable primarily to the increase in the size of our fleet.
Financial Results of Operations
Year ended December 31, 2013 compared to the year ended December 31, 2012
The following table summarizes our results of operations for the periods presented:
Contract operations revenue. Contract operations revenue was $150.4 million for the year ended December 31, 2013 compared to $116.4 million in 2012, an increase of 29.2%. Average revenue generating horsepower increased from 749,821 for the year ended December 31, 2012 to 902,168 for the year ended December 31, 2013, an increase of 20.3%, primarily due to growth in our core midstream compression assets along with the addition of assets in connection with the S&R Acquisition. Average revenue per revenue generating horsepower per month increased from $13.39 for the year ended December 31, 2012 to $14.15 for the year ended December 31, 2013, an increase of 5.7%, primarily due to higher revenue per horsepower per month from the gas lift compression units that were acquired in the S&R Acquisition. There were 2,137 revenue generating compression units at December 31, 2013 compared to 978 at December 31, 2012, a 118.5% increase, primarily due to the S&R Acquisition and organic growth in our core midstream compression assets. Revenue generating horsepower was 1,070,457 at December 31, 2013 compared to 794,324 at December 31, 2012, a 34.8% increase, primarily due to growth in our core midstream compression assets along with the S&R Acquisition.
Parts and service revenue. Parts and service revenue was $2.6 million for the year ended December 31, 2013 compared to $2.4 million in 2012, or a 6.0% increase.
Cost of operations, exclusive of depreciation and amortization. Cost of operations was $48.1 million for the year ended December 31, 2013 compared to $37.8 million for the year ended December 31, 2012, an increase of 27.3%. The increase is primarily attributable to the increase in our fleet size. Certain cost increases consisted of (1) a $2.8 million increase in lubrication oil expenses due to a 21.7% increase in gallons consumed, partially offset by a 3.9% decrease in the average price per gallon paid, (2) a $4.3 million increase in direct labor expenses, (3) a $0.9
million increase in training and safety expense, (4) a $0.4 million increase in maintenance parts and (5) a $0.6 million increase related to vehicle tools and gasoline. These factors are primarily attributable to the increase in our fleet size due to organic growth and four months of operations related to the assets acquired in the S&R Acquisition. In addition, business and property insurance increased by $0.4 million primarily due to certain insurance claims on our compression units and the increase in the size of our fleet. The cost of operations was 31.5% of revenue for the year ended December 31, 2013 as compared to 31.8% for the year ended December 31, 2012.
Selling, general and administrative expense. Selling, general and administrative expense was $27.6 million for the year ended December 31, 2013 compared to $18.3 million for the year ended December 31, 2012, an increase of 51.0%. Approximately $3.5 million of the increase in selling, general and administrative expense is related to a rise in salaries and benefits due to (i) an increase in employee headcount to support operations and sales management and (ii) the addition of certain executive positions to operate as a public company. Additionally, the Partnership expensed $1.3 million of unit-based compensation expense related to the issuance of phantom units in 2013 under the Partnership’s 2013 Long-Term Incentive Plan. Other significant increases included (1) a $0.6 million due to increased sales support costs, (2) $3.8 million of increased professional fees, including $2.1 million related to the S&R Acquisition and (3) $0.3 million of increased computer hardware and software expenses, all of which were attributable to increased employee headcount and support services. In addition, business and property insurance increased by $0.6 million due to certain insurance claims on our compression units and the increase in the size of our fleet and were offset by a $1.0 million decrease in management fees that are no longer owed by the Partnership subsequent to its initial public offering. The selling, general and administrative employee headcount was 86 at December 31, 2013, a 45.8% increase from December 31, 2012. The selling, general and administrative employee headcount increased to support the continued growth of the business, including the S&R Acquisition. Selling, general and administrative expense represented 18.0% and 15.4% of revenue for the years ended December 31, 2013 and 2012, respectively.
Depreciation and amortization expense. Depreciation and amortization expense was $52.9 million for the year ended December 31, 2013 compared to $41.9 million for the year ended December 31, 2012, an increase of 26.4%. The increase was related to an increase in property, plant and equipment, including the S&R Acquisition, of 39.8% for the year ended December 31, 2013 as compared to December 31, 2012.
Interest expense. Interest expense was $12.5 million for the year ended December 31, 2013 compared to $15.9 million for the year ended December 31, 2012, a decrease of 21.5%. Included in interest expense is amortization of deferred loan costs of $2.2 million and $1.9 million for the years ended December 31, 2013 and 2012, respectively. Interest expense for both periods was related to borrowings under our revolving credit facility. Average borrowings outstanding under our revolving credit facility were $370.8 million for the year ended December 31, 2013 compared to $442.1 million for the year ended December 31, 2012. Our revolving credit facility had an interest rate of 2.17% and 2.96% at December 31, 2013 and 2012, respectively, and an average interest rate of 2.43% and 2.99%, excluding the effects from the interest rate swap instruments discussed below for 2012, for the year then ended, respectively. The composite fixed interest rate for $140 million of notional coverage under three interest rate swap instruments was 2.52% at December 31, 2011 plus the applicable margin of 2.75%. These interest rate swaps expired during 2012. We did not designate our swap agreements as cash flow hedges. As a result, amounts paid or received from the interest rate swaps were charged or credited to interest expense. For the year ended December 31, 2012, we recorded a fair value gain of $2.2 million, with respect to these swaps as a reduction in interest expense.
Income tax expense. We incurred approximately $279,972 and $196,040 in franchise tax for the years ended December 31, 2013 and 2012, respectively, as a result of the Texas franchise tax.
Year ended December 31, 2012 compared to the year ended December 31, 2011
The following table summarizes our results of operations for the periods presented:
Contract operations revenue. Contract operations revenue was $116.4 million for the year ended December 31, 2012 compared to $93.9 million in 2011, an increase of 23.9%. Average revenue generating horsepower increased from 570,900 for the year ended December 31, 2011 to 749,821 for the year ended December 31, 2012, an increase of 31.3%, primarily due to organic growth and increasing customer demand. Average revenue per revenue generating horsepower per month declined from $14.07 for the year ended December 31, 2011 to $13.39 for the year ended December 31, 2012, a decrease of 4.8%. The decline in average revenue per revenue generating horsepower per month related primarily to the 14.3% increase in the estimated average horsepower per revenue generating compression unit, which was 692 and 791 at December 31, 2011 and 2012, respectively, as large horsepower compression units generally generate lower average monthly revenue per revenue generating horsepower. While pricing for these services stabilized in mid-2010 and 2011 and began to improve during 2012, compression units that were placed under service contracts during 2009 and 2010 were contracted at lower market rates. There were 978 revenue generating compression units at December 31, 2012 compared to 888 at December 31, 2011, a 10.1% increase. Revenue generating horsepower was 794,324 at December 31, 2012 compared to 649,285 at December 31, 2011, a 22.3% increase.
Parts and service revenue. Parts and service revenue was $2.4 million for the year ended December 31, 2012 compared to $4.8 million in 2011, or a 50.0% decrease. A portion of retail service revenue, including billings for trucking and crane services, was $1.1 million during 2011, including $1.0 million recognized during the fourth quarter of 2011 due to the deployment and redeployment of compression units. These ancillary trucking and crane services, all of which are billed to customers, result in no gross operating margin.
Cost of operations, exclusive of depreciation and amortization. Cost of operations was $37.8 million for the year ended December 31, 2012 compared to $39.6 million for the year ended December 31, 2011, a decrease of 4.6%. The decrease is attributable to a $4.1 million decrease in equipment operating lease expense, as the Caterpillar operating lease schedules were terminated on December 15, 2011. Partially offsetting the decrease related to the Caterpillar operating lease are certain cost increases consisting of (1) a $1.1 million increase in lubrication oil expenses due to both a 7.1% increase in the average price per gallon paid and a 12.7% increase in gallons consumed, (2) a $1.0 million increase in direct labor expenses and (3) a $0.3 million increase related to vehicle tools and gasoline, all of which were attributable primarily to the increase in the size of our fleet. The cost of operations was 31.8% of revenue for the year ended December 31, 2012 as compared to 40.2% for the year ended December 31, 2011.
Selling, general and administrative expense. Selling, general and administrative expense was $18.3 million for year ended December 31, 2012 compared to $12.7 million for the year ended December 31, 2011, an increase of 43.6%. Selling, general and administrative expense represented 15.4% and 12.9% of revenue for the years ended December 31, 2012 and 2011, respectively. Approximately $2.6 million of the increase in selling, general and administrative expense related to a rise in salaries and benefits due to (i) an increase in employee headcount to
support operations and sales management and (ii) certain executive positions to operate as a public company. Additionally, accounting fees increased $0.3 million due to increased services as we prepared to operate as a public company. Other significant increases included (1) $0.3 million due to increased office rent, (2) $0.6 million due to increased sales support costs, (3) $0.5 million of increased outside services costs and (4) $0.4 million of increased telephone and office supply expenses, all of which were attributable to increased employee headcount and support services. The selling, general and administrative employee headcount was 59 at December 31, 2012, a 15.7% increase from December 31, 2011. The selling, general and administrative employee headcount increased to support the continued growth of the business.
Restructuring charges. During the year ended December 31, 2011, we incurred $0.3 million of restructuring charges for severance and retention benefits related to the termination of certain administrative employees. These charges are reflected as restructuring charges in our consolidated statement of operations for the year ended December 31, 2011. We paid these restructuring charges in 2012.
Depreciation and amortization expense. Depreciation and amortization expense was $41.9 million for the year ended December 31, 2012 compared to $32.7 million for the year ended December 31, 2011, an increase of 27.9%. The increase was related to an increase in depreciable property, plant and equipment, including the compression units purchased from Caterpillar for $43.0 million, of 33.6% over these periods.
Interest expense. Interest expense was $15.9 million for the year ended December 31, 2012 compared to $13.0 million for the year ended December 31, 2011, an increase of 22.6%. Included in interest expense is amortization of deferred loan costs of $1.9 million and $1.5 million for the years ended December 31, 2012 and 2011, respectively. Interest expense for both periods was related to borrowings under our revolving credit facility. Average borrowings outstanding under our revolving credit facility were $442.1 million for the year ended December 31, 2012 compared to $275.1 million for the year ended December 31, 2011. Our revolving credit facility had an interest rate of 2.96% and 3.02% at December 31, 2012 and 2011, respectively, and an average interest rate of 2.99% and 3.71%, excluding the effects from the interest rate swap instruments discussed below, for the year then ended, respectively. The composite fixed interest rate for $140 million of notional coverage under three interest rate swap instruments was 2.52% at December 31, 2011 plus the applicable margin of 2.75%. These interest rate swaps expired during 2012. As of December 31, 2010, we no longer designate our swap agreements as cash flow hedges. As a result, amounts paid or received from the interest rate swaps are charged or credited to interest expense. For the years ended December 31, 2012 and 2011, we recorded a fair value gain of $2.2 million and $2.6 million, respectively, with respect to these swaps as a reduction in interest expense.
Income tax expense. We incurred approximately $196,000 and $155,000 in franchise tax for the years ended December 31, 2012 and 2011, respectively, as a result of the Texas franchise tax.
Liquidity and Capital Resources
The following table summarizes our sources and uses of cash for the years ended December 31, 2013, 2012 and 2011, and our cash as of the end of the periods presented:
Net cash provided by operating activities. Net cash provided by operating activities increased to $68.2 million for the year ended December 31, 2013, from $42.0 million for the year ended December 31, 2012. The increase relates primarily to an increase in net income during the year ended December 31, 2013, due to the increase in the size of our operating fleet, and a $4.5 million increase in working capital in 2013 due to increased purchases and timing of payments for new compression unit equipment. Net cash provided by operating activities increased to $42.0 million for the year ended December 31, 2012, from $33.8 million in the year ended December 31, 2011. The increase related primarily to a higher income level in 2012, offset by a $6.2 million decrease in working capital in the year ended December 31, 2012, primarily due to timing of payments for new compression unit equipment.
Net cash used in investing activities. Net cash used in investing activities decreased to $153.9 million for the year ended December 31, 2013, from $178.6 million for the year ended December 31, 2012. The decrease related primarily to lower capital expenditures of $159.5 million during the year ended December 31, 2013, offset by (1) $0.8 million of higher proceeds from the sale of equipment during the year ended December 31, 2013 and (2) cash received as part of a purchase price adjustment related to the S&R Acquisition of $3.4 million during 2013. Net cash used in investing activities increased to $178.6 million for the year ended December 31, 2012, from $140.4 million for the year ended December 31, 2011. The increase related primarily to higher capital expenditures of $180.0 million, offset by $0.6 million of higher proceeds from the sale of equipment during the year ended December 31, 2012.
Net cash provided by financing activities. Net cash provided by financing activities was $85.8 million for the year ended December 31, 2013 as compared $136.6 million for the year ended December 31, 2012. The decrease was due to lower borrowings under our revolving credit facility for the year ended December 31, 2013 due to the application of the net proceeds from our initial public offering to pay down outstanding borrowings as compared to higher borrowings for the year ended December 31, 2012 related to expansion capital expenditures. Net cash provided by financing activities was $136.6 million for the year ended December 31, 2012 as compared to $106.7 million for the year ended December 31, 2011. The increase was due to lower borrowings under our revolving credit facility for the year ended December 31, 2011 as compared to higher borrowings for the year ended December 31, 2012 related to increased expansion capital expenditures.
Capital Expenditures
The compression business is capital intensive, requiring significant investment to maintain, expand and upgrade existing operations. Our capital requirements have consisted primarily of, and we anticipate that our capital requirements will continue to consist primarily of, the following:
· maintenance capital expenditures, which are capital expenditures made to replace partially or fully depreciated assets, to maintain the operating capacity of our assets and extend their useful lives, or other capital expenditures that are incurred in maintaining our existing business and related cash flow; and
· expansion capital expenditures, which are capital expenditures made to expand the operating capacity or revenue generating capacity of existing or new assets, including by acquisition of compression units or through modification of existing compression units to increase their capacity.
We expect that our maintenance capital expenditure requirements will continue to increase as the overall size and age of our fleet increases. Our aggregate maintenance capital expenditures for the years ended December 31, 2013 and 2012 were $14.3 million and $13.3 million, respectively.
Given our growth objective, we anticipate that we will continue to make significant expansion capital expenditures. Our expansion capital expenditures for the years ended December 31, 2013 and 2012 were $323.7 million and $166.7 million, respectively. Of the $323.7 million, $178.5 million (including $120.0 million of fixed assets, $7.6 million of intangible assets and $51.0 million of goodwill) related to the S&R Acquisition and was financed through the issuance of 7,425,261 common units to S&R’s owners.
In addition to organic growth, we may also consider a variety of assets or businesses for potential acquisition. We expect to fund any future capital expenditures or acquisitions primarily with capital from external financing sources, such as borrowings under our revolving credit facility and issuances of debt and equity securities, including our issuance of additional partnership units and future debt offerings given market conditions.
Description of Revolving Credit Facility
We amended our revolving credit agreement in December 2010 to increase the overall commitments under the facility to $400 million and extend the term until October 5, 2015. On November 16, 2011, we amended the revolving credit agreement to increase the overall commitments under the facility from $400 million to $500 million and reduce our applicable margin for LIBOR loans from the previous range of 300 to 375 basis points above LIBOR to the new range of 200 to 275 basis points above LIBOR, depending on our leverage ratio. We further amended our revolving credit agreement on June 1, 2012 to increase the overall commitments under the facility from $500 million to $600 million and to provide an option to increase the overall commitments by an additional $50 million upon satisfaction of certain conditions.
In addition, on June 1, 2012, we entered into the Fourth Amended and Restated Credit Agreement in order to provide a covenant structure that was more appropriate for a public company than was the prior credit agreement, including a reduction of the applicable margin for LIBOR loans to a range of 175 to 250 basis points above LIBOR, depending on the our leverage ratio. This amended and restated credit agreement became effective on January 18, 2013, the closing date of our initial public offering, was secured by a first priority lien against our assets and had a schedule maturity of October 5, 2015. On December 10, 2012, we amended the Fourth Amended and Restated Credit Agreement to extend the periods during which the maximum funded debt to EBITDA ratio thresholds will apply. We paid various loan fees and incurred costs in respect of the third amendment to the credit agreement and the Fourth Amended and Restated Credit Agreement in the amount of $1.8 million in 2012.
On December 13, 2013, we entered into the Fifth Amended and Restated Credit Agreement whereby the aggregate commitment under the facility increased from $600 million to $850 million (subject to availability under a borrowing base and a further potential increase of $100 million) and reduced the applicable margin for LIBOR loans to a range of 150 to 225 basis points above LIBOR, depending on our leverage ratio. The revolving credit facility is secured by a first priority lien against our assets and matures on December 13, 2018, at which point all amounts outstanding will become due.
The Fifth Amended and Restated Credit Agreement permits us to make distributions of available cash to unitholders so long as (a) no default under the facility has occurred, is continuing or would result from the distribution, (b) immediately prior to and after giving effect to such distribution, we are in compliance with the facility’s financial covenants and (c) immediately after giving effect to such distribution, we have availability under the revolving credit facility of at least $20 million. In addition, the amended and restated credit agreement contains various covenants that may limit, among other things, our ability to (subject to certain exceptions):
· grant liens;
· make certain loans or investments;
· incur additional indebtedness or guarantee other indebtedness;
· enter into transactions with affiliates;
· merge or consolidate;
· sell our assets; or
· make certain acquisitions.
The Fifth Amended and Restated Credit Agreement also contains various financial covenants, including covenants requiring us to maintain:
· a minimum EBITDA to interest coverage ratio of 2.5 to 1.0; and
· a maximum funded debt to EBITDA ratio, determined as of the last day of each fiscal quarter, for the annualized trailing three months of (a) 5.50 to 1.0, with respect to any fiscal quarter ending on or after December 13, 2013, the closing date of the amended credit facility, through June 30, 2015 or (b) 5.00 to 1.0, with respect to the fiscal quarter ending September 30, 2015 and each fiscal quarter thereafter, in each case subject to a provision for increases to such thresholds by 0.5 in connection with certain future acquisitions for the six consecutive month period following the period in which any such acquisition occurs.
If a default exists under the revolving credit facility, the lenders will be able to accelerate the maturity on the amount then outstanding and exercise other rights and remedies.
As of December 31, 2013, we were in compliance with all of the covenants under our current credit agreement.
Distribution Reinvestment Plan
We have filed a registration statement with the SEC to register the issuance of up to 4,150,000 of our common units in connection with a DRIP, which initially became effective on January 30, 2013. Our DRIP provides our common unitholders a means by which they can increase the number of common units they own by reinvesting the quarterly cash distributions, which they would otherwise receive in cash, into the purchase of additional common units. As of February 18, 2014, 1,552,749 common units had been issued under this registration statement.
Total Contractual Cash Obligations
The following table summarizes our total contractual cash obligations as of December 31, 2013:
(1) Represents future principal repayments under our revolving credit facility.
(2) Represents future interest payments under our revolving credit facility based on the interest rate at December 31, 2013 of 2.17%.
(3) Represents commitments for new compression units that are being fabricated.
(4) Represents commitments for future minimum lease payments on noncancelable leases.
Effects of Inflation. Our revenues and results of operations have not been materially impacted by inflation and changing prices in the past three fiscal years.
Off-Balance Sheet Arrangements
We have not entered into any transactions, agreements or other contractual arrangements that would result in off-balance sheet liabilities.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations is based upon our financial statements. These financial statements were prepared in conformity with U.S. GAAP. As such, we are required to make certain estimates, judgments and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the periods presented. We base our estimates on historical experience, available information and various other assumptions we believe to be reasonable under the circumstances. On an ongoing basis, we evaluate our estimates; however, actual results may differ from these estimates under different assumptions or conditions. The accounting policies that we believe require management’s most difficult, subjective or complex judgments and are the most critical to its reporting of results of operations and financial position are as follows:
Depreciation
Property and equipment are stated at cost. Depreciation for financial reporting purposes is computed on the straight-line basis using estimated useful lives. If the actual useful life of our property and equipment is less than the estimate used for purposes of computing depreciation expense, we could experience an acceleration in depreciation
expense. Major overhauls and improvements that extend the life of an asset are capitalized. As of December 31, 2013, we had 2,390 compression units that were subject to depreciation. Given the large number of compression units being depreciated, the impact of a particular unit incurring an actual useful life that is less than the estimated useful life would not have a material impact on our results of operations.
Business Combinations and Goodwill
Goodwill acquired in connection with business combinations represents the excess of consideration over the fair value of net assets acquired. Certain assumptions and estimates are employed in determining the fair value of assets acquired and liabilities assumed, as well as in determining the allocation of goodwill to the appropriate reporting unit. Goodwill is not amortized, but is reviewed for impairment annually based on the carrying values as of October 1, or more frequently if impairment indicators arise that suggest the carrying value of goodwill may not be recovered.
We perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is impaired. Management uses all available information to make these determinations, including evaluating the macroeconomic environment, industry specific conditions, cost factors, overall financial performance and unit price, at the assessment date of October 1. If for any reason the fair value of our goodwill declines below the carrying value in the future, we may incur charges for the impairment. There was no impairment recorded for goodwill for the years ended December 31, 2013, 2012 and 2011.
Long-Lived Assets
Long-lived assets, which include property and equipment, and intangible assets comprise a significant amount of our total assets. Long-lived assets to be held and used by us are reviewed to determine whether any events or changes in circumstances indicate the carrying amount of the asset may not be recoverable. For long-lived assets to be held and used, we base our evaluation on impairment indicators such as the nature of the assets, the future economic benefit of the assets, any historical or future profitability measurements and other external market conditions or factors that may be present. If such impairment indicators are present or other factors exist that indicate the carrying amount of the asset may not be recoverable, we determine whether an impairment has occurred through the use of an undiscounted cash flows analysis. If an impairment has occurred, we recognize a loss for the difference between the carrying amount and the estimated fair value of the asset. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, is based on an estimate of discounted cash flows. In 2013, we recorded $203,149 related to the impairment of a certain group of our compression equipment. There was no impairment recorded for the years ended December 31, 2012 and 2011.
Allowances and Reserves
We maintain an allowance for bad debts based on specific customer collection issues and historical experience. On an ongoing basis, we conduct an evaluation of the financial strength of our customers based on payment history and specific identification and make adjustments to the allowance as necessary. The allowance for doubtful accounts was $246,410, $259,638 and $260,598 at December 31, 2013, 2012 and 2011, respectively.
Revenue Recognition
Revenue is recognized by us using the following criteria: (i) persuasive evidence of an arrangement, (ii) delivery has occurred or services have been rendered, (iii) the customer’s price is fixed or determinable and (iv) collectability is reasonably assured.
Revenue from compression services is recognized as earned under our fixed fee contracts. Compression services are billed monthly in advance of the service period, except for our gas lift compression customers (which are billed at the beginning of the service month), and are recognized as deferred revenue on the balance sheet until earned.
Recent Accounting Pronouncements
We qualify as an emerging growth company under Section 109 of the Jumpstart Our Business Startups, (“JOBS”) Act. An emerging growth company can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. In other words, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. However, we have chosen to “opt out” of such extended transition period, and as a result, are compliant with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Section 108 of the JOBS Act provides that our decision to opt out of the extended transition period for complying with new or revised accounting standards is irrevocable.
ITEM 7A.
ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Commodity Price Risk
Market risk is the risk of loss arising from adverse changes in market rates and prices. We do not take title to any natural gas in connection with our services and, accordingly, have no direct exposure to fluctuating commodity prices. However, the demand for our compression services depends upon the continued demand for, and production of, natural gas and crude oil. Lower natural gas prices or crude oil prices over the long term could result in a decline in the production of natural gas or crude oil, which could result in reduced demand for our compression services. Please read Part I, Item 1A “Risk Factors - Risks Related to Our Business.” We do not intend to hedge our indirect exposure to fluctuating commodity prices.
Interest Rate Risk
We are exposed to market risk due to variable interest rates under our financing arrangements.
As of December 31, 2013 we had approximately $420.9 million of variable-rate outstanding indebtedness at a weighted-average interest rate of 2.4%. A 1% increase in the effective interest rate on our variable-rate outstanding debt at December 31, 2013 would result in an annual increase in our interest expense of approximately $4.2 million.
For further information regarding our exposure to interest rate fluctuations on our debt obligations, see Note 5 to the Financial Statements. We may, in the future, hedge all or a portion of our variable rate debt.
Credit Risk
Our credit exposure generally relates to receivables for services provided. If any significant customer of ours should have credit or financial problems resulting in a delay or failure to repay the service fees owed to us, this could have a material adverse effect on our business, financial condition, results of operations or cash flows.
ITEM 8.
ITEM 8. Financial Statements and Supplementary Data
The financial statements and supplementary information specified by this Item are presented in Part IV, Item 15 of this report.
ITEM 9.
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
None.
ITEM 9A.
ITEM 9A. Controls and Procedures
Disclosure Controls and Procedures
As required by Rule 13a-15(b) of the Exchange Act, we have evaluated, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, the effectiveness of the design and operation of our disclosure controls
and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of the end of the period covered by this report. Our disclosure controls and procedures are designed to provide reasonable assurance that the information required to be disclosed by us in reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, and is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Commission. Based upon the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective as of December 31, 2013 at the reasonable assurance level.
Management’s Annual Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting for us. Our internal control system was designed to provide reasonable assurance regarding the preparation and fair presentation of our published financial statements.
There are inherent limitations to the effectiveness of any control system, however well designed, including the possibility of human error and the possible circumvention or overriding of controls. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Management must make judgments with respect to the relative cost and expected benefits of any specific control measure. The design of a control system also is based in part upon assumptions and judgments made by management about the likelihood of future events, and there can be no assurance that a control will be effective under all potential future conditions. As a result, even an effective system of internal control over financial reporting can provide no more than reasonable assurance with respect to the fair presentation of financial statements and the processes under which they were prepared.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in Internal Control - Integrated Framework. Based on this assessment, our management believes that, as of December 31, 2013, our internal control over financial reporting was effective. This annual report does not include an attestation report of the company’s registered public accounting firm due to a transition period established by rules of the Securities and Exchange Commission for emerging growth companies.
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.
ITEM 9B.
ITEM 9B. Other Information
None.
PART III
ITEM 10.
ITEM 10. Directors, Executive Officers and Corporate Governance
Board of Directors
Our general partner, USA Compression GP, LLC, manages our operations and activities. Our general partner is not elected by our unitholders and is not subject to re-election on a regular basis in the future. Our general partner has a board of directors that manages our business.
The board of directors of our general partner is comprised of eight members, all of whom have been designated by USA Compression Holdings and three of whom are independent as defined under the independence standards established by the New York Stock Exchange. The NYSE does not require a listed limited partnership like us to have a majority of independent directors on the board of directors of our general partner or to establish a compensation committee or a nominating committee.
Independent Directors. The board of directors of our general partner has determined that Robert F. End, John D. Chandler and Forrest E. Wylie are independent directors under the standards established by the NYSE and the Exchange Act. The board of directors considered all relevant facts and circumstances and applied the independent guidelines of the NYSE and the Exchange Act in determining that none of these directors has any material relationship with us, our management, our general partner or its affiliates or our subsidiaries.
Audit Committee. The board of directors has appointed an audit committee comprised solely of directors who meet the independence and experience standards established by the NYSE and the Exchange Act. The audit committee consists of Robert F. End, John D. Chandler and Forrest E. Wylie. Mr. Chandler serves as chairman of the audit committee. The board of directors has determined that Mr. Chandler is an “audit committee financial expert” as defined in Item 407(d)(5)(ii) of SEC Regulation S-K, and that each of Messrs. End, Chandler and Wylie is “independent” within the meaning of the applicable NYSE and Exchange Act rules regulating audit committee independence. The audit committee assists the 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 the terms thereof, and pre-approve any non-audit services to be rendered 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 will be given unrestricted access to the audit committee. A copy of the charter of the audit committee is available under the Investor Relations tab on our website at www.usacpartners.com. We also will provide a copy of the charter of the audit committee to any of our unitholders without charge upon written request to Investor Relations, 100 Congress Avenue, Suite 450, Austin, TX 78701.
Compensation Committee. The NYSE does not require a listed limited partnership like us to have a compensation committee. However, our board has established a compensation committee to, among other things, oversee the compensation plans described below in Item 11
ITEM 11. Executive Compensation
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 our general partner. All of our employees, including our executive officers are employees of USAC Management, a wholly owned subsidiary of our general partner. We sometimes refer herein to USAC Management’s management and executive officers as “our management” and “our executive officers,” respectively.
Executive Compensation
We are an “emerging growth company” as defined under the Jumpstart Our Business Startups (JOBS) Act. As such, we are permitted to meet the disclosure requirements of Item 402 of Regulation S-K by providing the reduced disclosure required of a “smaller reporting company.”
Executive Summary
This Executive Compensation disclosure provides an overview of the executive compensation program for our named executive officers identified below. Our general partner intends to provide our named executive officers with compensation that is significantly performance based. For the year ended December 31, 2013, our named executive officers, or our NEOs, were:
· Eric D. Long, President and Chief Executive Officer;
· Joseph C. Tusa, Jr., Vice President, Chief Financial Officer and Treasurer; and
· David A. Smith, Vice President and President, Northeast Region.
Mr. Kevin Bourbonnais resigned effective August 2, 2013. He is included as an NEO below due to the fact that he would have been one of our most highly compensated employees had he been employed on December 31, 2013, but he was no longer considered an executive officer at the end of the 2013 fiscal year.
Summary Compensation Table
The following table sets forth certain information with respect to the compensation paid to our NEOs for the years ended December 31, 2012 and 2013.
(1) Represents the awards earned under annual incentive bonus programs and commission program for Mr. Smith for the years ended December 31, 2012 and 2013. For a discussion of the determination of the 2013 bonus amounts, see “-Annual Performance Based Compensation for 2013” below.
(2) On March 11, 2013, each of our NEOs received an award of phantom units under our 2013 Long-Term Incentive Plan (the “LTIP”). Each phantom unit is the economic equivalent of one common unit. The phantom units shall vest in three equal annual installments, with the first installment vesting on March 11, 2014. In the event of cessation of the NEO’s service for any reason, all phantom units that have not vested prior to or in connection with such cessation of service shall automatically be forfeited. The phantom unit values reflect the grant date fair value of the awards calculated in accordance with FASB ASC Topic 718. For a detailed discussion of the assumptions utilized in coming to these values, please see Note 7 to our consolidated financial statements.
(3) Includes $18,000 of automobile allowance, $8,316 of club membership dues, $7,650 of employer contributions under the 401(k) plan and $3,000 of parking.
(4) Includes $18,000 of automobile allowance, $8,078 of club membership dues, $8,500 of employer contributions under the 401(k) plan and $3,000 of parking.
(5) Includes $7,650 of employer contributions under the 401(k) plan and $3,000 of parking.
(6) Includes $6,313 of employer contributions under the 401(k) plan and $3,000 of parking.
(7) Includes $9,960 of automobile allowance, $7,120 of club membership dues and $7,650 of employer contributions under the 401(k) plan.
(8) Includes $9,960 of automobile allowance, $6,120 of club membership dues and $10,085 of employer contributions under the 401(k) plan.
(9) On July 3, 2013, Mr. Bourbonnais announced his resignation as Vice President and Chief Operating Officer. Mr. Bourbonnais’ resignation became effective on August 2, 2013.
(10) Includes fees and other payments pursuant to the Resignation and Consulting Agreement Mr. Boubonnais entered into in connection with his resignation. The Resignation and Consulting Agreement is described more fully below.
(11) In connection with his resignation and pursuant to the terms of his grant agreement, Mr. Bourbonnais forfeited all rights to his grant under the LTIP and this value was not actually paid to him.
Narrative Disclosure to Summary Compensation Table
Elements of the Compensation Program
Compensation for our NEOs consists primarily of the elements, and their corresponding objectives, identified in the following table.
Base Compensation For 2013
Base salaries for our NEOs have generally been set at a level deemed necessary to attract and retain individuals with superior talent. Base salary increases are determined based upon the job responsibilities, demonstrated proficiency and performance of the executive officers and market conditions, each as assessed by the board of managers of USA Compression Holdings. No formulaic base salary increases are provided to the NEOs. Additionally, no changes to base salaries for our NEOs were made for the fiscal year ended December 31, 2013.
The current 2014 base salaries for our NEOs, including for our Chief Executive Officer, are set forth in the following table:
Annual Performance-Based Compensation For 2013
Each of our NEOs participates in a discretionary annual incentive bonus compensation program, under which incentive awards are determined annually, with reference to target bonus amounts that are set forth in their employment agreements. For 2013, the target bonus amounts for each of our NEOs were as follows: Mr. Long: $300,000; Mr. Tusa: $110,000; Mr. Smith: $120,000 and Mr. Bourbonnais: $137,500. In making individual annual bonus decisions, our general partner’s board of directors, following the recommendations of our compensation committee, does not rely solely on pre-determined performance goals or targets. Instead, determinations regarding annual bonus compensation awards are based on a subjective assessment of all reasonably available information, including the applicable executive’s performance, business impact, contributions and leadership, and any pre-determined performance goals are used as guidelines in making these end of year decisions.
For 2013, our general partner’s board of directors determined to provide each NEO with a 2013 annual bonus award above the NEO’s target bonus, generally on what it viewed as strong leadership and overall financial performance. In addition, the board of directors sought to reward our NEOs for our operational results and significantly increased sales activity during the year. As a result of these considerations, Mr. Long received an annual incentive award equal to 150% of his target amount in recognition of his strong leadership in sales and operations, Mr. Smith received 208% of his target amount to recognize his strong sales performance and Mr. Tusa received an award equal to 205% of his target amount due to his leadership in building a strengthened financial and accounting team in 2013 and expanding and improving our credit facility. Mr. Bourbonnais was no longer an officer at the end of the year, thus he did not receive a bonus award from this program.
Awards with respect to the 2013 year were:
Mr. Smith also receives commissions in an amount up to $200,000 annually based on a percentage of qualifying sales. Based on sales performance in 2013, as in prior recent years, Mr. Smith earned the maximum potential amount of commissions available under this arrangement.
Benefit Plans and Perquisites
We provide our executive officers, including our NEOs, with certain personal benefits and perquisites, which we do not consider to be a significant component of executive compensation but which we recognize are an important factor in attracting and retaining talented executives. Executive officers are eligible under the same plans as all other employees with respect to our medical, dental, vision, disability and life insurance plans and a defined contribution plan that is tax-qualified under Section 401(k) of the Internal Revenue Code and that we refer to as the 401(k) Plan. We also provide certain executive officers with an annual automobile allowance. We provide these supplemental benefits to our executive officers due to the relatively low cost of such benefits and the value they provide in assisting us in attracting and retaining talented executives. The value of personal benefits and perquisites we provide to each of our NEOs is set forth above in our “-Summary Compensation Table.”
Discretionary Long-Term Equity Incentive Awards
In connection with our initial public offering, we adopted a new long-term equity incentive plan, or the LTIP. The LTIP was designed to promote our interests, as well as the interests of our unitholders, by rewarding the officers, employees and directors of us, our subsidiaries and our general partner for delivering desired performance results, as well as by strengthening our and our general partner’s ability to attract, retain and motivate qualified individuals to serve as directors, consultants and employees. The LTIP provides for the grant, from time to time at the discretion of the board of directors of our general partner, of unit awards, restricted units, phantom units, unit options, unit appreciation rights, distribution equivalent rights and other unit-based awards, although in 2013 we only granted phantom unit awards pursuant to the LTIP. The outstanding LTIP awards held by our NEOs are reflected in the table below.
Prior to the Holdings Acquisition, our NEOs historically received various forms of equity compensation, in the form of both capital and profits interests in us and our predecessor entities, and in connection with the Holdings Acquisition, each of our NEOs re-invested a substantial portion of the cash proceeds received in respect of his prior equity interests in certain classes of capital or profit interest units in USA Compression Holdings.
Our NEOs were also granted Class B Units of USA Compression Holdings at the time of the Holdings Acquisition. The grants the NEOs received had time-based vesting requirements (which were satisfied in full as of December 31, 2013) and are designed not only to compensate but also to motivate and retain the recipients by providing an opportunity for equity ownership by our NEOs. The grants to our NEOs also provide our NEOs with meaningful incentives to increase unitholder value over time. The Class B Units are profits interests that allow our NEOs to participate in the increase in value of USA Compression Holdings over and above an 8% annual and cumulative preferred return hurdle. Available cash will be distributed to the USA Compression Holdings members at such times as determined by its board of managers, at which time the holders of Class B Units could receive distributions if the cash distributed reaches the required distribution hurdles. Distributions to the Class B Unit holders could also occur in connection with a sale or liquidation event of USA Compression Holdings. To date, our NEOs have not received distributions with respect to these awards.
Outstanding Equity Awards at December 31, 2013
The following table provides information regarding the Class B Units in USA Compression Holdings held by the NEOs as of December 31, 2013. None of our NEOs held any option awards that were outstanding as of December 31, 2013. Also reflected within the table are the outstanding phantom units that were granted to our NEOs from the LTIP during the 2013 year. Mr. Bourbonnais forfeited all equity awards in connection with his resignation during the 2013 year.
(1) Represents the number of Class B Units in USA Compression Holdings that became vested but had not been settled as of December 31, 2013. These Class B Units vested in thirty-six equal monthly installments on each monthly anniversary of December 31, 2011.
(2) As described under the heading “-Discretionary Long Term Equity Incentive Awards,” the Class B Units are intended to allow recipients to receive a percentage of profits generated by USA Compression Holdings over and above certain return hurdles. The Class B Units had no recognizable value as of December 31, 2013 and the holders of the Class B Units had not received any distributions with respect to those awards during the 2013 year.
(3) Represents the number of phantom units issued pursuant to the 2013 Long Term Incentive Plan that have not vested as of December 31, 2013. Each phantom unit is the economic equivalent of one common unit. The phantom units shall vest in three equal annual installments, with the first installment vesting on March 11, 2014. In the event of cessation of the NEO’s service for any reason, all phantom units that have not vested prior to or in connection with such cessation of service shall automatically be forfeited.
(4) The phantom unit values reflect the grant date fair value of the awards calculated in accordance with FASB ASC Topic 718. For a detailed discussion of the assumptions utilized in coming to these values, please see Note 7 to our consolidated financial statements.
Severance and Change in Control Arrangements
Our NEOs are entitled to severance payments and benefits upon certain terminations of employment and, in certain cases, in connection with a change in control of Holdings.
Each NEO currently has an employment agreement with USAC Management that provides for severance benefits upon a termination of employment. On January 1, 2013, we entered into the services agreement with USAC Management, pursuant to which USAC Management provides to us and our general partner management, administrative and operating services and personnel to manage and operate our business. Pursuant to the services agreement, we will reimburse USAC Management for the allocable expenses for the services performed, including the salary, bonus, cash incentive compensation and other amounts paid to our NEOs. See Part III, Item 13 “Certain Relationships and Related Transactions, and Director Independence.”
Severance Arrangements
Each NEO’s employment agreement, dated as of December 23, 2010, has an initial four-year term and will be extended automatically for successive twelve month periods thereafter unless either party delivers written notice to the other within ninety days prior to the expiration of the then-current employment term. Upon termination of an NEO’s employment for any reason, all earned, unpaid annual base salary and all accrued, unused sick time off and vacation time shall be paid to the NEO within thirty (30) days of the date of the NEO’s termination of employment. Upon termination of an NEO’s employment either by us for convenience or due to the NEO’s resignation for good reason, subject to the timely execution of a general release of claims, the NEO is entitled to receive (i) an amount equal to one times his annual base salary (plus, in the case of Mr. Long, an amount equal to one times his target annual bonus), payable in equal semi-monthly installments over one year following termination (the “Severance Period”) (or, if such termination occurs within two years following a change in control, in a lump sum within thirty days following the termination of employment), subject to acceleration upon the NEO’s death during the Severance Period, and (ii) continued coverage for twenty-four (24) months (or, with respect to Mr. Long, thirty (30) months) under our group medical plan in which the executive and any of his dependents were participating immediately prior to his termination. Continued coverage under our group medical plan is subsidized for the first twelve (12) months following termination, after which time continued coverage shall be provided at the NEO’s sole expense (except with respect to Mr. Long, who is entitled to reimbursement by us to the extent the cost of such coverage exceeds $1,200 per month) for the remainder of the applicable period. Additionally, upon a termination of an NEO’s employment by us for convenience, by the NEO for good reason, or due to the NEO’s death or disability, the NEO is entitled to receive (i) an amount equal to one times his annual bonus (up to his target annual bonus) for the immediately preceding year and (ii) a pro-rata portion of any earned annual bonus for the year in which termination occurs (calculated with reference to the performance targets established by the board of managers of USA Compression Holdings for that year). During employment and for two years following termination, each NEO’s employment agreement prohibits him from competing with certain of our businesses.
As used in the NEOs’ employment agreements, a termination for “convenience” means an involuntary termination for any reason, including a failure to renew the employment agreement at the end of an initial term or any renewal term, other than a termination for “cause.” “Cause” is defined in the NEOs’ employment agreements to mean (i) any material breach of the employment agreement or the Holdings Operating Agreement, by the executive, (ii) the executive’s breach of any applicable duties of loyalty to us or any of our affiliates, gross negligence or misconduct, or a significant act or acts of personal dishonesty or deceit, taken by the executive, in the performance of the duties and services required of the executive that has a material adverse effect on us or any of our affiliates, (iii) conviction or indictment of the executive of, or a plea of nolo contendere by the executive to, a felony, (iv) the executive’s willful and continued failure or refusal to perform substantially the executive’s material obligations pursuant to the employment agreement or the Holdings Operating Agreement or follow any lawful and reasonable directive from the board of managers of USA Compression Holdings or, as applicable, the Chief Executive Officer, other than as a result of the executive’s incapacity, or (v) a pattern of illegal conduct by the executive that is materially injurious to us or any of our affiliates or our or their reputation.
“Good reason” is defined in the NEOs’ employment agreements to mean (i) a material breach by us of the employment agreement, the Holdings Operating Agreement, or any other material agreement with the executive, (ii) any failure by us to pay to the executive the amounts or benefits to which he is entitled, other than an isolated and inadvertent failure not committed in bad faith, (iii) a material reduction in the executive’s duties, reporting relationships or responsibilities, (iv) a material reduction by us in the facilities or perquisites available to the executive or in the executive’s base salary, other than a reduction that is generally applicable to all similarly situated employees, or (v) the relocation of the geographic location of the executive’s principal place of employment by more than fifty miles from the location of the executive’s principal place of employment as of December 23, 2010. With respect to Mr. Long’s employment agreement, “good reason” also means the failure to appoint and maintain Mr. Long in the office of President and Chief Executive Officer.
On July 3, 2013, Mr. Bourbonnais announced his resignation as Vice President and Chief Operating Officer. Mr. Bourbonnais’ resignation became effective on August 2, 2013. In connection with his resignation, Mr. Bourbonnais entered into an agreement with USAC Management and us (the “Resignation and Consulting Agreement”). Pursuant to the Resignation and Consulting Agreement, Mr. Bourbonnais’ resignation was treated as a termination by Mr. Bourbonnais for convenience, and thus he was generally only entitled to receive accrued but unpaid amounts under his employment agreement. In addition, in exchange for receipt of his executed release, under the Resignation and Consulting Agreement Mr. Bourbonnais was entitled to continued health insurance coverage for twenty-four (24) months under our group medical plan, with the first twelve (12) month period being subsidized and the second 12 month period being provided at Mr. Bourbonnais’ sole expense. Mr. Bourbonnais’ rights to these benefits terminated on December 1, 2013 when he became eligible under another employer’s plan. Furthermore, Mr. Bourbonnais continued to serve us as a consultant from the period beginning August 2, 2013 through August 31, 2013 (the “Consulting Term”). Under the Resignation and Consulting Agreement, during the Consulting Term, Mr. Bourbonnais received a daily rate equal to (x) $275,000 divided by (y) 365 for a total of $21,725. At the end of the Consulting Term and pursuant to the Resignation and Consulting Agreement, Mr. Bourbonnais was paid a lump sum of $150,000.
Each of the Class B Units held by the NEOs would be forfeited for no consideration if the NEO was terminated for cause. A termination for “Cause” under the USA Compression Holdings limited liability company agreement is defined substantially the same as the term used within the employment agreements described above. In the event that the NEO’s employment is terminated for any reason, however, USA Compression Holdings (or its nominee) shall have the right, but not the obligation, to repurchase any vested Class B Units held by the terminated NEO for then-current fair market value or other agreed value.
Change in Control Benefits
We generally have double- trigger change in control benefits for our outstanding LTIP awards. If a change in control occurs, and our NEOs are also terminated without cause or for good reason (each term as defined in the NEO’s employment agreement) in connection with that change in control event, the current LTIP phantom units would become fully vested. The one exception to this practice is with respect to our CEO, who would receive immediate vesting of any outstanding phantom units upon the change in control event.
Changes Made in 2014
In February 2014, our board of directors approved the adoption of an Annual Cash Incentive Plan (the “Cash Plan”). Each of our NEOs would be entitled to participate in the Cash Plan and their potential bonus will be governed both by the Cash Plan and their employment agreement. The compensation committee will act as the administrator of the Cash Plan under the supervision of the full board of directors, and will have the discretion to amend, modify or terminate the Cash Plan at any time upon approval by the board of directors.
The board of directors will set a target bonus amount (the “Target Bonus”) for each NEO prior to or during the first quarter of the calendar year. The Target Bonus will be subject to the satisfaction of both a partnership performance goal and an individual performance goal. Fifty percent (50%) of the Target Bonus will be subject to our achievement of our budgeted adjusted distributable cash flow level (“Adjusted DCF”) for the year, as determined by our board of directors. Payouts with respect to the portion of the bonus subject to Adjusted DCF (the “Adjusted DCF Bonus”) will not occur unless we have satisfied the threshold set for Adjusted DCF. For 2014, the board of directors has set the threshold for Adjusted DCF at $81 million. The threshold, target and maximum requirements for the Adjusted DCF target for each year, as well as the portion of the Adjusted DCF Bonus that would become payable if performance was satisfied for the year, are set forth below:
If Adjusted DCF performance falls in between threshold and target, or between target and maximum, the amounts payable will be adjusted ratably using straight line interpolation. If Adjusted DCF is satisfied above maximum levels, the potential payment of the Adjusted DCF Bonus will be capped at the maximum level of 200%.
The remaining fifty percent (50%) of the Target Bonus will be subject to individual objectives specific to each eligible individual’s role at USAC (the “Individual Bonus”). The individual objectives will be agreed upon in advance between the NEO and his immediate supervisor (or, with respect to the chief executive officer, between the board of directors and the chief executive officer) that address the key priorities for that NEO’s position. They may include key operating objectives as well as personal development criteria. The Individual Bonus will be subject to a maximum payout of 100% of the targeted Individual Bonus amount, although the Board will have discretion to pay out smaller amounts ranging from 0% to 100%, at their sole discretion, after analyzing the individual’s personal performance for the year.
In the aggregate, the maximum amount payable with respect to a Target Bonus under the Plan will be 150%, as the Adjusted DCF Bonus will be capped at 200% of target and the Individual Bonus will be capped at 100% of target. Target Bonuses, if any, shall be paid within one week following delivery by our independent auditor of the audit of our financial statements for the year in which the Target Bonus relates, but in no case later than March 15 of the year following the year in which the Target Bonus relates.
Director Compensation
For the year ended December 31, 2013, our NEOs who also served as directors did not receive additional compensation for their service as directors. Only the independent members of our board of directors receive compensation for their service as directors.
The following table shows the total compensation paid to each non-employee director during 2013.
(1) Represents the grant date fair value of our phantom units, calculated in accordance with ASC 718. For a detailed discussion of the assumptions utilized in coming to these values, please see Note 7 to our consolidated financial statements. As of December 31, 2013, our independent members of the board of directors held the following number of outstanding equity awards under the LTIP: Mr. Chandler, 3,020 phantom units; Mr. End, 3,826 phantom units; and Mr. Wylie, 3,826 phantom units.
(2) Amounts in this column reflect the value of dividend equivalent rights, or DERs, received by the directors with respect to their outstanding phantom unit awards.
(3) Mr. Chandler was appointed to serve on the board on October 28, 2013.
(4) Mr. Manias resigned from the board on July 15, 2013.
(5) Mr. Wylie elected to receive his annual cash retainer of $75,000 in phantom units that vested in quarterly installments on each of March 31, 2013, June 30, 2013, September 30, 2013 and December 31, 2013.
Officers, employees or paid consultants or advisors of us or our general partner or its affiliates who also serve as directors do not receive additional compensation for their service as directors. Our directors who are not officers, employees or paid consultants or advisors of us or our general partner or its affiliates receive cash and equity based compensation for their services as directors. Our director compensation program consists of the following and will be subject to revision by the board of directors of our general partner from time to time:
· an annual cash retainer of $75,000,
· an additional annual retainer of $15,000 for service as the chair of any standing committee,
· meeting attendance fees of $2,000 per meeting attended, and
· an annual equity based award in the form of phantom units that will be granted under our LTIP, having a value as of the grant date of $75,000. Phantom unit awards are expected to be subject to vesting conditions (which, for the 2013 phantom unit grants was a one year vesting period). DERs will be paid either on a current or deferred basis, in each case as will be determined at the time of grant of the awards; the 2013 phantom unit awards provided for deferred DERs.
Directors will also receive reimbursement for out-of-pocket expenses associated with attending such board or committee meetings and director and officer liability insurance coverage. Each director will be fully indemnified by us for actions associated with being a director to the fullest extent permitted under Delaware law.
ITEM 12.
ITEM 12. Security Ownership of Certain Beneficial Owners and Management and Related Unitholder Matters
Security Ownership of Certain Beneficial Owners and Management
The following table sets forth the beneficial ownership of our units as of February 18, 2014 held by:
· each person who beneficially owns 5% or more of our outstanding units;
· all of the directors of USA Compression GP, LLC;
· each named executive officer of USA Compression GP, LLC; and
· all directors and officers of USA Compression GP, LLC as a group.
Except as indicated by footnote, the persons named in the table below have sole voting and investment power with respect to all units shown as beneficially owned by them and their address is 100 Congress Avenue, Suite 450, Austin, Texas 78701.
* Less than 1%.
(1) Eric D. Long, Joseph C. Tusa, Jr., William G. Manias, J. Gregory Holloway, David A. Smith and Matthew C. Liuzzi, each of whom are executive officers of our general partner, Aladdin Partners, L.P., a limited partnership affiliated with Mr. Long, and R/C IV USACP Holdings, L.P., or R/C Holdings, own equity interests in USA Compression Holdings. USA Compression Holdings is managed by a three person board of managers consisting of Mr. Long, Mr. Ward and Ms. Wassenaar. The board of managers exercises investment discretion and control over the units held by USA Compression Holdings.
R/C Holdings is the record holder of approximately 97.4% of the limited liability company interests of USA Compression Holdings and is entitled to elect a majority of the members of the board of managers of USA Compression Holdings. R/C Holdings is an investment partnership affiliated with Riverstone/Carlyle Global Energy and Power Fund IV, L.P., or R/C IV. Management and control of R/C Holdings is vested in its general partner, which is in turn managed and controlled by its general partner, R/C Energy GP IV, LLC. R/C Energy GP IV, LLC is managed by an eight person management committee that includes Andrew W. Ward. The principal business address of R/C Energy GP IV, LLC is 712 Fifth Avenue, 51st Floor, New York, New York 10019.
Mr. Long, Mr. Ward and Ms. Wassenaar, each of whom is a member of the board of managers of USA Compression Holdings and a member of the board of directors of our general partner, disclaims beneficial ownership of the units owned by USA Compression Holdings.
(2) Argonaut Private Equity, L.L.C. has sole voting and dispositive power of 6,922,504 common units. The principal business address of Argonaut Private Equity, L.L.C. is 6733 South Yale Avenue, Tulsa, Oklahoma 74136.
(3) Oppenheimer Funds, Inc. has the shared power to vote or to direct the vote, and the shared power to dispose or to direct the disposition of, 2,681,222 common units, including 2,650,571 common units held by Oppenheimer SteelPath MLP Income Fund, based on Amendment No. 3 to Schedule 13G filed on February 10, 2014 with the SEC. The principal business address of Oppenheimer Funds, Inc. is Two World Financial Center, 225 Liberty Street, New York, New York 10281, and the principal business address of Oppenheimer SteelPath MLP Income Fund is 2100 Mckinney Ave, Suite 1401, Dallas, Texas 75201.
(4) Includes 1,071 common units held directly by Mr. Long, 10,712 common units held by certain trusts of which Mr. Long is the trustee, 1,606 common units held by Mr. Long’s spouse and 20,408 common units that Mr. Long has the right to acquire within 60 days upon the vesting of his phantom units.
(5) Includes 11,906 common units that Mr. Tusa has the right to acquire within 60 days upon the vesting of his phantom units.
(6) Includes 3,402 common units that Mr. Smith has the right to acquire within 60 days upon the vesting of his phantom units.
(7) Includes 53,476 common units that certain of our directors and executive officers have the right to receive within 60 days upon the vesting of phantom units held by such directors and executive officers.
Securities Authorized for Issuance Under Equity Compensation Plans
In connection with the consummation of our initial public offering on January 18, 2013, the board of directors of our general partner adopted the 2013 Long-Term Incentive Plan. The following table provides certain information with respect to this plan as of December 31, 2013:
For more information about our 2013 Long-Term Incentive Plan, please see Note 7 to our consolidated financial statements.
ITEM 13.
ITEM 13. Certain Relationships and Related Transactions, and Director Independence
Certain Relationships And Related Party Transactions
In connection with our formation and initial public offering, we and other parties have entered into the following agreements. These agreements were not the result of arm’s length negotiations, and they, or any of the transactions that they provide for, may not be effected on terms as favorable to the parties to these agreements as could have been obtained from unaffiliated third parties.
Services Agreement
We entered into a services agreement with USAC Management, effective on January 1, 2013, pursuant to which USAC Management provides to us and our general partner management, administrative and operating services and personnel to manage and operate our business. We or one of our subsidiaries pays USAC Management for the allocable expenses it incurs in its performance under the services agreement. These expenses include, among other things, salary, bonus, cash incentive compensation and other amounts paid to persons who perform services for us or on our behalf and other expenses allocated by USAC Management to us. USAC Management has substantial discretion to determine in good faith which expenses to incur on our behalf and what portion to allocate to us.
The services agreement has an initial term of five years, at which point it automatically renews for additional one year terms. The services agreement may be terminated at any time by (i) the board of directors of our general partner upon 120 days’ written notice for any reason in its sole discretion or (ii) USAC Management upon 120 days’ written notice if (a) we or our general partner experience a change of control, (b) we or our general partner breach the terms of the services agreement in any material respect following 30 days’ written notice detailing the breach (which breach remains uncured after such period), (c) a receiver is appointed for all or substantially all of our or our general partner’s property or an order is made to wind up our or our general partner’s business; (d) a final judgment, order or decree that materially and adversely affects the ability of us or our general partner to perform under the services agreement is obtained or entered against us or our general partner, and such judgment, order or decree is not vacated, discharged or stayed; or (e) certain events of bankruptcy, insolvency or reorganization of us or our general partner occur. USAC Management will not be liable to us for their performance of, or failure to perform, services under the services agreement unless its acts or omissions constitute gross negligence or willful misconduct.
Management Fees
For the year ended December 31, 2013, the Partnership incurred $49,315 of expenses related to a management fee under an agreement between USA Compression Holdings, LLC and certain of its affiliates, for services provided to the Partnership for the period from January 1, 2013 through January 17, 2013. For the year ended December 31, 2012, the Partnership incurred $1.0 million of management fees under such agreement. After the completion of our initial public offering on January 18, 2013, we and our subsidiaries are no longer required to pay this management fee.
Relationship with PVR Partners
Mr. Shea, a director of USA Compression GP, LLC, is currently a director and the chief executive officer of the general partner of PVR Partners, L.P. (“PVR”). For the years ended December 31, 2013 and 2012, subsidiaries of PVR made compression services payments to us of approximately $3.0 million and $2.2 million, respectively.
Procedures for Review, Approval and Ratification of Related Person Transactions
The board of directors of our general partner adopted a code of business conduct and ethics in connection with the closing of our initial public offering that provides that the board of directors of our general partner or its authorized committee will periodically review all related person transactions that are required to be disclosed under SEC rules and, when appropriate, initially authorize or ratify all such transactions. If the board of directors of our general partner or its authorized committee considers ratification of a related person transaction and determines not to so ratify, the code of business conduct and ethics provides that our management will make all reasonable efforts to cancel or annul the transaction.
The code of business conduct and ethics provides that, in determining whether or not to recommend the initial approval or ratification of a related person transaction, the board of directors of our general partner or its authorized committee should consider all of the relevant facts and circumstances available, including (if applicable) but not limited to: (i) whether there is an appropriate business justification for the transaction; (ii) the benefits that accrue to us as a result of the transaction; (iii) the terms available to unrelated third parties entering into similar transactions; (iv) the impact of the transaction on a director’s independence (in the event the related person is a director, an immediate family member of a director or an entity in which a director or an immediately family member of a director is a partner, shareholder, member or executive officer); (v) the availability of other sources for comparable products or services; (vi) whether it is a single transaction or a series of ongoing, related transactions; and (vii) whether entering into the transaction would be consistent with the code of business conduct and ethics.
The code of business conduct and ethics described above was adopted in connection with the closing of our initial public offering, and as a result the transactions described above were not reviewed under such policy. The transactions described above were not approved by an independent committee of our board of directors and the terms were determined by negotiation among the parties.
Conflicts of Interest
Conflicts of interest exist and may arise in the future as a result of the relationships between our general partner and its affiliates, including USA Compression Holdings, on the one hand, and our partnership and our limited partners, on the other hand. The directors and officers of our general partner have fiduciary duties to manage our general partner in a manner beneficial to its owners. At the same time, our general partner has a fiduciary duty to manage our partnership in a manner beneficial to us and our unitholders.
Whenever a conflict arises between our general partner or its affiliates, on the one hand, and us and our limited partners, on the other hand, our general partner will resolve that conflict. Our partnership agreement contains provisions that modify and limit our general partner’s fiduciary duties to our unitholders. Our partnership agreement also restricts the remedies available to our unitholders for actions taken by our general partner that, without those limitations, might constitute breaches of its fiduciary duty.
Our general partner will not be in breach of its obligations under our partnership agreement or its fiduciary duties to us or our unitholders if the resolution of the conflict is:
· approved by the conflicts committee of our general partner, although our general partner is not obligated to seek such approval;
· approved by the vote of a majority of the outstanding common units, excluding any common units owned by our general partner or any of its affiliates;
· on terms no less favorable to us than those generally being provided to or available from unrelated third parties; or
· fair and reasonable to us, taking into account the totality of the relationships among the parties involved, including other transactions that may be particularly favorable or advantageous to us.
Our general partner may, but is not required to, seek the approval of such resolution from the conflicts committee of its board of directors. In connection with a situation involving a conflict of interest, any determination by our general partner involving the resolution of the conflict of interest must be made in good faith, provided that, if our general partner does not seek approval from the conflicts committee and its board of directors determines that the resolution or course of action taken with respect to the conflict of interest satisfies either of the standards set forth in the third and fourth bullet points above, then it will conclusively be deemed that, in making its decision, the board of directors acted in good faith. Unless the resolution of a conflict is specifically provided for in our partnership agreement, our general partner or the conflicts committee may consider any factors that it determines in good faith to be appropriate when resolving a conflict. When our partnership agreement provides that someone act in good faith, it requires that person to reasonably believe he is acting in the best interests of the partnership.
Director Independence
Please see Part III, Item 10 (“Directors, Executive Officers and Corporate Governance-Board of Directors”) of this report for a discussion of director independence matters.
ITEM 14.
ITEM 14. Principal Accountant Fees and Services
The following table presents fees for professional services rendered by our independent registered public accounting firm, KPMG LLP during the years ended December 31, 2013 and 2012:
(1) Expenditures classified as “Audit Fees” above were billed to USA Compression Partners, LP and include the audits of our annual financial statements, work related to the registration statement on Form S-1 filed in connection with our initial public offering, work related to the pro forma financial statements in connection with the S&R Acquisition and reviews of our quarterly financial statements.
Our audit committee has adopted an audit committee charter, which is available on our website and which requires the audit committee to pre-approve all audit and non-audit services to be provided by our independent registered public accounting firm. The audit committee does not delegate its pre-approval responsibilities to management or to an individual member of the audit committee. Since our audit committee was not established until January 2013, none of the services reported in the audit, tax and all other fees categories above for the year ended December 31, 2012 were pre-approved by the audit committee. Our audit committee pre-approved all of the services reported in the audit, tax and all other fees categories for the year ended December 31, 2013.
PART IV
ITEM 15.
ITEM 15. Exhibits and Financial Statement Schedules
(a) Documents filed as a part of this report.
1. Financial Statements. See “Index to Consolidated Financial Statements” set forth on Page.
2. Financial Statement Schedule
All other schedules have been omitted because they are not required under the relevant instructions.
3. Exhibits
The following documents are filed as exhibits to this report:
Exhibit
Number
Description
2.1
Contribution Agreement dated August 12, 2013 by and among USA Compression Partners, LP, S&R Compression, LLC and Argonaut Private Equity, L.L.C. (incorporated by reference to Exhibit 2.1 to the Partnership’s Quarterly Report on Form 10-Q (File No. 001-35779) filed on August 14, 2013)
3.1
Certificate of Limited Partnership of USA Compression Partners, LP (incorporated by reference to Exhibit 3.1 to Amendment No. 3 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on December 21, 2011)
Exhibit
Number
Description
3.2
First Amended and Restated Agreement of Limited Partnership of USA Compression Partners, LP (incorporated by reference to Exhibit 3.1 to the Partnership’s Current Report on Form 8-K (File No. 001-35779) filed on January 18, 2013)
4.1
Registration Rights Agreement dated August 30, 2013 (incorporated by reference to Exhibit 4.1 to the Partnership’s Current Report on Form 8-K (File No. 001-35779) filed on September 5, 2013)
10.1
Fourth Amended and Restated Credit Agreement (incorporated by reference to Exhibit 10.9 to Amendment No. 6 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on June 8, 2012)
10.2
First Amendment to Fourth Amended and Restated Credit Agreement (incorporated by reference to Exhibit 10.10 to Amendment No. 10 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on January 7, 2013)
10.3
Fifth Amended and Restated Credit Agreement dated as of December 13, 2013, by and among USA Compression Partners, LP, USAC OpCo 2, LLC and USAC Leasing 2, LLC, as guarantors, USA Compression Partners, LLC and USAC Leasing, LLC, as borrowers, the lenders party thereto from time to time, JPMorgan Chase Bank, N.A., as agent and LC issuer, J.P. Morgan Securities LLC, as lead arranger and sole book runner, Wells Fargo Bank, N.A., as documentation agent, and Regions Bank, as syndication agent (incorporated by reference to Exhibit 10.1 to the Partnership’s Current Report on Form 8-K (File No. 001-35779) filed on December 17, 2013)
10.4
Long-Term Incentive Plan of USA Compression Partners, LP (incorporated by reference to Exhibit 10.1 to the Partnership’s Current Report on Form 8-K (File No. 001-35779) filed on January 18, 2013)
10.5
Employment Agreement, dated December 23, 2010, between USA Compression Partners, LLC and Eric D. Long (incorporated by reference to Exhibit 10.5 to Amendment No. 4 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on February 13, 2012)
10.6
Employment Agreement, dated December 23, 2010, between USA Compression Partners, LLC and Joseph C. Tusa, Jr. (incorporated by reference to Exhibit 10.6 to Amendment No. 4 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on February 13, 2012)
10.7
Employment Agreement, dated December 23, 2010, between USA Compression Partners, LLC and David A. Smith (incorporated by reference to Exhibit 10.8 to Amendment No. 4 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on February 13, 2012)
10.8
Services Agreement, dated effective January 1, 2013, by and among USA Compression Partners, LP, USA Compression GP, LLC and USA Compression Management Services, LLC (incorporated by reference to Exhibit 10.11 to Amendment No. 10 of the Partnership’s registration statement on Form S-1 (Registration No. 333-174803) filed on January 7, 2013)
10.9
USA Compression Partners, LP 2013 Long-Term Incentive Plan-Form of Director Phantom Unit Agreement (incorporated by reference to Exhibit 10.8 to the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-35779) filed on March 28, 2013)
10.10*
USA Compression Partners, LP 2013 Long-Term Incentive Plan-Form of Employee Phantom Unit Agreement
10.11
USA Compression Partners, LP 2013 Long-Term Incentive Plan-Form of Director Phantom Unit Agreement (in lieu of Annual Cash Retainer) (incorporated by reference to Exhibit 10.10 to the Partnership’s Annual Report on Form 10-K for the year ended December 31, 2012 (File No. 001-35779) filed on March 28, 2013).
10.12*
USAC Compression Partners, LP Annual Cash Incentive Program
Exhibit
Number
Description
21.1*
List of subsidiaries of USA Compression Partners, LP
23.1*
Consent of KPMG LLP
31.1*
Certification of Chief Executive Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
31.2*
Certification of Chief Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934
32.1#
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2#
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS##
XBRL Instance Document
101.SCH##
XBRL Extension Schema Document
101.CAL##
XBRL Calculation Linkbase Document
101.DEF##
XBRL Definition Linkbase Document
101.LAB##
XBRL Label Linkbase Document
101.PRE##
XBRL Presentation Linkbase Document
* Filed Herewith.
# Furnished herewith; not considered to be “filed” for the purposes of Section 18 of the Securities Exchange Act of 1934 or otherwise subject to the liabilities of that section.
 Management contract or compensatory plan or arrangement required to be filed as an exhibit to this Annual Report on Form 10-K pursuant to Item 15(b).
## Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Section 11 and 12 of the Securities Act of 1933, are deemed not filed for purposes of Section 18 of the Securities Exchange Act of 1934 and otherwise are not subject to any liability under those sections.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 20, 2014.
Name
Title
/s/ Eric D. Long
President and Chief Executive Officer
Eric D. Long
(Principal Executive Officer) and Director
/s/ Joseph C. Tusa, Jr.
Vice President, Chief Financial Officer and Treasurer (Principal Financial Officer and
Joseph C. Tusa, Jr.
Principal Accounting Officer
/s/ John D. Chandler
Director
John D. Chandler
/s/ Jim H. Derryberry
Director
Jim H. Derryberry
/s/ Robert F. End
Director
Robert F. End
/s/ William H. Shea, Jr.
Director
William H. Shea, Jr.
/s/ Andrew W. Ward
Director
Andrew W. Ward
/s/ Olivia C. Wassenaar
Director
Olivia C. Wassenaar
/s/ Forrest E. Wylie
Director
Forrest E. Wylie
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2013 and 2012
Consolidated Statements of Operations for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Changes in Partners’ Capital for the years ended December 31, 2013, 2012 and 2011
Consolidated Statements of Cash Flows for the years ended December 31, 2013, 2012 and 2011
Notes to Consolidated Financial Statements
Report of Independent Registered Public Accounting Firm
The Partners
USA Compression Partners, LP:
We have audited the accompanying consolidated balance sheets of USA Compression Partners, LP (a Delaware limited partnership) and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of operations, changes in partners’ capital, and cash flows for each of the years in the three-year period ended December 31, 2013. These consolidated financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of USA Compression Partners, LP and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.
/s/ KPMG LLP
Dallas, Texas
February 20, 2014
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2013 and 2012
(in thousands, except for unit amounts)
See accompanying notes to consolidated financial statements.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Consolidated Statements of Operations
Years ended December 31, 2013, 2012 and 2011
(in thousands, except per unit amounts)
See accompanying notes to consolidated financial statements.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Consolidated Statements of Changes in Partners’ Capital
Years ended December 31, 2013, 2012 and 2011
(in thousands)
See accompanying notes to consolidated financial statements.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Consolidated Statements of Cash Flows
Years ended December 31, 2013, 2012 and 2011
(in thousands)
See accompanying notes to consolidated financial statements.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(1) The Partnership, Nature of Business, and Recent Transactions
USA Compression Partners, L.P., a Texas limited partnership (the “Former Partnership”), was formed on July 10, 1998. In October 2008, the Former Partnership entered into several transactions through which the Former Partnership was reorganized into a holding company, USA Compression Holdings, LP (the “Partnership”). The owners of the Former Partnership caused the Partnership to be formed as a Texas limited partnership to conduct its affairs as the holding company of an operating and leasing structure of entities. The Former Partnership’s owners then transferred their equity interests in the Former Partnership to the Partnership in exchange for identical interests in the Partnership. The Former Partnership became a wholly-owned subsidiary of the Partnership, and was converted into USA Compression Partners, LLC, a Delaware, single-member, limited liability company (the “Operating Subsidiary”) to continue providing compression services to customers of the Former Partnership. Concurrently, the Operating Subsidiary formed a wholly-owned subsidiary, USAC Leasing, LLC, as a Delaware limited liability company (the “Leasing Subsidiary”), and agreed to sell its then existing compressor fleet to the Leasing Subsidiary for assumption of debt relating to the then existing fleet. The Leasing Subsidiary leases its compressor fleet to the Operating Subsidiary for use in providing compression services to its customers. The Partnership joined the Operating Subsidiary’s revolving credit facility as a guarantor and the Leasing Subsidiary joined the revolving credit facility as a co-borrower (see note 4). On June 7, 2011, the Partnership converted from a Texas limited partnership into a Delaware limited partnership and changed its name from USA Compression Holdings, LP to USA Compression Partners, LP. USA Compression GP, LLC, a Delaware limited liability Company and the general partner of the Partnership, is referred to herein as the “General Partner.” In connection with the S&R Acquisition (as defined below), the Partnership acquired all of the membership interests in USAC OpCo 2, LLC, a Texas limited liability company (“OpCo 2”), which owned all of the membership interests in USAC Leasing 2, LLC, a Texas limited liability company (“LeaseCo 2”). LeaseCo 2 owns all of the compression assets acquired in the S&R Acquisition. LeaseCo 2 leases its compressor fleet to OpCo 2 for use in providing compression services to its customers. The accompanying consolidated financial statements include the accounts of the Partnership, the Operating Subsidiary, the Leasing Subsidiary, OpCo 2 and LeaseCo 2, and all intercompany balances and transactions have been eliminated in consolidation. The Operating Subsidiary, the Leasing Subsidiary, OpCo 2 and LeaseCo 2, are collectively referred to herein, as the “Operating Subsidiaries.”
The Partnership, through the Operating Subsidiaries, primarily provides natural gas compression services under term contracts with customers in the oil and gas industry, using natural gas compressor packages that it designs, engineers, operates and maintains.
Partnership net income (loss) is allocated to the partners, both general and limited, in proportion to their respective interest in the Partnership.
On January 18, 2013, the Partnership completed its initial public offering (“IPO”) pursuant to a Registration Statement on Form S-1, as amended (Reg. No. 333-174803), that was declared effective on January 14, 2013. Under the registration statement, the Partnership sold 11,000,000 common units at a price to the public of $18.00 per common unit, which generated net proceeds to the Partnership of approximately $180.5 million after deducting underwriting discounts and commissions of $12.1 million, structuring fees of $0.7 million and offering expenses of $4.6 million. The Partnership used the net proceeds from the offering to repay $180.5 million of indebtedness outstanding under its revolving credit facility.
On August 30, 2013, the Partnership completed the acquisition of assets and certain liabilities related to the business of providing gas lift compression services to third parties engaged in the exploration, production, gathering, processing, transportation or distribution of oil and gas (the “S&R Acquisition”) in exchange for 7,425,261 common units, which were valued at $181.9 million at the time of issuance. The S&R Acquisition was consummated pursuant to the Contribution Agreement dated August 12, 2013 (the “Contribution Agreement”) with S&R Compression, LLC, (“S&R”) and Argonaut Private Equity, L.L.C. (“Argonaut”). The S&R Acquisition had an effective date (from a standpoint of revenues and selected costs) of June 30, 2013. The common units issued in the S&R Acquisition were not registered pursuant to the Securities Act of 1933, as amended (the “Securities Act”), or any applicable state securities laws, and, at the time of issuance, were restricted securities under the federal securities laws.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(2) Summary of Significant Accounting Policies
(a) Cash and Cash Equivalents
Cash and cash equivalents consist of all cash balances. As of December 31, 2013 and 2012, $6,500 in cash was subject to certain provisions under credit agreements with a financial institution, as more fully described in Note 5.
(b) Trade Accounts Receivable
Trade accounts receivable are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts of $246,410 and $259,638 at December 31, 2013 and 2012, respectively, is the Partnership’s best estimate of the amount of probable credit losses in the Partnership’s existing accounts receivable. The Partnership determines the allowance based upon historical write-off experience and specific identification. The Partnership does not have any off-balance-sheet credit exposure related to its customers.
(c) Inventories
Inventories are valued at the lower of cost or market using the first-in, first-out method. Inventory consists of parts used in the assembly of compression units. Purchases of these assets are considered operating activities in the consolidated statement of cash flows.
(d) Property and Equipment
Property and equipment are carried at cost. Overhauls and major improvements that increase the value or extend the life of compressor units are capitalized and depreciated over 3 to 5 years. Ordinary maintenance and repairs are charged to income. Depreciation is calculated using the straight-line method of accounting over the estimated useful lives of the assets as follows:
Depreciation expense for the years ended December 31, 2013, 2012 and 2011 was $49.7 million, $38.9 million and $29.7 million, respectively.
(e) Impairments of Long-Lived Assets
Long-lived assets with recorded values that are not expected to be recovered through future cash flows are written-down to estimated fair value. An asset shall be tested for impairment when events or circumstances indicate that its carrying value may not be recoverable. The carrying value of a long-lived asset is not recoverable if it exceeds the sum of the undiscounted cash flows expected to result from the use and eventual disposition of the asset. If the carrying value exceeds the sum of the undiscounted cash flows, an impairment loss equal to the amount of the carrying value exceeding the fair value of the asset is recognized. The fair value of the asset is measured using quoted market prices or, in the absence of quoted market prices, is based on an estimate of discounted cash flows. In 2013, the Partnership recorded $203,149 related to the impairment of a certain group of its compression equipment. The Partnership did not record impairment of long-lived assets in 2012 or 2011.
(f) Revenue Recognition
Revenue from compression service and equipment rental operations is recorded when earned over the period of service, rental and maintenance contracts, which generally range from one month to five years. Parts and service revenue is recorded as parts are delivered or services are performed for the customer.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(g) Income Taxes
The Partnership elected to be treated under SubChapter K of the Internal Revenue Code. Under SubChapter K, a partnership return is filed annually reflecting each partner’s share of the partnership’s income or loss. Therefore, no provision has been made for federal income tax. Partnership net income (loss) is allocated to the partners in proportion to their respective interest in the Partnership.
As a partnership, all income, gains, losses, expenses, deductions and tax credits generated by the Partnership generally flow through to its unitholders. However, Texas imposes an entity-level income tax on partnerships.
The State of Texas’ margin tax became effective for tax reports originally due on or after January 1, 2008. This margin tax requires partnerships and other forms of legal entities to pay a tax of 1.0% on its ‘‘margin,’’ as defined in the law, based on 2013, 2012 and 2011 results. The margin tax base to which the tax rate will be applied is either the lesser of 70% of total revenues for federal income tax purposes, total revenue less cost of goods sold or compensation for federal income tax purposes. For the years ended December 31, 2013, 2012 and 2011, the Partnership recorded expense related to the Texas margin tax of $279,972, $196,040 and $154,872, respectively.
Recognized tax positions are initially and subsequently measured as the largest amount of tax benefit that is more likely than not of being realized upon ultimate settlement with a taxing authority. Interest and penalties related to unrecognized tax benefits are included in income tax expense.
(h) Fair Value Measurements
The accounting standard for fair value measurements and disclosures establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three broad categories:
Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that the Partnership has the ability to access at the measurement date.
Level 2 inputs are inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
Level 3 inputs are unobservable inputs for the asset or liability.
At December 31, 2013 and 2012, the Partnership’s financial instruments consist primarily of cash and cash equivalents, trade accounts receivable, trade accounts payable and long-term debt. The book values of cash and cash equivalents, trade accounts receivable, and trade accounts payable are representative of fair value due to their short-term maturity. The carrying amount of long-term debt approximates fair value based on the interest rates charged on instruments with similar terms and risks.
(i) Pass Through Taxes
Taxes incurred on behalf of, and passed through to, customers are accounted for on a net basis.
(j) Use of Estimates
The preparation of the consolidated financial statements of the Partnership in conformity with accounting principles generally accepted in the United States of America requires the management of the Partnership to make estimates and assumptions that affect the amounts reported in these consolidated financial statements and the accompanying results. Actual results could differ from these estimates.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(k) Intangible Assets
As of December 31, 2013, intangible assets consisted of the following (in thousands):
Intangible assets are amortized on a straight-line basis over their estimated useful lives, which is the period over which the assets are expected to contribute directly or indirectly to the Partnership’s future cash flows. The estimated useful lives range from 4 to 30 years. The expected amortization of the intangible assets for each of the five succeeding years is as follows (in thousands):
The Partnership assesses long-lived assets, including intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability is assessed by comparing the carrying amount of an asset to undiscounted future net cash flows expected to be generated by the asset. If such assets are considered to be impaired, the impairment to be recognized is measured as the amount by which the carrying amounts exceed the fair values of the assets. The Partnership did not record any impairment of intangible assets in 2013, 2012 or 2011.
(l) Goodwill
Goodwill represents consideration paid in excess of the fair value of the identifiable assets acquired in a business combination. Goodwill is not amortized, but is reviewed for impairment annually based on the carrying values as of October 1, or more frequently if impairment indicators arise that suggest the carrying value of goodwill may not be recovered.
As of October 1, 2013, a qualitative assessment was performed to determine whether it is more likely than not that the fair value of the reporting unit is impaired. Management used all available information to make these determinations, including evaluating the macroeconomic environment, industry specific conditions, cost factors, overall financial performance and unit price, at the assessment date of October 1, 2013.
As a result of the qualitative assessment, the Partnership has determined that it is not more likely than not that the fair value of the reporting unit is less than its carrying amount. The Partnership did not record any impairment of goodwill for the years ended December 31, 2013, 2012 or 2011.
(3) Acquisition
On August 30, 2013, the Partnership completed the acquisition of assets and certain liabilities related to the business of providing gas lift compression services to third parties engaged in the exploration, production, gathering, processing, transportation or distribution of oil and gas in exchange for 7,425,261 common units, which were valued at $181.9 million at the time of issuance. The S&R Acquisition was consummated pursuant to the Contribution Agreement with S&R and Argonaut. The S&R Acquisition had an effective date (from a standpoint of revenues and selected costs) of June 30, 2013. The common units issued in the S&R Acquisition were not registered pursuant to the Securities Act, or any applicable state securities laws, and, at the time of issuance, were restricted securities under the federal securities laws. In connection with the S&R Acquisition, Argonaut and certain related parties
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
agreed to participate in the Partnership’s Distribution Reinvestment Plan (“DRIP”) through the distribution relating to the quarter ended June 30, 2014, provided that USA Compression Holdings continues to participate in the DRIP through that same period. The effective purchase price of $178.5 million reflects customary effective-date adjustments such as a $3.4 million purchase price adjustment due to working capital changes from the effective date to the closing date.
The transaction was accounted for in accordance with Accounting Standards Codification 805, Business Combinations. The purchase price allocation as of August 30, 2013 is comprised of the following components (in thousands):
Expenses associated with acquisition activities and transaction activities related to the S&R Acquisition for the year ended December 31, 2013 were $2.1 million and are included in selling, general and administrative expenses (“SG&A”). The acquisition was recorded at fair value, which was determined using the cost and market approaches for the fixed assets, the multi-period excess earnings method for the customer relationships asset and the with-and-without method for the non-compete agreement. In applying these accounting principles, we estimated the fair value of the S&R assets acquired to be $127.6 million. This measurement resulted in the recognition of goodwill totaling approximately $51.0 million. Goodwill was calculated as the excess of the consideration transferred to acquire S&R over the acquisition date estimated fair value of the assets acquired. Goodwill recorded in the S&R Acquisition primarily represents the value of the opportunity to expand into gas lift operations with a high quality fleet, the experience and technical expertise of former S&R employees who have joined the Partnership and the addition of strategic areas of operations in which the Partnership did not previously have a significant presence. The intangible asset customer relationships will be amortized over a life of 20 years and the intangible asset non-compete will be amortized over the 4-year term of the agreement.
The Partnership recorded a purchase price adjustment of $292,496 related to S&R Acquisition expenses during the fourth quarter of 2013, increasing the amount of goodwill recorded on the December 31, 2013 balance sheet, included in amounts noted above.
Revenue, Net Income and Pro Forma Financial Information - Unaudited
The S&R Acquisition was not included in the Partnership’s consolidated results until the closing date of August 30, 2013. For the period of August 30, 2013 to December 31, 2013, the S&R Acquisition accounted for $14.5 million of revenue, $4.4 million of direct operating expenses and $3.7 million of depreciation and amortization, resulting in $6.4 million of net income. The net income attributable to these assets does not reflect certain expenses, such as SG&A and interest expense; therefore, this information is not intended to report results as if these operations were managed on a stand-alone basis.
The unaudited pro forma financial information was prepared assuming the S&R Acquisition occurred on January 1, 2011. The financial information was derived from the Partnership’s audited historical consolidated financial statements for the years ended December 31, 2013, 2012 and 2011, S&R’s audited historical consolidated financial statements for the years ended December 31, 2012 and 2011, and S&R’s unaudited interim financial statements from January 1, 2013 through August 30, 2013.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
The pro forma adjustments were based on currently available information and certain estimates and assumptions by management. If the S&R Acquisition had been in effect on the dates or for the periods indicated, the results may have been substantially different. For example, we may have operated the assets differently than S&R, realized revenue may have been different and costs of operation of the compression assets may have been different. This pro forma financial information is provided for illustrative purposes only and may not provide an indication of results in the future. The following table presents a summary of our pro forma financial information (in thousands, except earnings per share):
(1) The Partnership did not complete its initial public offering until January 18, 2013. Therefore, earnings per unit information is not applicable for the 2012 or 2011 period.
In preparing the pro forma financial information, certain information was derived from financial records and certain information was estimated. The sources of information and significant assumptions are described below:
(a) Revenues and direct operating expenses for S&R were derived from the historical financial records of S&R. Incremental revenue adjustments related to the S&R Acquisition were $27.1 million, $25.2 million and $17.2 million for the years ended December 31, 2013, 2012 and 2011, respectively. Incremental operating costs related to the S&R Acquisition were $12.2 million, $12.4 million and $9.5 million for the years ended December 31, 2013, 2012 and 2011, respectively.
(b) Depreciation and amortization was estimated using the straight-line method and reflects the incremental depreciation and amortization expense incurred due to adding the compression assets and intangible fair value assets acquired from S&R. Incremental depreciation and amortization was estimated at $9.7 million for the years ended December 30, 2013, 2012 and 2011.
(c) Incremental transaction expenses related to the S&R Acquisition were $2.1 million and were assumed to be funded from cash on hand.
(d) The S&R Acquisition was financed solely with common units issued in consideration for the assets and liabilities acquired as part of the S&R Acquisition.
(e) The capital contribution made by the General Partner to maintain its 2% general partner interest in the Partnership in connection with the issuance of common units in the S&R Acquisition was used to pay down the Partnership’s revolving credit facility resulting in a reduction of interest expense. Incremental interest expense reductions were estimated at $90,000, $111,000 and $138,000 for the years ended December 31, 2013, 2012 and 2011, respectively.
(4) Property and Equipment
Property and equipment consisted of the following at December 31 (in thousands):
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
As of December 31, 2013 and 2012, there was $15.8 million and $5.9 million, respectively, of property and equipment purchases in accounts payable and accrued liabilities.
(5) Long-Term Debt
The long-term debt of the Partnership consisted of the following at December 31 (in thousands):
(a) Senior Debt
On December 23, 2010, the Partnership entered into a Third Amended and Restated Credit Agreement. Borrowing availability under this senior debt facility was limited to the lesser of the $400 million committed facility amount and a borrowing base defined in the credit agreement. The senior debt facility was evidenced by notes issued to each of several lenders named in the credit agreement, was secured by a first priority lien against the assets of the Partnership and matured on October 5, 2015. Interest on debt issued under the facility was due and payable in arrears and calculated, at the option of the Partnership, on either a floating rate basis, payable monthly or a LIBOR basis, payable at the end of the applicable LIBOR period (1, 2, 3, or 6 months), but no less frequently than quarterly. LIBOR borrowings bore interest at LIBOR for the applicable period plus a margin of 3.00% to 3.75% based on the leverage ratio of the Partnership’s amount outstanding under this facility to consolidated EBITDA (earnings before interest, taxes, depreciation and amortization) as defined in the credit agreement. Floating rate borrowings bore interest at a rate per annum that is the higher of the bank prime rate or the federal funds rate plus 0.50%, without additional margin. Generally, the Partnership has maintained several tranches of LIBOR and floating rate borrowings at any time. In addition, the Partnership paid an annual administration fee and an unused commitment fee of 0.50%. The $400 million facility included a $20 million sub-line for issuing letters of credit for a fee at a per annum rate equal to the margin for LIBOR borrowings on the average daily undrawn stated amount of each letter of credit issued under the facility. The Partnership paid various loan fees and incurred costs in respect of the Third Amended and Restated Credit Agreement in the amount of $5.1 million in 2010.
On June 6, 2011, the Partnership entered into the first amendment to the credit agreement converting each reference to “USA Compression Holdings, LP” to “USA Compression Partners, LP” and each reference to USA Compression Holdings, LP as a “Texas limited partnership” in the credit agreement or any other loan document to be a reference to USA Compression Partners, LP as a “Delaware limited partnership.”
On November 16, 2011, the Partnership entered into the second amendment to the credit agreement whereby the aggregate commitment under the facility increased from $400 million to $500 million and reduced the applicable margin for LIBOR loans to a range of 200 to 275 basis points above LIBOR, depending on the Partnership’s leverage ratio. In addition, the unused commitment fee was reduced to 0.375%. The Partnership paid various loan fees and incurred costs in respect of the first and second amendment to the credit agreement in the amount of $1.1 million in 2011.
On June 1, 2012, the Partnership entered into the third amendment to the credit agreement whereby the aggregate commitment under the facility increased from $500 million to $600 million. In addition, on June 1, 2012, the Partnership entered into the Fourth Amended and Restated Credit Agreement in order to provide a covenant structure that is more appropriate for a public company than was the prior credit agreement, including a reduction of the applicable margin for LIBOR loans to a range of 175 to 250 basis points above LIBOR, depending on the Partnership’s leverage ratio. This amended and restated credit agreement became effective on January 18, 2013, the closing date of the Partnership’s initial public offering, continued to be secured by a first priority lien against our assets and had a scheduled maturity of October 5, 2015. On December 10, 2012, the Partnership amended the Fourth Amended and Restated Credit Agreement to extend the periods during which the maximum funded debt to EBITDA ratio thresholds would apply. The Partnership paid various loan fees and incurred costs in respect of the third amendment to the credit agreement and the Fourth Amended and Restated Credit Agreement in the amount of $1.6 million, in 2012.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
On December 13, 2013, the Partnership entered into the Fifth Amended and Restated Credit Agreement whereby the aggregate commitment under the facility increased from $600 million to $850 million (subject to availability under our borrowing base and a further potential increase of $100 million) and reduced the applicable margin for LIBOR loans to a range of 150 to 225 basis points above LIBOR, depending on the Partnership’s leverage ratio. The revolving credit facility is secured by a first priority lien against the Partnership’s assets and matures on December 13, 2018, at which point all amounts outstanding will become due.
The Fifth Amended and Restated Credit Agreement permits us to make distributions of available cash to unitholders so long as (a) no default under the facility has occurred, is continuing or would result from the distribution, (b) immediately prior to and after giving effect to such distribution, the Partnership is in compliance with the facility’s financial covenants and (c) immediately after giving effect to such distribution, the Partnership has availability under the revolving credit facility of at least $20 million. In addition, the amended and restated credit agreement contains various covenants that may limit, among other things, the Partnership’s ability to(subject to exceptions):
· grant liens;
· make certain loans or investments;
· incur additional indebtedness or guarantee other indebtedness;
· enter into transactions with affiliates;
· merge or consolidate;
· sell the Partnership’s assets; or
· make certain acquisitions.
The Fifth Amended and Restated Credit Agreement also contains various financial covenants, including covenants requiring the Partnership to maintain:
· a minimum EBITDA to interest coverage ratio of 2.5 to 1.0; and
· a maximum funded debt to EBITDA ratio, determined as of the last day of each fiscal quarter, for the annualized trailing three months of (a) 5.50 to 1.0, with respect to any fiscal quarter ending on or after December 13, 2013, the closing date of the amended credit facility, through June 30, 2015 or (b) 5.00 to 1.0, with respect to the fiscal quarter ending September 30, 2015 and each fiscal quarter thereafter, in each case subject to a provision for increases to such thresholds by 0.5 in connection with certain future acquisitions for the six consecutive month period following the period in which any such acquisition occurs.
If a default exists under the revolving credit facility, the lenders will be able to accelerate the maturity on the amount then outstanding and exercise other rights and remedies.
The Partnership paid various loan fees and incurred costs in respect of the Fifth Amended and Restated Credit Agreement in the amount of $3.0 million in 2013, which were capitalized to loan costs and will be amortized through December 2018. The Partnership wrote off $0.3 million in 2013 related to certain third parties that exited the credit facility.
As of December 31, 2013 and 2012, the Partnership was in compliance with all of its covenants under the current credit agreement.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
At December 31, 2013, the Partnership had outstanding borrowings of $420.9 million and borrowing availability under the revolving credit facility of $264.6 million. The borrowing base consists of eligible accounts receivable, inventory and compression units. The largest component, representing 94% and 96% of the borrowing base at December 31, 2013 and 2012, respectively, is eligible compression units-compressor packages that are leased, rented or under service contracts to customers and carried in the financial statements as fixed assets. The Partnership’s effective interest rate in effect for all borrowings under its revolving credit facility at December 31, 2013 and 2012, was 2.17% and 2.96%, respectively, and an average interest rate of 2.43% and 2.99%, excluding the effects from the interest rate swap instruments discussed below for 2012, for the year then ended, respectively. There were no letters of credit issued at December 31, 2013 and 2012.
The senior debt facility expires in December 2018 and the Partnership expects to maintain this facility for the term. The facility is a ‘‘revolving credit facility’’ that includes a ‘‘springing’’ lock box arrangement, whereby remittances from customers are forwarded to a bank account controlled by the Partnership, and the Partnership is not required to use such remittances to reduce borrowings under the facility, unless there is a default or excess availability under the facility is reduced below $20 million. As the remittances do not automatically reduce the debt outstanding absent the occurrence of a default or a reduction in excess availability below $20 million, the debt has been classified as long-term at December 31, 2013 and 2012.
Maturities of long-term debt (in thousands):
(b) Hedging and Use of Derivative Instruments
During 2012, the Partnership had only limited involvement with derivative financial instruments and used them principally to manage well-defined interest rate risk. Interest rate swap agreements are used to reduce the potential impact of fluctuations in interest rates on variable rate long-term debt. The swaps were not used for trading or speculative purposes.
In November 2008, the Partnership entered into an interest rate swap agreement expiring October 5, 2012 for a notional amount of $75 million. In May 2009, the Partnership entered into an interest rate swap agreement expiring June 1, 2012 for a notional amount of $35 million. In August 2009, the Partnership entered into an interest rate swap agreement expiring August 1, 2012 for a notional amount of $30 million.
As of December 31, 2011, the Partnership did not designate these interest rate swaps as cash flow hedges.
The swap agreements entitled the Partnership to pay or receive from the counter-party, monthly, the amount by which the counter-party’s variable rate (reset monthly) was less than or exceeded the Partnership’s fixed rate under the agreements with respect to the notional amount. Under the swaps, the Partnership received fixed rates of 3%, 1.9% and 2.055% on the notional amounts of $75 million, $35 million and $30 million, respectively, in exchange for a floating rate tied to the BBA London Interbank Offering Rate (“LIBOR”). The swaps minimized interest rate exposure on the revolving senior debt facility, and in effect, converted variable interest payments on the aggregate notional amount to fixed interest payments. Amounts paid or received from the interest rate swap were charged or credited to interest expense and matched with the cash flow and interest expense of the senior debt being hedged, resulting in an adjustment to the effective interest rate. The swap payments for the years ended December 31, 2012 and 2011 were $2.3 million and $3.3 million, respectively. During 2012 and 2011, interest expense was reduced by $2.2 million and $2.6 million, respectively, due to changes in the fair value of the interest rate swaps.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(6) Partner’s Capital
As of February 18, 2014, USAC Compression Holdings held 5,337,977 common units and 14,048,588 subordinated units and USA Compression GP, LLC held a 2% general partner interest and the incentive distribution rights (“IDRs”). See the condensed consolidated statement of changes in Partners’ Capital.
Subordinated Units
All of the subordinated units are held by USA Compression Holdings. The partnership agreement provides that, during the subordination period, the common units have the right to receive distributions of Available Cash from Operating Surplus (each as defined in the Partnership’s agreement) each quarter in an amount equal to $0.425 per common unit (the “Minimum Quarterly Distribution”), plus any arrearages in the payment of the Minimum Quarterly Distribution from Operating Surplus on the common units from prior quarters, before any distributions of Available Cash from Operating Surplus may be made on the subordinated units. These units are deemed “subordinated” because for a period of time, referred to as the subordination period, the subordinated units will not be entitled to receive any distributions from Operating Surplus until the common units have received the Minimum Quarterly Distribution plus any arrearages from prior quarters. The practical effect of the subordinated units is to increase the likelihood that during the subordination period there will be Available Cash from Operating Surplus to be distributed on the common units. The subordination period will end on the first business day after the Partnership has earned and paid at least (i) $1.70 (the Minimum Quarterly Distribution on an annualized basis) on each outstanding unit and the corresponding distribution on the General Partner’s 2.0% interest for each of three consecutive, non-overlapping four-quarter periods ending on or after December 31, 2015 or (ii) $2.55 (150.0% of the annualized Minimum Quarterly Distribution) on each outstanding unit and the corresponding distributions on the General Partner’s 2.0% interest and the related distribution on the incentive distribution rights for the four-quarter period immediately preceding that date. When the subordination period ends, all subordinated units will convert into common units on a one-for-one basis, and all common units thereafter will no longer be entitled to arrearages.
Incentive Distribution Rights
The General Partner holds the IDRs. The following table illustrates the percentage allocations of available cash from operating surplus between the unitholders and the General Partner based on the specified target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of the General Partner and the unitholders in any available cash from operating surplus the Partnership distributes up to and including the corresponding amount in the column “Total Quarterly Distribution per Unit.” The percentage interests shown for our unitholders and our general partner for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests set forth below for the General Partner include its 2.0% general partner interest, assume the General Partner has contributed any additional capital necessary to maintain its 2.0% general partner interest and has not transferred its incentive distribution rights and there are no arrearages on common units.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
Cash Distributions
The Partnership has declared quarterly distributions per unit to unitholders of record, including holders of common and subordinated units and the 2% general partner interest held by the General Partner as follows (in millions, except distribution per unit):
(1) Prorated to reflect 72 days of quarterly cash distribution rate of $0.435 per unit.
The Partnership’s partnership agreement requires that, within 45 days after the end of each quarter, the Partnership distribute all of its available cash (as defined in the partnership agreement) to the partners of record on the applicable record date. Certain limited partners, including USA Compression Holdings, and Argonaut Private Equity and certain related parties, have elected to receive distributions in the form of additional common units in accordance with the Partnership’s DRIP. Such distributions, which are treated as non-cash transactions in the accompanying statements of cash flows, totaled $6.3 million, $8.1 million and $11.9 million for the first, second and third quarter of 2013, respectively.
On January 23, 2014, the Partnership announced a cash distribution of $0.48 per unit on its common units and subordinated units. The distribution was paid on February 14, 2014 to unitholders of record as of the close of business on February 4, 2014. USA Compression Holdings, the owner of 50.6% of the Partnership’s outstanding limited partner interests, and Argonaut Private Equity and certain related parties, the owners of 19.3% of the Partnership’s outstanding limited partner interests, elected to reinvest all of this distribution with respect to their units pursuant to the Partnership’s DRIP. Following the issuance of common units under the DRIP, USAC Compression Holdings owned 50.9% of the Partnership’s outstanding limited partner interests, and Argonaut Private Equity and the related parties participating in the DRIP, owned 19.4% of the Partnership’s outstanding limited partner interests.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
Earnings Per Common and Subordinated Unit
The computations of earnings per common unit and subordinated unit are based on the weighted average number of common units and subordinated units, respectively, outstanding during the applicable period. The Partnership’s subordinated units meet the definition of a participating security; therefore, the Partnership is required to use the two-class method in the computation of earnings per unit. Basic earnings per common unit and subordinated unit are determined by dividing net income allocated to the common units and subordinated units, respectively, after deducting the amount allocated to the Partnership’s general partner (including distributions to the general partner on its IDRs), by the weighted average number of outstanding common units and subordinated units, respectively, during the period.
Pursuant to the partnership agreement, to the extent that the quarterly distributions exceed certain targets, the General Partner is entitled to receive certain incentive distributions that will result in more earnings proportionately being allocated to the General Partner than to the holders of common units and subordinated units. The Partnership’s earnings per unit calculations, which allocate 2% of earnings to the General Partner, assume that, while such distribution to the General Partner with respect to its 2% general partner interest was made, no incentive distributions were permitted to be, or were, made to the General Partner because quarterly distributions declared by the board of directors for the fourth quarter of 2013 did not exceed the specified targets.
(7) Unit-Based Compensation
Class B Units
During 2011 and 2013, USA Compression Holdings, LLC issued to certain employees and members of its management, who provide services to the Partnership, Class B nonvoting units. These Class B units are liability-classified profits interest awards which have a service condition.
The holders of Class B units in USA Compression Holdings, LLC are entitled to a cash payment of 10% of net proceeds primarily from a monetization event, as defined under the provisions of the Amended and Restated Limited Liability Company Agreement of USA Compression Holdings, or the Holdings Operating Agreement, related to these Class B unit awards, in excess of USA Compression Holdings, LLC’s Class A unitholder’s capital contributions and an 8% cumulative annual dividend (both of which are due upon a monetization event) to the extent of vested units over total units of the respective class. Each holder of Class B units is then allocated their pro-rata share of the respective class of unit’s entitlement based on the number of units held over the total number of units in that class of units. The Class B units vest 25% on the first anniversary date of the grant date and then monthly for the next three years (at the rate of 1/48 per month) subject to certain continued employment. Half of the remaining vesting was achieved in connection with the Partnership’s IPO. The units have no expiry date provided the employee remains employed with USA Compression Holdings, LLC or one of its subsidiaries.
The Class B units vesting schedule consisted of the following at December 31 (in thousands, except unit amounts):
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
Fair value of the Class B units is based on enterprise value calculated by a predetermined formula. As of December 31, 2013, there was no unit-based compensation expense or liability that has been recorded related to these Class B units.
The Partnership’s IPO constituted a qualified public offering for purposes of certain vesting provisions of the employee holder’s Class B Units, which resulted in 50% of certain employee’s unvested Class B Units vesting. Any remaining unvested Class B Units generally (i) vest 25% percent on the first anniversary dated of the grant date and (ii) with respect to the remaining Class B Units, will vest monthly for the next three years (at the rate of 1/48 per month) subject to the employee’s continued employment on each applicable vesting date. If any employee holder’s employment is terminated by the Partnership’s general partner without cause or the employee resigns for good reason, the remaining unvested Class B Units will vest in full. As used in the Holdings Operating Agreement, “good reason” and “cause” have the meanings set forth in each employee’s employment agreement.
Long-Term Incentive Plan
In connection with the Partnership’s IPO, the Board adopted the USA Compression Partners, LP 2013 Long-Term Incentive Plan (“LTIP”) for employees, consultants and directors of the General Partner and any of its affiliates who perform services for the Partnership. The LTIP consists of unit options, unit appreciation rights, restricted units, phantom units, distribution equivalent rights, unit awards, profits interest units and other unit-based awards. The LTIP initially limits the number of common units that may be delivered pursuant to awards under the plan to 1,410,000 common units. Awards that are forfeited, cancelled, paid or otherwise terminate or expire without the actual delivery of units will be available for delivery pursuant to other awards. The LTIP is administered by the Board or a committee thereof.
During the year ended December 31, 2013, an aggregate of 269,521 phantom units (including the corresponding distribution equivalent rights) were granted under the LTIP to the General Partner’s executive officers and employees and independent directors. The phantom units (including the corresponding distribution equivalent rights) awarded are subject to restrictions on transferability, customary forfeiture provisions and time vesting provisions generally in which, for employees, one-third of each award vests on the first, second, and third anniversaries of the date of grant. Grants of phantom units to the independent directors of the General Partner generally vest in full on the one year anniversary of the grant date. Award recipients do not have all the rights of a unitholder in the partnership with respect to the phantom units until the units have vested.
The fair value of the phantom units awarded to the General Partner’s executive officers, employees and independent directors was $4.7 million, based on the market price per unit on the date of grant, less any forfeitures. This amount will be recognized as compensation cost on a straight-line basis over the requisite service period. The General Partner’s executive officers, employees and independent directors were granted these awards to incentivize them to help drive the Partnership’s future success and to share in the economic benefits of that success. The compensation costs associated with these awards are recorded as direct general and administrative expenses. During the year ended December 31, 2013, the Partnership recognized $1.3 million of compensation expense associated with these awards, net of expense related to forfeited units.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
The following table summarizes information regarding phantom unit awards for the periods presented:
(1) Determined by dividing the aggregate grant date fair value of awards by the number of awards issued.
The unrecognized compensation cost associated with phantom unit awards was an aggregate $3.3 million at December 31, 2013. We expect to recognize the unrecognized compensation cost for these awards on a weighted-average basis over a period of 2.1 years.
Each phantom unit granted is granted in tandem with a corresponding distribution equivalent right (“DER”), which shall remain outstanding and unpaid from the grant date until the earlier of the payment or forfeiture of the related phantom units. Each vested DER shall entitle the participant to receive payments in the amount equal to any distributions made by the Partnership following the grant date in respect of the common unit underlying the phantom unit to which such DER relates.
(8) Transactions with Related Parties
For the year ended December 31, 2013, the Partnership incurred $49,315 of expenses related to management fees under an agreement between USA Compression Holdings, LLC and certain of its affiliates, for services provided to the Partnership for the period from January 1, 2013 through January 17, 2013. For the years ended December 31, 2012 and 2011, the Partnership incurred $1.0 million of management fees under such agreement. After the completion of the Partnership’s initial public offering on January 18, 2013, the Partnership and its subsidiaries are no longer required to pay this management fee.
William Shea, Jr., who has served as a director of USA Compression GP, LLC since June 2011, is currently a director and the chief executive officer of the general partner of PVR Partners, L.P. (“PVR”). For the years ended December 31, 2013, 2012 and 2011, subsidiaries of PVR made compression services payments of approximately $3.0 million, $2.2 million and $1.3 million, respectively.
The Partnership provides compression services to affiliated entities controlled by Riverstone, who owns a majority of the membership interest in USA Compression Holdings. As of February 18, 2013, USA Compression Holdings owned and controlled the Partnership’s general partner and owned 50.9% of our limited partner interests. For the years ended December 31, 2013, 2012 and 2011, affiliated entities made compression services payments to the Partnership of approximately $0.5 million, $0.8 million and $40,613, respectively. The Partnership may provide compression services to additional entities controlled by Riverstone in the future, and any significant transactions will be disclosed.
(9) Commitments and Contingencies
(a) Operating Leases
Rent expense for office space, warehouse facilities and certain corporate equipment for the years ended December 31, 2013, 2012 and 2011 was $1.6 million, $1.1 million and $0.8 million, respectively. Commitments for future minimum lease payments for non-cancelable leases are as follows (in thousands):
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(b) Operating Lease Facility
On August 4, 2009, the Partnership entered into an operating lease facility with Caterpillar Financial Services Corporation (“CFSC”), whereby the Partnership had the ability to lease compression equipment with an aggregate value of up to $45 million. The Partnership paid commitment and arrangement fees of $0.2 million. As part of the facility, the Partnership would pay 150 basis points, amended December 23, 2010 to 220 basis points, on the value of the equipment for each lease as funded. The facility was available for leases with inception dates up to and including June 30, 2011, subject to renewals at the discretion of CFSC, and mitigated the need to use available capacity under the existing senior debt facility. Each compressor leased under this facility had a lease term of one hundred twenty (120) months with a buyout option of 25% of cost which approximated fair value at the end of the lease term. At the end of the lease term, the Partnership also had an option to extend the lease term for an additional period of sixty (60) months at an adjusted rate equal to the fair market rate at the time. In the event the Partnership elected not to exercise the buyout or renewal option, the equipment was to be returned in a manner fit for use at the end of the lease term. In addition to the fair value buyout option at the end of the lease term, early buyout option provisions existed at month sixty (60) and at month eighty four (84) of the one hundred twenty (120) month lease term.
On December 15, 2011, the Partnership purchased all the compression units previously leased from CFSC for $43 million and terminated all the lease schedules and covenants under the facility. This purchase was funded by additional borrowings under the revolving credit facility. Lease expense under the terms of the facility for the year ended December 31, 2011 was $4.1 million. There are no commitments for future minimum lease payments as the lease schedules have been terminated.
(c) Major Customers
The Partnership had revenue from one customer representing 14.3%, 14.5% and 15.9% of total revenue for the years ended December 31, 2013, 2012 and 2011, respectively.
(d) Litigation
The Partnership may be involved in various claims and litigation arising in the ordinary course of business. In management’s opinion, the resolution of such matters is not expected to have a material adverse effect on the Partnership’s consolidated financial position, results of operations or cash flows.
(10) Selected Quarterly Financial Data (Unaudited)
In the opinion of the Partnership’s management, the summarized quarterly financial data below (in thousands, except per unit amounts) contains all appropriate adjustments, all of which are normally recurring adjustments, considered necessary to present fairly the Partnership’s financial position and the results of operations for the respective periods.
USA COMPRESSION PARTNERS, LP AND SUBSIDIARIES
Notes to Consolidated Financial Statements
December 31, 2013, 2012 and 2011
(1) Gross profit is defined as revenue less cost of operations, exclusive of depreciation and amortization expense.
(2) During the third quarter of 2013, we completed the S&R Acquisition (see Note 3).
(11) Subsequent Events
(a) Shelf Registration
On February 3, 2014, the Partnership filed a Registration Statement on Form S-3, (Reg. No. 333-193724) (the “Shelf Registration Statement”). Under the Shelf Registration Statement, the Partnership registered the offer and sale of up to $1,000,000,000 aggregate principal amount of Partnership securities including, common units and other classes of units representing limited partner interests in the Partnership, debt securities and guarantees of debt securities. In addition, the Partnership registered up to 33,336,784 common units that may be sold from time to time by certain selling unitholders. The Partnership will use the net proceeds from any primary offering of securities consummated under the Shelf Registration Statement for general partnership purposes, including repayment of debt, acquisitions, capital expenditures and additions to working capital. The actual application of proceeds the Partnership receives from any particular primary offering of securities will be set forth in the applicable prospectus supplement to the prospectus included in the Shelf Registration Statement. The Partnership will not receive any of the proceeds from a sale of common units by the selling unitholders.
(b) Phantom Units
On February 4, 2014, an aggregate of 9,087 phantom units (including the corresponding distribution equivalent rights) were granted under the LTIP to the independent directors of our general partner. The phantom units (including the corresponding distribution equivalent rights) awarded are subject to restrictions on transferability, customary forfeiture provisions and will vest in full on February 15, 2015.