UNIVERSAL COMPRESSION PARTNERS, L.P.
NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
June 30, 2007
1. Basis of Presentation
Universal Compression Partners, L.P. (the “Partnership”) is a publicly held Delaware limited partnership formed on June 22, 2006, to acquire certain contract compression customer service agreements and a related compressor fleet used to service those customers from Universal Compression Partners Predecessor. Universal Compression Partners Predecessor’s operations are owned by Universal Compression Holdings, Inc. and its subsidiaries (“Universal Compression Holdings”).
These unaudited consolidated financial statements should be read in conjunction with the consolidated financial statements presented in the Partnership’s Annual Report on Form 10-K for the period from June 22, 2006 through December 31, 2006. That report contains a more comprehensive summary of the Partnership’s major accounting policies. In the opinion of management, the accompanying unaudited consolidated financial statements contain all appropriate adjustments, all of which are normally recurring adjustments unless otherwise noted, considered necessary to present fairly the financial position of the Partnership and its consolidated subsidiaries and the results of operations and cash flows for the respective periods. Operating results for the three-month and six-month periods ended June 30, 2007 are not necessarily indicative of the results that may be expected for the twelve months ending December 31, 2007.
Because the Partnership was formed on June 22, 2006 and had no operations prior to October 20, 2006, Consolidated Statement of Operations and Consolidated Statement of Cash Flows are not presented for the six months ended June 30, 2006. Financial statements and notes for Universal Compression Partners Predecessor can be found elsewhere in this report.
Goodwill
The Partnership performs an impairment test for goodwill assets annually, or more often if indicators of potential impairment exist. The Partnership’s goodwill impairment test involves a comparison of its reporting unit’s fair value with its carrying value. The fair value is determined using discounted cash flows and other market-related valuation models. Certain estimates and judgments are required in the application of the fair value models. As of February 2007, the Partnership performed its annual impairment analysis in accordance with the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets,” and determined that no impairment had occurred. If for any reason the fair value of the Partnership’s goodwill or that of its reporting unit declines below the carrying value in the future, the Partnership may incur charges for the impairment.
Unit-Based Compensation
Effective June 22, 2006, the Partnership adopted SFAS No. 123R, “Share-Based Payment,” which requires that compensation cost relating to share-based payment transactions be recognized in the financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued.
Income Taxes
As a partnership, all income, gains, losses, expenses, deductions and tax credits generated by the Partnership generally flow through to the unitholders of the Partnership. However, Texas, through a recently enacted margin tax, imposes an entity-level income tax on partnerships.
The State of Texas margin tax will become 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 2007 results. The margin tax base to which the tax rate will be applied is either the lesser of 70% of the Partnership’s total revenues for federal income tax purposes or total revenue less cost of goods sold or compensation for federal income tax purposes. For the six months ended June 30, 2007, the Partnership recorded an accrued liability related to the Texas margin tax of $50,000.
Segment Reporting
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” established standards for entities to report information about the operating segments and geographic areas in which they operate. The Partnership operates in only one segment and all of its operations are located in the United States of America.
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Earnings Per Limited Partner Unit
The computation of earnings per limited partner unit is based on the weighted average number of common and subordinated units outstanding during the applicable period. Basic earnings per limited partner unit is determined by dividing net income, after deducting the amount allocated to the general partner interest (including its incentive distribution in excess of its 2% interest), by the weighted average number of outstanding limited partner units during the period.
The only potentially dilutive securities issued by the Partnership are unit options and phantom units, neither of which would impact the calculation of net income for dilutive earnings per unit purposes. The dilutive effects of unit option and phantom unit grants outstanding for the three months and six months ended June 30, 2007 were 59,000 units and 26,000 units, respectively. For the three months and six months ended June 30, 2007, no unit options or phantom units were excluded from the computation of diluted earnings per unit.
2. New Accounting Pronouncements
In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109.” FIN 48 was issued to clarify the accounting for uncertainty in income taxes recognized in an entity’s financial statements by prescribing a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Partnership adopted the provisions of FIN 48 on January 1, 2007. The adoption of FIN 48 did not have an impact on its consolidated financial statements.
In June 2006, the FASB’s Emerging Issues Task Force (“EITF”) reached a consensus on Issue 06-3, “How Taxes Collected from Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That Is, Gross versus Net Presentation),” that concludes that the presentation of taxes within EITF 06-3’s scope is an accounting policy decision that should be disclosed. If the taxes are reported on a gross basis, companies are required to disclose the amounts of those taxes if such amounts are deemed significant. This pronouncement is effective for interim and annual reporting periods beginning after December 15, 2006. The Partnership presents the taxes within the scope of EITF 06-3 on a net basis. The adoption of EITF 06-3 did not have an impact on the Partnership’s consolidated financial statements.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements,” which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. The Partnership is currently evaluating the impact that the adoption of SFAS No. 157 will have on its consolidated financial statements.
In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities,” which permits entities to choose to measure many financial instruments and certain other items at fair value that are not currently required to be measured at fair value. SFAS No. 159 will be effective for the Partnership on January 1, 2008. The Partnership is currently evaluating the impact that the adoption of SFAS No. 159 will have on its consolidated financial statements.
3. Related Party Transactions
Upon the closing of the Partnership’s initial public offering, it entered into an omnibus agreement (“Omnibus Agreement”) with Universal Compression Holdings, its general partner and others. The Omnibus Agreement will terminate on a change of control of the Partnership’s general partner or the removal or withdrawal of its general partner, and certain provisions will terminate upon a change of control of Universal Compression Holdings (see Note 10).
Under the Omnibus Agreement, Universal Compression Holdings agreed that, for a period that will terminate on December 31, 2008, the Partnership’s obligation to reimburse Universal Compression Holdings for (1) any cost of sales that it incurs in the operation of the Partnership’s business will be capped at an amount equal to $16.95 per horsepower (after taking into account any such costs the Partnership incurs and pays directly) on a quarterly basis; and (2) any selling, general and administrative costs allocated to the Partnership will be capped at $2.5 million per quarter (after taking into account any such costs the Partnership incurs and pays directly). These caps may be subject to increases in connection with expansions of the Partnership’s operations through the acquisition or construction of new assets or businesses (see Note 11). For the three months and six months ended June 30, 2007, the Partnership’s cost of sales exceeded the cap by $1.7 million and $3.1 million, respectively. For the three months and six months ended June 30, 2007, the Partnership’s selling, general and administrative expense exceeded the cap by approximately $0.1 million and $0.3 million, respectively. The excess amounts over the caps are being accounted for as a capital contribution. The Omnibus Agreement was amended in July 2007 and, among other things, increased the caps (see Note 11).
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During the six months ended June 30, 2007, the Partnership purchased $13.4 million of new compression equipment from Universal Compression Holdings and Universal Compression Holdings contributed $1.8 million of cost to overhaul compression equipment to the Partnership. These costs relate to overhauls on equipment that was contributed to the Partnership by Universal Compression Holdings on the date of the Partnership’s initial public offering and where the overhaul was in-progress on that date.
For the three months and six months ended June 30, 2007, the Partnership had revenue of $0.3 million and $0.5 million, respectively, and cost of sales of $1.0 million and $1.4 million, respectively, with affiliates related to leases of compression equipment.
4. Long-Term Debt
As of June 30, 2007, the Partnership had approximately $121.0 million outstanding under its revolving credit facility (see Note 11). Covenants in the credit facilities require that the Partnership maintain various financial ratios. As of June 30, 2007, the Partnership was in compliance with all financial covenants.
5. Cash Distributions
On February 14, 2007, the Partnership distributed approximately $3.6 million, or $0.278 per unit, which reflects the pro rata portion of the quarterly distribution rate of $0.35, covering the period from the closing of the initial public offering on October 20, 2006, through December 31, 2006. On May 15, 2007, the Partnership distributed approximately $4.5 million, or $0.35 per unit, the Partnership’s minimum quarterly distribution covering the period from January 1, 2007 to March 31, 2007.
On July 30, 2007, the board of directors of the Partnership’s general partner approved a cash distribution of $0.35 per unit, or approximately $6.0 million. The distribution reflects the Partnership’s minimum quarterly distribution rate of $0.35 and covers the time period from April 1, 2007 to June 30, 2007. The record date for this distribution is August 9, 2007 and payment is expected to occur on August 14, 2007. Because the Partnership issued approximately 4.1 million common and general partner units on July 9, 2007, prior to the record date, to fund its recent acquisition of contract compression assets from Universal Compression Holdings (see Note 11), this distribution will also be paid to the holders of those units.
6. Unit-Based Compensation
The following table presents the unit-based compensation expense included in the Partnership’s results of operations (in thousands):
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2007 | |
Unit options | | $ | 1,301 | | $ | 1,887 | |
Phantom units | | 2 | | 4 | |
Total unit-based compensation expense | | $ | 1,303 | | $ | 1,891 | |
There was no unit-based compensation cost capitalized during the three months and six months ended June 30, 2007. During the six months ended June 30, 2007, no unit options or phantom units were granted, exercised or cancelled.
7. Accounting for Interest Rate Swap Agreements
In accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended, all derivative instruments must be recognized on the balance sheet at fair value, and changes in such fair values are recognized in earnings unless specific hedging criteria are met. Changes in the values of derivatives that meet these hedging criteria will ultimately offset related earnings effects of the hedged item pending recognition in earnings.
As of June 30, 2007, the notional amount of the interest rate swap agreement related to the Partnership’s revolving credit facility was $125.0 million and the fair value of this interest rate swap agreement as of June 30, 2007 was a derivative asset of approximately $0.4 million. The swap agreement terminates in December 2011 and has a fixed rate of 5.28%. As of June 30, 2007, all of our outstanding variable rate debt had been converted to a fixed rate through the swap agreement. Because the terms of the hedged item and this swap do not substantially coincide, the Partnership performs calculations to determine the amount of ineffectiveness, if any. For the three months and six months ended June 30, 2007, the Partnership recorded approximately $36,000 of ineffectiveness.
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8. Comprehensive Income
Comprehensive income consisted of the following (in thousands):
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2007 | |
Net income | | $ | 2,264 | | $ | 4,607 | |
Other comprehensive income: | | | | | |
Interest rate swap gain | | 2,413 | | 1,864 | |
| | | | | |
Comprehensive income | | $ | 4,677 | | $ | 6,471 | |
9. Commitments and Contingencies
In the ordinary course of business, the Partnership is involved in various pending or threatened legal actions. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a material adverse effect on the Partnership’s financial position, results of operations or cash flows; however, because of the inherent uncertainty of litigation, the Partnership cannot provide assurance that the resolution of any particular claim or proceeding to which it is a party will not have a material adverse effect on the Partnership’s financial position, results of operations or cash flows for the period in which that resolution occurs.
10. Proposed Merger Between Universal Compression Holdings and Hanover Compressor Company
In February 2007, Universal Compression Holdings and Hanover Compressor Company (“Hanover”) entered into a merger agreement. Upon consummation of the transactions set forth in the merger agreement, each common share of Hanover will be converted into 0.325 shares of common stock of a newly created holding company, Exterran Holdings, Inc. (“Exterran”), and each common share of Universal Compression Holdings will be converted into one share of Exterran. Hanover will be treated as the acquirer for accounting purposes.
The merger agreement has been unanimously approved by both companies’ boards of directors. Completion of the merger is subject to a number of conditions, including the approval of the stockholders of both companies and customary regulatory approvals, including the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“Hart-Scott-Rodino Act”). On July 3, 2007, Universal Compression Holdings and Hanover each received notice that the waiting period required by the Hart-Scott-Rodino Act with respect to the merger had been terminated. On July 10, 2007, the SEC declared effective the registration statement relating to the proposed merger. Each company has scheduled its annual meeting of stockholders, at which the proposed merger will be considered, for August 16, 2007. Universal Compression Holdings and Hanover expect the merger to close on or about August 20, 2007, but no assurances can be given as to the timing of the satisfaction of all closing conditions or that all required approvals will be received.
The merger agreement requires Universal Compression Holdings and Hanover to continue to operate their businesses in the ordinary course of business and to obtain the other party’s consent prior to engaging in certain specified activities, such as issuing or repurchasing securities, acquiring or disposing of businesses above specified thresholds, incurring new debt other than below specified thresholds and for specified purposes, paying dividends or granting awards with respect to their common stock (other than under employee compensation arrangements). These agreements are subject to specified exceptions, including those (1) permitting Universal Compression Holdings to repurchase up to an additional $75 million of its common stock in accordance with its previously announced open-market stock repurchase program, (2) permitting the Partnership to make cash distributions in accordance with its partnership agreement, (3) permitting Universal Compression Holdings to make contributions of its domestic compression assets to the Partnership, subject to certain limitations, and (4) permitting Universal Compression Holdings to redeem its 7 1/4% senior notes due 2010.
Upon the closing of the proposed merger, the Partnership will remain a subsidiary of Universal Compression Holdings, and Universal Compression Holdings will become a wholly owned indirect subsidiary of Exterran.
The closing of the proposed merger of Universal Compression Holdings and Hanover will constitute a change of control of Universal Compression Holdings under the Omnibus Agreement, which will cause a termination of the non-competition and equipment-sharing provisions of the Omnibus Agreement. The Partnership expects to negotiate and enter into suitable substitute arrangements with Universal Compression Holdings that would take effect upon the termination of these provisions of the Omnibus Agreement, although it cannot provide any assurance that it will be able to do so.
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11. Subsequent Events
In July 2007, the Partnership acquired from Universal Compression Holdings contract compression customer service agreements with eight customers and a fleet of 722 compressor units, comprising 281,992 horsepower, or 13% (by available horsepower) of the combined domestic contract compression business of Universal Compression Holdings and the Partnership. These compressor units serve the compression service needs of the eight customers that became customers of the Partnership upon the closing of the acquisition. In connection with this acquisition, the Partnership assumed $159.6 million in debt from Universal Compression Holdings and issued to Universal Compression Holdings approximately 2.0 million common units and approximately 82,000 general partner units. Additionally, the Partnership issued approximately 2.0 million common units for proceeds of $69.1 million (net of private placement fees of $0.9 million) to institutional investors in a private placement. The Partnership used the proceeds from the private placement to repay a portion of the debt assumed from Universal Compression Holdings.
Additionally, in connection with this acquisition, the Partnership expanded its revolving credit facility from $225 million to $315 million and borrowed an additional $90 million under that facility, which it used, along with available cash, to repay the remainder of the debt assumed from Universal Compression Holdings in conjunction with this acquisition.
In July 2007, the Partnership entered into two interest rate swap agreements related to its revolving credit facility. Each swap agreement has a notional amount of $40 million. These swap agreements both terminate in October 2011 and have a weighted average fixed rate of 5.33%.
Also, in connection with the closing of the acquisition, the Partnership entered into an amendment (the “First Amendment”) to the Omnibus Agreement. The First Amendment, among other things, increased the cap on selling, general and administrative costs allocable from Universal Compression Holdings to the Partnership based on such costs incurred by Universal Compression Holdings on behalf of the Partnership from $2.5 million per quarter to $4.75 million (after taking into account any such costs that the Partnership incurs and pays directly) per quarter and increased the cap on cost of sales from $16.95 per horsepower per quarter to $18.00 per horsepower (after taking into account any such costs that the Partnership incurs and pays directly) per quarter. These caps are scheduled to terminate on December 31, 2008, as previously agreed.
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UNIVERSAL COMPRESSION PARTNERS PREDECESSOR
COMBINED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME
(In thousands)
(unaudited)
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2006 | |
| | | | | |
Revenue | | $ | 101,460 | | $ | 195,505 | |
| | | | | |
Cost of sales (excluding depreciation) | | 35,792 | | 68,706 | |
Depreciation | | 19,192 | | 38,001 | |
Selling, general and administrative expenses | | 13,028 | | 22,479 | |
Other (income) expense, net | | (527 | ) | (577 | ) |
Net income and comprehensive income | | $ | 33,975 | | $ | 66,896 | |
See accompanying notes to unaudited combined financial statements.
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UNIVERSAL COMPRESSION PARTNERS PREDECESSOR
COMBINED STATEMENT OF CASH FLOWS
(In thousands)
(unaudited)
| | Six Months
Ended
June 30,
2006 | |
Cash flows from operating activities: | | | |
Net income | | $ | 66,896 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | |
Depreciation | | 38,001 | |
Gain on asset sales | | (575 | ) |
(Increase) decrease in receivables | | (33,979 | ) |
Increase (decrease) in accrued liabilities | | 743 | |
Net cash provided by operating activities | | 71,086 | |
Cash flows from investing activities: | | | |
Additions to property and equipment | | (51,905 | ) |
Proceeds from sale of property and equipment | | 4,721 | |
Net cash used in investing activities | | (47,184 | ) |
Cash flows from financing activities: | | | |
Net distributions to parent | | (23,902 | ) |
Net cash used in financing activities | | (23,902 | ) |
Increase (decrease) in cash and cash equivalents | | — | |
Cash and cash equivalents at beginning of period | | — | |
Cash and cash equivalents at end of period | | $ | — | |
See accompanying notes to unaudited combined financial statements.
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UNIVERSAL COMPRESSION PARTNERS PREDECESSOR
NOTES TO UNAUDITED COMBINED FINANCIAL STATEMENTS
1. Basis of Presentation and Summary of Significant Accounting Policies
Organization
These notes apply to the unaudited combined financial statements of the natural gas contract compression business that is provided in the United States of America (“United States”) by Universal Compression Holdings, Inc. (along with its subsidiaries, “Universal Compression Holdings”) and its subsidiaries (the “Predecessor”).
In October 2006, a subsidiary of Universal Compression Holdings, Universal Compression Partners, L.P. (along with its subsidiaries, “the Partnership”), completed an initial public offering of 6,325,000 common units representing limited partner interests in the Partnership, at a price of $21.00 per unit, including 825,000 common units sold pursuant to the exercise of the underwriters’ overallotment option. As of the closing of the initial public offering, Universal Compression Holdings contributed to the Partnership a portion of the Predecessor’s business comprising contract compression services contracts with nine customers and a fleet of compressor units to service those customers, comprising approximately 330,000 horsepower, or approximately 17% (by available horsepower) of the Predecessor’s business. For financial reporting purposes, the Predecessor is deemed to be the predecessor of the Partnership. A subsidiary of Universal Compression Holdings is the general partner of the Partnership.
Basis of Presentation
The combined financial statements include the accounts of the Predecessor and have been prepared in accordance with accounting principles generally accepted in the Unites States. The combined statements of operations include all revenue and costs directly attributable to the Predecessor. In addition, cost of sales (excluding depreciation expense) and selling, general and administrative expenses include costs incurred by Universal Compression Holdings and allocated to the Predecessor based on allocation factors that it believes are reasonable. These costs include, among other things, indirect field labor, vehicle fuel cost, vehicle and field operations facilities repair and maintenance costs, miscellaneous supplies cost and centralized corporate functions such as legal, accounting, treasury, insurance administration and claims processing, risk management, health, safety and environmental, information technology, human resources, credit, payroll, taxes and other corporate services and the use of facilities that support these functions. These allocations may not be necessarily indicative of the costs and expense that would result if the Partnership was an independent entity.
Comprehensive Income
The Predecessor had no items of other comprehensive income for the period presented in the Combined Statements of Operations and Comprehensive Income. As a result, net income and comprehensive income are the same for the periods presented.
Segment Reporting
SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information,” established standards for entities to report information about the operating segments and geographic areas in which they operate. The Predecessor only operates in one segment and all of its operations are located in the United States.
Non-cash Financing and Investing Activities
Net distributions to parent on the Combined Statement of Cash Flows for the six months ended June 30, 2006 exclude certain non-cash transactions related to net transfers of contract compression equipment (from)/to the Predecessor and from/(to) other subsidiaries of Universal Compression Holdings.
2. Related Party Transactions
The Predecessor has no employees. The employees supporting the Predecessor are employees of Universal Compression Holdings. Services provided by Universal Compression Holdings to the Predecessor include support of the contract compression services provided by the Predecessor to its customers utilizing equipment owned by the Predecessor, such as designing, sourcing, installing, operating, servicing, repairing and maintaining the equipment. Additionally, Universal Compression Holdings provides to the Predecessor centralized corporate functions such as legal, accounting, treasury, insurance administration and claims processing, risk management, health, safety and environmental, information technology, human resources, credit, payroll, taxes and other corporate services and the use of facilities that support these functions. Costs
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incurred by Universal Compression Holdings on behalf of the Predecessor and that can be directly identified to the Predecessor are included in the Predecessor’s results of operations. Costs incurred by Universal Compression Holdings that are indirectly attributable to the Predecessor and Universal Compression Holdings’ other operations are allocated among the Predecessor and Universal Compression Holdings’ other operations. For the three months and six months ended June 30, 2006, Universal Compression Holdings’ defined contribution 401(k) plan and employees’ supplemental savings plan expense allocated to the Predecessor was $0.4 million and $0.7 million, respectively. The allocation methodologies vary based on the nature of the charge and include, among other things, revenue, employee headcount and net assets. Management believes that the allocation methodologies used to allocate indirect costs to it are reasonable.
The Predecessor purchases new natural gas compression equipment from Universal Compression Holdings and other services related to existing equipment that are capitalized such as overhauls and repackaging. In addition, the Predecessor has transferred used and idle natural gas compression equipment to subsidiaries of Universal Compression Holdings. Such transfers were recorded at historical cost and treated as a decrease in net parent equity.
The Predecessor’s balance sheets contain no cash. All payments made on behalf of the Predecessor, such as direct costs, indirect costs and capital expenditures discussed above, are paid by Universal Compression Holdings and have been recorded as increases in net parent equity. All payments received on behalf of the Predecessor, such as receipts for revenue earned or sales of assets, are received by Universal Compression Holdings and have been recorded as decreases in net parent equity.
3. Universal Compression Holdings Stock-Based Compensation
Universal Compression Holdings grants stock options and restricted stock to designated employees. Effective January 1, 2006, Universal Compression Holdings adopted SFAS No. 123R, “Share-Based Payment,” which requires that compensation cost relating to share-based payment transactions be recognized in the financial statements. That cost will be measured based on the fair value of the equity or liability instruments issued.
A portion of the stock-based compensation expense incurred by Universal Compression Holdings is an indirect cost allocated to the Predecessor based on factors discussed in Note 2. In the three months and six months ended June 30, 2006, the adoption of SFAS No. 123R by Universal Compression Holdings impacted the Predecessor’s results of operation by increasing selling, general and administrative expenses by $0.6 million and $1.1 million, respectively, as compared to the expense that would have been recognized under APB 25.
4. Commitments and Contingencies
In the ordinary course of business, the Predecessor is involved in various pending or threatened legal actions. In the opinion of management, the amount of ultimate liability, if any, with respect to these actions will not have a material adverse effect on the Predecessor’s financial position, results of operations or cash flows; however, because of the inherent uncertainty of litigation, the Predecessor cannot provide assurance that the resolution of any particular claim or proceeding to which it is a party will not have a material adverse effect on the Predecessor’s financial position, results of operations or cash flows for the period in which that resolution occurs.
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ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
References in Management’s Discussion and Analysis of Financial Condition and Results of Operations to “we,” “our,” “us” or like terms refer to Universal Compression Partners, L.P. References to “our predecessor” or like terms refer to the natural gas contract compression business that is provided in the United States of America (“United States”) by Universal Compression Holdings, Inc. and its subsidiaries (“Universal Compression Holdings”). In connection with our initial public offering which was completed in October 2006, approximately 17% (by available horsepower) of our predecessor’s business was contributed to us by Universal Compression Holdings. The following discussion analyzes the historical financial condition and results of operations of us and our predecessor and should be read in conjunction with our unaudited financial statements, and notes thereto, and our predecessor’s unaudited combined financial statements and notes thereto appearing elsewhere in this report, as well as our consolidated financial statements and our predecessor’s combined financial statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations in our annual report on Form 10-K for the period from June 22, 2006 through December 31, 2006.
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS
This report contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical fact contained in this report are forward-looking statements, including, without limitation, statements regarding future financial position, business strategy, proposed acquisitions, budgets, litigation, projected costs and plans and objectives of management for future operations. You can identify many of these statements by looking for words such as “believes,” “expects,” “will,” “intends,” “projects,” “anticipates,” “estimates” or similar words or the negative thereof.
Such forward-looking statements in this report include, without limitation, statements regarding:
· our business growth strategy and projected costs;
· our future financial position;
· the sufficiency of available cash flows to make cash distributions;
· the expected amount of our capital expenditures;
· anticipated cost savings, future revenue, gross margin and other financial or operational measures related to our business;
· the future value of our equipment;
· plans and objectives of our management for our future operations;
· any potential contribution of additional assets from Universal Compression Holdings to us and the effect of any such contribution; and
· the ability of Universal Compression Holdings and Hanover Compressor Company (“Hanover”) to successfully complete their anticipated merger.
Such forward-looking statements are subject to various risks and uncertainties that could cause actual results to differ materially from those anticipated as of the date of this report. Although we believe that the expectations reflected in these forward-looking statements are based on reasonable assumptions, no assurance can be given that these expectations will prove to be correct. These forward-looking statements are also affected by the risk factors and forward-looking statements described in our Annual Report on Form 10-K for the period from June 22, 2006 through December 31, 2006 and those set forth from time to time in our filings with the Securities and Exchange Commission (“SEC”), which are available through our website and through the SEC’s Electronic Data Gathering and Retrieval System (“EDGAR”) at www.sec.gov. Important factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include, among other things:
· conditions in the oil and gas industry, including a sustained decrease in the level of supply or demand for natural gas and the impact on the price of natural gas;
· competition among the various providers of natural gas compression services;
· our ability to negotiate and enter into suitable substitute arrangements with Universal Compression Holdings that would take effect upon the termination of the Omnibus Agreement;
· the ability of Universal Compression Holdings and Hanover to obtain necessary approvals for the proposed merger and the success of the merger if approved and consummated;
· employment workforce factors, including our ability to hire, train and retain key employees;
· changes in safety and environmental regulations pertaining to the production and transportation of natural gas;
· acts of war or terrorism or governmental or military responses thereto;
· introduction of competing technologies by other companies;
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· our ability to grow our asset base, particularly our fleet of compressors;
· our ability to retain and grow our customer base;
· an IRS challenge to our valuation methodologies, which may result in a shift of income, gain, loss and deduction between the general partner and the unitholders;
· our level of indebtedness and ability to fund our business; and
· liability claims related to the use of our products and services.
All forward-looking statements included in this report are based on information available to us on the date of this report. Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the cautionary statements contained throughout this report.
Overview
We are a Delaware limited partnership recently formed by Universal Compression Holdings to provide natural gas contract compression services to customers throughout the United States. Our contract compression services include designing, sourcing, owning, installing, operating, servicing, repairing and maintaining equipment to provide compression to our customers.
In October 2006, we completed an initial public offering of 6,325,000 of our common units at a price of $21.00 per unit, including 825,000 common units sold pursuant to the exercise of the underwriters’ overallotment option. The common units sold to the public represent a 49% limited partner interest in us.
Recent Developments
Universal Compression Holdings Pending Merger With Hanover
In February 2007, Universal Compression Holdings and Hanover entered into a merger agreement. Upon consummation of the transactions set forth in the merger agreement, each common share of Hanover will be converted into 0.325 shares of common stock of a newly created holding company, Exterran Holdings, Inc. (“Exterran”), and each common share of Universal Compression Holdings will be converted into one share of Exterran. Hanover will be treated as the acquirer for accounting purposes.
The merger agreement has been unanimously approved by both companies’ boards of directors. Completion of the merger is subject to a number of conditions, including the approval of the stockholders of both companies and customary regulatory approvals, including the expiration of the applicable waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976 (“Hart-Scott-Rodino Act”). On July 3, 2007, Universal Compression Holdings and Hanover each received notice that the waiting period required by the Hart-Scott-Rodino Act with respect to the merger had been terminated. On July 10, 2007, the SEC declared effective the registration statement relating to the proposed merger. Each company has scheduled its annual meeting of stockholders, at which the proposed merger will be considered, for August 16, 2007. Universal Compression Holdings and Hanover expect the merger to close on or about August 20, 2007, but no assurances can be given as to the timing of the satisfaction of all closing conditions or that all required approvals will be received.
The merger agreement requires Universal Compression Holdings and Hanover to continue to operate their businesses in the ordinary course of business and to obtain the other party’s consent prior to engaging in certain specified activities, such as issuing or repurchasing securities, acquiring or disposing of businesses above specified thresholds, incurring new debt other than below specified thresholds and for specified purposes, paying dividends or granting awards with respect to their common stock (other than under employee compensation arrangements). These agreements are subject to specified exceptions, including those (1) permitting Universal Compression Holdings to repurchase up to an additional $75 million of its common stock in accordance with its previously announced open-market stock repurchase program, (2) permitting us to make cash distributions in accordance with our partnership agreement, (3) permitting Universal Compression Holdings to make contributions of its domestic compression assets to us, subject to certain limitations, and (4) permitting Universal Compression Holdings to redeem its 7 1/4% senior notes due 2010.
Upon the closing of the proposed merger, we will remain a subsidiary of Universal Compression Holdings, and Universal Compression Holdings will become a wholly owned subsidiary of Exterran.
The closing of the proposed merger of Universal Compression Holdings and Hanover will constitute a change of control of Universal Compression Holdings under the omnibus agreement (“Omnibus Agreement”), among us, our general partner, Universal Compression Holdings and others, which will cause a termination of the non-competition and equipment-sharing provisions of the Omnibus Agreement. We expect to negotiate and enter into suitable substitute arrangements with Universal Compression Holdings that
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would take effect upon the termination of these provisions of the Omnibus Agreement, although we cannot provide any assurance that we will be able to do so.
July 2007 Contract Compression Acquisition
In July 2007, we acquired from Universal Compression Holdings contract compression customer service agreements with eight customers and a fleet of 722 compressor units, comprising 281,992 horsepower, or 13% (by available horsepower) of the combined domestic contract compression business of Universal Compression Holdings and us. These compressor units serve the compression service needs of the eight customers that became our customers upon the closing of the acquisition. In connection with this acquisition, we assumed $159.6 million in debt from Universal Compression Holdings and issued to Universal Compression Holdings approximately 2.0 million common units and approximately 82,000 general partnership units. Additionally, we issued approximately 2.0 million common units for proceeds of $69.1 million, (net of private placement fees of $0.9 million) to institutional investors in a private placement. We used the proceeds from the private placement to repay a portion of the debt assumed from Universal Compression Holdings.
Additionally, in connection with this acquisition, we expanded our revolving credit facility from $225 million to $315 million and borrowed an additional $90 million under that facility, which we used, along with available cash, to repay the remainder of the debt assumed from Universal Compression Holdings in conjunction with this transaction.
In July 2007, the Partnership entered into two interest rate swap agreements related to its revolving credit facility. Each swap agreement has a notional amount of $40 million. These swap agreements both terminate in October 2011 and have a weighted average fixed rate of 5.33%.
Also, in connection with the closing of the acquisition, we entered into an amendment (the “First Amendment”) to the Omnibus Agreement. The First Amendment, among other things, increased the cap on selling, general and administrative costs allocable from Universal Compression Holdings to us based on such costs incurred by Universal Compression Holdings on our behalf from $2.5 million per quarter to $4.75 million (after taking into account any such costs that we incur and pay directly) per quarter and increases the cap on cost of sales from $16.95 per horsepower per quarter to $18.00 per horsepower (after taking into account any such costs that we incur and pay directly) per quarter. These caps are scheduled to terminate on December 31, 2008, as previously agreed.
Items Impacting the Comparability of Our Financial Results
Our future and historical results of operations may not be comparable to the historical results of operations for the periods presented below for our predecessor, for the reasons described below:
· Only approximately 17% (by available horsepower) of our predecessor was contributed to us upon closing of our initial public offering. Accordingly, the results of operations of our predecessor reflect a substantially larger business than the business contributed to us;
· Due to the contribution of only operating horsepower in connection with our initial public offering, our utilization was initially 100%, which is higher than the historical utilization achieved by our predecessor. As of June 30, 2007, our spot utilization rate was 92.7 %. We expect our utilization rate to continue to decline over time, ultimately approximating the utilization rates of our predecessor;
· Because the average horsepower of the compression assets contributed to us in connection with the initial public offering was larger than the average horsepower of the fleet of our predecessor, we generate lower revenue per horsepower and incur lower costs per horsepower than our predecessor, however, we expect this difference to become less pronounced over time as we acquire additional assets and grow our business;
· Because we own a substantially smaller fleet of compressors than our predecessor, our operating costs per horsepower may be subject to more variability than those of our predecessor. This additional variability in our operating costs per horsepower may result from, among other things, the fact that repair costs associated with our compressors that experience unanticipated downtime will be allocated over our smaller fleet of compressors;
· Because our revenue per horsepower is currently lower than that for our predecessor and because our selling, general and administrative expenses are allocated to us by Universal Compression Holdings based on horsepower,
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our selling, general and administrative expenses are higher as a percentage of revenue than historically experienced by our predecessor;
· Because we lease compression equipment from Universal Compression Holdings to meet the specific compression needs of our customers, we incur lease expense that increases our cost of sales (excluding depreciation expense) and reduces our gross margin percentage as compared to our predecessor;
· We anticipate incurring incremental selling, general and administrative expenses of approximately $2.5 million per year as a result of being a publicly traded limited partnership, including costs associated with annual and quarterly reports to unitholders, financial statement audit, tax return and Schedule K-1 preparation and distribution, investor relations activities, registrar and transfer agent fees, incremental director and officer liability insurance costs and director compensation; and
· At June 30, 2007, we had $121.0 million outstanding under our revolving credit facility and will incur related interest expense, whereas our predecessor historically had no debt.
Operating Highlights
The following table summarizes total available horsepower, average operating horsepower and horsepower utilization percentages of us and our predecessor for the periods presented. We were formed in June 2006, but we commenced operations on October 20, 2006. As a result, operating data is shown for us for the period in 2006 in which we had operations.
| | Universal Compression Partners, L.P. | | Universal Compression Partners
Predecessor | |
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | | October 20, 2006
through
December 31, | | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2007 | | 2006 | | 2006 | |
| | | | | | | | | | | |
Total Available Horsepower (at period end) | | 386,988 | | 386,988 | | 343,010 | | 1,988,798 | | 1,988,798 | |
Average Operating Horsepower | | 347,852 | | 340,092 | | 330,276 | | 1,793,551 | | 1,797,425 | |
Horsepower Utilization: | | | | | | | | | | | |
Spot (at period end) | | 92.7 | % | 92.7 | % | 96.9 | % | 89.6 | % | 89.6 | % |
Average | | 93.1 | % | 94.1 | % | 98.6 | % | 90.6 | % | 91.1 | % |
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Financial Results of Operations
The three months and six months ended June 30, 2007 — Universal Compression Partners, L.P.
The following table summarizes our revenue, gross margin, gross margin percentage, expenses and net income:
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2007 | |
| | (In thousands) | |
| | | | | |
Revenue | | $ | 18,804 | | $ | 36,389 | |
Gross margin (1) | | 11,231 | | 21,798 | |
Gross margin percentage | | 59.7 | % | 59.9 | % |
Expenses: | | | | | |
Depreciation | | $ | 2,968 | | $ | 5,750 | |
Selling, general and administrative | | 3,915 | | 7,174 | |
Interest expense, net | | 2,093 | | 4,226 | |
Other (income) expense, net | | (3 | ) | (9 | ) |
Income tax (benefit) expense | | (6 | ) | 50 | |
Net income | | $ | 2,264 | | $ | 4,607 | |
(1) For a reconciliation of gross margin to its most directly comparable financial measure calculated and presented in accordance with GAAP, please read Part I, Item 2 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures”) of this report.
Revenue. Revenue per average monthly operating horsepower for the three months and six months ended June 30, 2007 was $18.02 and $17.83, respectively. Average monthly operating horsepower for the three months and six months ended June 30, 2007 was 347,852 and 340,092, respectively.
Gross Margin. Gross margin (defined as revenue less cost of sales, excluding depreciation expense) for the three months and six months ended June 30, 2007 was $11.2 million and $21.8 million, respectively. Cost of sales includes direct costs such as labor and parts associated with the maintenance and repair of our compressor fleet, oil and fluids, transportation cost of units and remote monitoring cost. Cost of sales includes indirect costs such as fuel cost and repair and maintenance cost related to our service vehicle fleet, field supplies, tools, facilities and communication cost, among others. Gross margin, a non-GAAP financial measure, is reconciled to net income, its most directly comparable financial measure calculated and presented in accordance with GAAP within Part I, Item 2 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures”) of this report.
Gross Margin Percentage. Gross margin percentage (defined as gross margin as a percentage of revenue) for the three months and six months ended June 30, 2007 was 59.7% and 59.9%, respectively.
Selling, General and Administrative (“SG&A”) Expenses. SG&A expenses are primarily comprised of an allocation from Universal Compression Holdings of expenses for the three months and six months ended June 30, 2007. These allocated costs include costs for personnel support and related expenditures for legal, accounting, treasury, insurance administration and claims processing, risk management, information technology, human resources, credit, payroll, internal audit, taxes, facilities management, investor relations, ERP, training, executive, sales and business development. In addition, we incurred directly expenses for ad valorem taxes, compensation related to our unit options and phantom units and professional service fees related to the preparation of our K-1 schedules. We grant unit options to individuals who are not our employees, but who are employees of Universal Compression Holdings. Because we grant unit options to non-employees, we are required to re-measure the fair value of the unit options each period and to record a cumulative adjustment of the expense previously recognized. The cumulative effect recognized in SG&A expenses as a result of the re-measurement of fair value of the unit options for the three months and six months ended June 30, 2007 was $1.2 million and $1.7 million, respectively. SG&A expenses for the three months and six months ended June 30, 2007 represented 20.8% and 19.7%, respectively, of revenues.
Depreciation Expense. Depreciation expense is related to our contract compression fleet and for the three months and six months ended June 30, 2007 was $3.0 million and $5.8 million, respectively.
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Interest Expense, Net. Interest expense for the three months and six months ended June 30, 2007 includes interest on the borrowings outstanding under our revolving credit facility and amortization of deferred financing costs incurred to obtain that facility.
Income Tax (Benefit) Expense. Income tax (benefit) expense reflects taxes recorded under the Texas margins tax.
The three months and six months ended June 30, 2006 – Universal Compression Partners Predecessor
The following table summarizes the revenue, gross margin, gross margin percentage, expenses and net income of our predecessor for the period presented:
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2006 | |
| | (In thousands) | |
| | | | | |
Revenue | | $ | 101,460 | | $ | 195,505 | |
Gross margin(1) | | 65,668 | | 126,799 | |
Gross margin percentage | | 64.7 | % | 64.9 | % |
Expenses: | | | | | |
Depreciation | | $ | 19,192 | | $ | 38,001 | |
Selling, general and administrative | | 13,028 | | 22,479 | |
Other (income) expense, net | | (527 | ) | (577 | ) |
Net income | | $ | 33,975 | | $ | 66,896 | |
(1) For a reconciliation of gross margin to its most directly comparable financial measure calculated and presented in accordance with GAAP, please read Part I, Item 2 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures”) of this report.
Revenue. Revenue per average monthly operating horsepower for the three months and six months ended June 30, 2006 was $18.86 and $18.13, respectively. Average monthly operating horsepower for the three months and six months ended June 30, 2006 was 1,793,551 and 1,797,425, respectively.
Gross Margin. Gross margin, a non-GAAP financial measure, is reconciled to net income, its most directly comparable financial measure calculated and presented in accordance with GAAP within Part I, Item 2, (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measures”) of this report. Gross margin for the three months and six months ended June 30, 2006 was $65.7 million and $126.8 million, respectively.
Gross Margin Percentage. Gross margin percentage for the three months and six months ended June 30, 2006 was 64.7% and 64.9%, respectively.
SG&A Expenses. SG&A expenses are allocations of indirect corporate overhead from Universal Compression Holdings to cover costs of centralized corporate functions such as legal, accounting, treasury, insurance administration and claims processing, risk management, health, safety and environmental, information technology, human resources, credit, payroll, taxes and other corporate services. SG&A expenses also include an allocation of costs from Universal Compression Holdings related to costs associated with its office building and other facilities that we use. The allocated SG&A expenses for the three months and six months ended June 30, 2006 represented 12.8% and 11.5%, respectively, of revenues.
Depreciation Expense. Depreciation expense is related to our predecessor’s contract compression fleet and for the three months and six months ended June 30, 2006 was $19.2 million and $38.0 million, respectively.
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Liquidity and Capital Resources
We have established our own bank accounts but Universal Compression Holdings’ personnel will continue to manage our cash and investments.
Our primary sources of cash are operating activities and financing activities. Our primary uses of cash are operating expenditures and capital expenditures. The following table summarizes our sources of cash for the six months ended June 30, 2007 (in thousands):
| | Six Months
Ended
June 30,
2007 | |
Net cash provided by (used in): | | | |
Operating activities | | $ | 13,580 | |
Investing activities | | (16,150 | ) |
Financing activities | | 1,298 | |
| | | | |
| | As of
June 30,
2007 | |
Cash and cash equivalents | | $ | 1,158 | |
Working capital, net of cash and cash equivalents | | (9,013 | ) |
| | | | |
Investing Activities. Capital expenditures for the six months ended June 30, 2007 were $16.2 million, consisting of $13.4 million for fleet additions and $2.8 million for compressor maintenance activities. There were no asset sales for the three or six months ended June 30, 2007.
Financing Activities. Net cash provided by financing activities for the six months ended June 30, 2007 was $1.3 million which was the result of distributions to unitholders, changes in accounts receivable and accounts payable with affiliates and repayment of debt obligations under our revolving credit facility.
Capital Requirements. The natural gas compression business is capital intensive, requiring significant investment to maintain and upgrade existing operations. Both our and our predecessor’s capital requirements have consisted primarily of, and we anticipate that our capital requirements will continue to consist of, the following:
· maintenance capital expenditures, which are capital expenditures made to maintain the existing operating capacity of our assets and related cash flows further extending the useful lives of the assets; and
· expansion capital expenditures, which are capital expenditures made to expand or to replace partially or fully depreciated assets or to expand the operating capacity or revenue generating capabilities of existing or new assets, whether through construction, acquisition or modification.
Given our objective of growth through acquisitions, expansion capital expenditure projects and other internal growth projects, we anticipate that we will continue to invest significant amounts of capital to grow and acquire assets. We will actively consider a variety of assets for potential acquisitions and expansion projects. We expect to fund future capital expenditures with borrowings under our credit facility, the issuance of additional partnership units and future debt offerings.
Long-term Debt. As of June 30, 2007, we had approximately $121.0 million in outstanding debt obligations under our revolving credit facility. All amounts under the revolving credit facility mature in October 2011. Covenants within our credit facility require that we maintain various financial ratios. As of June 30, 2007, we were in compliance with all financial covenants.
We expect our future sources of liquidity to include cash generated from operations, borrowings under our revolving credit facility, issuance of additional partnership units and debt offerings. We believe that cash generated from these sources will be sufficient to meet our short-term working capital requirements, long-term capital expenditure requirements and quarterly cash distributions.
Distributions to Unitholders. Our partnership agreement requires us to distribute all of our “available cash” quarterly. Under the partnership agreement, available cash is defined to generally mean, for each fiscal quarter, (i) our cash on hand at the end of the
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quarter in excess of the amount of reserves our general partner determines is necessary or appropriate to provide for the conduct of our business, to comply with applicable law, any of our debt instruments or other agreements or to provide for future distributions to our unitholders for any one or more of the upcoming four quarters, plus, (ii) if our general partner so determines, all or a portion of our cash on hand on the date of determination of available cash for the quarter.
On February 14, 2007, the board of directors of our general partner approved a cash distribution of approximately $3.6 million, or $0.278 per unit, which reflects the pro rata portion of the quarterly distribution rate of $0.35, covering the period from the closing of the initial public offering on October 20, 2006, through December 31, 2006. On May 15, 2007, the board of directors of our general partner approved a cash distribution of approximately $4.5 million, or $0.35 per unit, the Partnership’s minimum quarterly distribution covering the period from January 1, 2007 to March 31, 2007.
On July 30, 2007, the board of directors of our general partner approved a cash distribution of $0.35 per unit, or $6.0 million. The distribution reflects the minimum quarterly distribution rate of $0.35 per unit and covers the time period from April 1, 2007 to June 30, 2007. The record date for this distribution is August 9, 2007 and payment is expected to occur on August 14, 2007. Because we issued approximately 4.1 million common and general partner units on July 9, 2007, prior to the record date, to fund our recent acquisition of contract compression assets from Universal Compression Holding, as described within Part I, Item 2, (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Recent Developments”) of this report, this distribution will also be paid to the holders of those units.
July 2007 Contract Compression Acquisition. In July 2007, we acquired from Universal Compression Holdings contract compression customer service agreements with eight customers and a fleet of 722 compressor units comprising 281,992 horsepower, or 13% (by available horsepower) of the combined domestic contract compression business of Universal Compression Holdings and us. These compressor units serve the compression service needs of the eight customers that became customers of us upon the closing of the transaction. In connection with the acquisition, we assumed $159.6 million in debt from Universal Compression Holdings and issued to Universal Compression Holdings approximately 2.0 million common units and approximately 82,000 general partnership units. Additionally, we issued approximately 2.0 million common units for proceeds of $69.1 million, (net of private placement fees of $0.9 million) to institutional investors in a private placement. We used the proceeds from the private placement to repay a portion of the debt assumed from Universal Compression Holdings.
Additionally, in connection with this acquisition, we expanded our revolving credit facility from $225 million to $315 million and borrowed an additional $90 million under that facility, which we used, along with available cash, to repay the remainder of the debt assumed from Universal Compression Holdings in conjunction with this acquisition.
In July 2007, we entered into two interest rate swap agreements related to our revolving credit facility. Each swap agreement has a notional amount of $40 million. These swap agreements both terminate in October 2011 and have a weighted average fixed rate of 5.33%.
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Non-GAAP Financial Measures
We and our predecessor define gross margin as total revenue less cost of sales (excluding depreciation expense). Gross margin is included as a supplemental disclosure because it is a primary measure used by our and our predecessor’s management as it represents the results of revenue and cost of sales (excluding depreciation expense), which are key components of our and our predecessor’s operations. As an indicator of our and our predecessor’s operating performance, gross margin should not be considered an alternative to, or more meaningful than, net income as determined in accordance with GAAP. Our and our predecessor’s gross margin may not be comparable to a similarly titled measure of another company because other entities may not calculate gross margin in the same manner.
The following table reconciles our and our predecessor’s net income to gross margin (in thousands):
| | Universal Compression Partners, L.P. | | Universal Compression Partners
Predecessor | |
| | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | | Three Months
Ended
June 30, | | Six Months
Ended
June 30, | |
| | 2007 | | 2006 | |
| | | | | | | | | |
Net income | | $ | 2,264 | | $ | 4,607 | | $ | 33,975 | | $ | 66,896 | |
Depreciation | | 2,968 | | 5,750 | | 19,192 | | 38,001 | |
Selling, general and administrative | | 3,915 | | 7,174 | | 13,028 | | 22,479 | |
Interest expense, net | | 2,093 | | 4,226 | | — | | — | |
Other (income) expense, net | | (3 | ) | (9 | ) | (527 | ) | (577 | ) |
Income tax (benefit) expense | | (6 | ) | 50 | | — | | — | |
Gross margin | | $ | 11,231 | | $ | 21,798 | | $ | 65,668 | | $ | 126,799 | |
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to market risk due to variable interest rates under our financing and interest rate swap arrangement.
As of June 30, 2007, the notional amount of the interest rate swap agreement related to our revolving credit facility was $125.0 million and the fair value of this interest rate swap agreement as of June 30, 2007 was a derivative asset of approximately $0.4 million. The swap agreement terminates in December 2011 and has a fixed rate of 5.28%. As of June 30, 2007, all of our outstanding variable rate debt has been converted to a fixed rate through the swap agreement. Because the terms of the hedged item and this swap do not substantially coincide, the Partnership performs calculations to determine the amount of ineffectiveness, if any. For the three months and six months ended June 30, 2007, the Partnership recorded approximately $36,000 of ineffectiveness.
ITEM 4T. Controls and Procedures
Management’s Evaluation of Disclosure Controls and Procedures
As required by Rule 13a-15(b) under the Securities Exchange Act of 1934 (the “Exchange Act”), our general partner’s management, including the Chief Executive Officer and Chief Financial Officer of our general partner, evaluated as of the end of the period covered by this report, the effectiveness of the Partnership’s disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, the Chief Executive Officer and Chief Financial Officer of our general partner concluded that the Partnership’s disclosure controls and procedures, as of the end of the period covered by this report, were effective for the purpose of ensuring that information required to be disclosed by the Partnership in this report is recorded, processed, summarized and reported within the time periods specified by the rules and forms under the Exchange Act and is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer of our general partner, as appropriate to allow timely decisions regarding required disclosures.
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PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings
Additional information concerning legal proceedings of Universal Compression Partners, L.P. and Universal Compression Partners Predecessor is contained in Note 9 and Note 4, respectively, to the unaudited consolidated and combined financial statements included in Part I, Item 1 (“Financial Statements”) of this report, which we have incorporated by reference into this Item 1.
ITEM 1a. Risk Factors
In addition to the other information included in this Quarterly Report on Form 10-Q and the risk factors reported in our Annual Report on Form 10-K for the period from June 22, 2006 through December 31, 2006, you should consider the following risk factor in evaluating our business and future prospects. If any of the risks contained in this Quarterly Report or our Annual Report occur, our business, results of operations, financial condition and ability to make cash distributions to our unitholders could be materially adversely affected.
We have adopted certain valuation methodologies that may result in a shift of income, gain, loss and deduction between the general partner and the 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 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 the general partner, which may be unfavorable to such unitholders. Moreover, subsequent purchasers of common units may have a greater portion of their Internal Revenue Code Section 743(b) adjustment allocated to our tangible assets and a lesser portion allocated to our intangible assets. The IRS may challenge our valuation methods, or our allocation of the Section 743(b) adjustment attributable to our tangible and intangible assets, and allocations of income, gain, loss and deduction between the general partner and certain of our unitholders.
A successful IRS challenge to these methods or allocations could adversely affect the amount of taxable income or loss being allocated to our unitholders. It also could affect the amount of gain from our unitholders’ sale of common units and could have a negative impact on the value of the common units or result in audit adjustments to our unitholders’ tax returns without the benefit of additional deductions.
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ITEM 6. Exhibits
Exhibit No. | | Description |
2.1 | | Contribution Conveyance and Assumption Agreement, dated May 29, 2007, by and among Universal Compression Partners, L.P., Universal Compression, Inc., UCO Compression 2005 LLC, UCI Leasing Holding GP LLC, UCI Leasing Holding LP LLC, UCI Compressor Holding, L.P., UCO GP, LLC, UCI GP LP LLC, UCO General Partner, LP, UCI MLP LP LLC, UCLP OLP GP LLC, UC Operating Partnership, L.P., UCLP Leasing GP LLC and UCLP Leasing, L.P. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on May 30, 2007). |
| | |
2.2 | | Amended and Restated Contribution Conveyance and Assumption Agreement, dated July 6, 2007, by and among Universal Compression Partners, L.P., Universal Compression, Inc., UCO Compression 2005 LLC, UCI Leasing LLC, UCO GP, LLC, UCI GP LP LLC, UCO General Partner, LP, UCI MLP LP LLC, UCLP Operating LLC and UCLP Leasing LLC. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on July 11, 2007). |
| | |
10.1 | | Common Unit Purchase Agreement dated June 19, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on June 25, 2007). |
| | |
10.2 | | First Amendment to Omnibus Agreement, dated July 9, 2007, by and among Universal Compression Partners, L.P., Universal Compression Holdings, Inc., Universal Compression, Inc., UCO GP, LLC, UCO General Partner, LP and UCLP Operating LLC (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on July 11, 2007). |
| | |
10.3* | | Registration Rights Agreement dated July 9, 2007, by and among Universal Compression Partners, L.P., Kayne Anderson Energy Total Return Fund, Inc. and each party listed as signatory thereto. |
| | |
31.1 | | Certification of the Chief Executive Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. |
| | |
31.2 | | Certification of the Chief Financial Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. |
| | |
32.1 | | Certifications of the Chief Executive Officer and Chief Financial Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Filed herewith.
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SIGNATURES
Pursuant to the requirements 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.
| Universal Compression Partners, L.P. |
| |
Date: August 7, 2007 | By: UCO GENERAL PARTNER, LP |
| its General Partner |
| |
| By: UCO GP, LLC |
| its General Partner |
| |
| By: | /s/ DANIEL K. SCHLANGER | |
| Daniel K. Schlanger |
| Senior Vice President, Chief Financial Officer and Director, UCO GP, LLC
As General Partner of UCO General Partner, LP
As General Partner of Universal Compression Partners, L.P.
(Principal Financial Officer) |
| |
| |
| By: | /s/ KENNETH R. BICKETT | |
| Kenneth R. Bickett |
| |
| Vice President and Controller, UCO GP, LLC
As General Partner of UCO General Partner, LP
As General Partner of Universal Compression Partners, L.P.
(Principal Accounting Officer) |
| |
| |
25
EXHIBIT INDEX
Exhibit No. | | Description |
2.1 | | Contribution Conveyance and Assumption Agreement, dated May 29, 2007, by and among Universal Compression Partners, L.P., Universal Compression, Inc., UCO Compression 2005 LLC, UCI Leasing Holding GP LLC, UCI Leasing Holding LP LLC, UCI Compressor Holding, L.P., UCO GP, LLC, UCI GP LP LLC, UCO General Partner, LP, UCI MLP LP LLC, UCLP OLP GP LLC, UC Operating Partnership, L.P., UCLP Leasing GP LLC and UCLP Leasing, L.P. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on May 30, 2007). |
| | |
2.2 | | Amended and Restated Contribution Conveyance and Assumption Agreement, dated July 6, 2007, by and among Universal Compression Partners, L.P., Universal Compression, Inc., UCO Compression 2005 LLC, UCI Leasing LLC, UCO GP, LLC, UCI GP LP LLC, UCO General Partner, LP, UCI MLP LP LLC, UCLP Operating LLC and UCLP Leasing LLC. (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on July 11, 2007). |
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10.1 | | Common Unit Purchase Agreement dated June 19, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on June 25, 2007). |
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10.2 | | First Amendment to Omnibus Agreement, dated July 9, 2007, by and among Universal Compression Partners, L.P., Universal Compression Holdings, Inc., Universal Compression, Inc., UCO GP, LLC, UCO General Partner, LP and UCLP Operating LLC (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on July 11, 2007). |
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10.3* | | Registration Rights Agreement dated July 9, 2007, by and among Universal Compression Partners, L.P., Kayne Anderson Energy Total Return Fund, Inc. and each party listed as signatory thereto. |
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31.1 | | Certification of the Chief Executive Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. |
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31.2 | | Certification of the Chief Financial Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 1934. |
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32.1 | | Certifications of the Chief Executive Officer and Chief Financial Officer of UCO GP, LLC (as ultimate general partner of the general partner of Universal Compression Partners, L.P.) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. |
* Filed herewith.
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