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GSJK > SEC Filings for GSJK > Form 10-K on 11-Mar-2013All Recent SEC Filings

Show all filings for COMPRESSCO PARTNERS, L.P. | Request a Trial to NEW EDGAR Online Pro

Form 10-K for COMPRESSCO PARTNERS, L.P.


11-Mar-2013

Annual Report


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

The following discussion is intended to analyze major elements of our consolidated financial statements and provide insight into important areas of management's focus. This section should be read in conjunction with our Consolidated Financial Statements and accompanying Notes included in this Annual Report. This discussion includes forward-looking statements that involve certain risks and uncertainties. For periods prior to June 20, 2011, the accompanying audited consolidated financial statements and related notes represent the combined financial position, results of operations, cash flows and changes in net parent equity of our Predecessor, which consists of the assets, liabilities and operations of Compressco, Inc. and its subsidiaries and certain assets, liabilities and operations of certain other subsidiaries of TETRA conducting business primarily in Mexico (together, our Predecessor). For the periods on and after June 20, 2011, the accompanying consolidated financial statements and related notes thereto represent our financial position, results of operations, cash flows, and changes in partners' capital.

Statements in the following discussion may include forward-looking statements. These forward- looking statements involve risks and uncertainties. See "Item 1A. Risk Factors," for additional discussion of these factors and risks.

Business Overview

We are a provider of compression-based production enhancement services, which are used in both conventional wellhead compression applications and unconventional compression applications, and, in certain circumstances, well monitoring and sand separation services. We provide our services to a broad base of natural gas and oil exploration and production companies operating throughout many of the onshore producing regions of the United States. Internationally, we have significant operations in Mexico and Canada and a growing presence in certain countries in South America, Eastern Europe, and the Asia-Pacific region.

Over time, oil and natural gas wells exhibit declining pressure and production. Production enhancement technologies are designed to enhance daily production and total recoverable reserves. Our conventional compression-based production enhancement services are utilized to increase production by deliquifying wells, lowering wellhead pressure, and increasing gas velocity. Our conventional applications include production enhancement services for dry gas wells and liquid-loaded gas wells, and backside auto injection systems ("BAIS") for liquid-loaded gas wells. Our unconventional applications are utilized primarily in connection with oil and liquids production and include vapor recovery and casing gas system applications. In certain circumstances, in connection with our primary production enhancement services, we also provide ongoing well monitoring services and automated sand separation services. While our conventional applications are primarily associated with mature gas wells with low formation pressures, they are also effectively utilized on newer gas wells that have experienced significant production declines. Our field services are performed by our highly trained staff of regional service supervisors, optimization specialists, and field mechanics. In addition, we design and manufacture most of the compressor units we use to provide our services, and, in certain markets, we sell our compressor units to customers.

The level of our production enhancement services operations is generally dependent upon the demand for, and prices of, natural gas in the locations in which we operate. However, despite significantly lower domestic natural gas prices during 2012 compared to 2011, our overall production enhancement service revenues increased. Nevertheless, any prolonged substantial reduction in natural gas prices could result in a decline in demand for our production enhancement services.

Overall, our total revenues increased during the year ended December 31, 2012, compared to the prior year. This increase reflects:

increased compression and well monitoring services in Latin America;

growth of the fleet within our other international operations; and

improved overall utilization of the existing fleet, including for our unconventional applications, primarily in vapor recovery applications.

The increased activity in Latin America has required investments in fixed assets and working capital and resulted in additional personnel and related administrative services provided under the Omnibus Agreement and other related party agreements with TETRA. Our ability to maintain the increased activity in Latin America is subject to potential volatility relating to our Mexico operations as addressed in more detail under "Liquidity and Capital Resources - Cash Flows."


How We Evaluate Our Operations

Operating Expenses. We use operating expenses as a performance measure for our business. We track our operating expenses using month-to-month, year-to-date, and year-to-year comparisons, and as compared to budget. This analysis is useful in identifying adverse cost trends and allows us to investigate the cause of these trends and implement remedial measures if possible. The most significant portions of our operating expenses are the labor costs of our field personnel, repair and maintenance of our equipment, and the fuel and other supplies consumed while providing our services. Other materials consumed while performing our services, ad valorem taxes, other labor costs, truck maintenance, rent on storage facilities, and insurance expenses comprise the significant remainder of our operating expenses. Our operating expenses generally fluctuate with the level of activities performed.

Our labor costs consist primarily of wages and benefits for our field personnel, as well as expenses related to their training and safety. Additional information regarding our operating expenses for the period ended December 31, 2011 and the year ended December 31, 2012, is provided within the results of operations sections below.

EBITDA. We view EBITDA as one of our primary management tools, and we track it on a monthly basis, both in dollars and as a percentage of revenues (compared to the prior month, prior year period, and to budget). We define EBITDA as earnings before interest, taxes, depreciation, and amortization. EBITDA is used as a supplemental financial measure by our management and by external users of our financial statements, including investors, to:

assess our ability to generate available cash sufficient to make distributions to our unitholders and general partner;

evaluate the financial performance of our assets without regard to financing methods, capital structure, or historical cost basis;

measure operating performance and return on capital as compared to our competitors; and

determine our ability to incur and service debt and fund capital expenditures.

EBITDA should not be considered an alternative to net income, operating income, cash flows from operating activities, or any other measure of financial performance presented in accordance with GAAP. Our EBITDA may not be comparable to EBITDA or similarly titled financial metrics of other entities, as other entities may not calculate EBITDA in the same manner as we do. Management compensates for the limitations of EBITDA as an analytical tool by reviewing the comparable GAAP measures, understanding the differences between the measures, and incorporating this knowledge into management's decision-making processes. EBITDA should not be viewed as indicative of the actual amount we have available for distributions or that we plan to distribute for a given period, nor should it be equated with "available cash" as defined in our partnership agreement.

The following table reconciles net income to EBITDA for the periods indicated:

                                       Year Ended December 31,
                                  2012          2011          2010
                                           (In Thousands)
Net income                     $ 16,331      $  7,257      $  1,617
Provision for income taxes        3,353         1,905         1,169
Depreciation and amortization    13,227        12,521        13,112
Interest (income) expense, net       25         5,052        13,096
EBITDA                         $ 32,936      $ 26,735      $ 28,994


The following table reconciles cash flow from operating activities to EBITDA for the periods indicated:

                                                          Year Ended December 31,
                                                     2012          2011          2010
                                                              (In Thousands)
Cash flow from operating activities               $ 31,109      $ 18,885      $ 20,391
Changes in current assets and current liabilities    2,864          (392)       (5,834)
Deferred income taxes                               (1,930)        2,536           895
Other non-cash charges                              (2,485)       (1,251)         (723)
Interest (income) expense, net                          25         5,052        13,096
Provision for income taxes                           3,353         1,905         1,169
EBITDA                                            $ 32,936      $ 26,735      $ 28,994

Average Utilization Rate of our Compressor Units. We measure the average compressor unit utilization rate of our fleet of compressor units as the average number of compressor units used to provide services during a particular period, divided by the average number of compressor units in our fleet during such period. Our management primarily uses this metric to determine our future need for additional compressor units.

The following table sets forth our historical fleet size and average number of compressor units being utilized to provide our production enhancement services during the periods indicated and our average utilization rates during those periods.

                                                     Year Ended December 31,
                                            2012               2011               2010
Total compressor units in fleet (at
period end)                                   3,743              3,653              3,651
Total compressor units in service (at
period end)                                   3,198              2,941              2,711
Average number of compressor units in
service (during period)(1)                    3,070              2,826              2,686
Average compressor unit utilization
(during period)(2)                            83.0%              77.4%              73.8%



(1) "Average number of compressor units in service" for each period shown is determined by calculating an average of two numbers, the first of which is the number of compressor units being used to provide services at the beginning of the period and the second of which is the number of compressor units being used to provide services at the end of the period.
(2) "Average compressor unit utilization" for each period shown is determined by dividing the average number of compressor units in service during such period by the average of two numbers, the first of which is the total number of compressor units in our fleet at the beginning of such period and the second of which is the total number of compressor units in our fleet at the end of such period.

Net Increase in Compressor Fleet Size. We define the net increase in our compressor fleet size during a given period of time as the difference between the number of compressor units we placed into service, less the number of compressor units we removed from service. Management uses this metric to evaluate our operating performance and specifically the effectiveness of our marketing efforts. Additional information regarding changes in the size of our compressor fleet for the year ended December 31, 2012, is provided within the results of operations sections below.

Items Impacting the Comparability of Our Predecessor's Results of Operations to Our Results of Operations

Results of our operations after the June 20, 2011, completion date of the Offering may not be comparable to the historical results of operations of our Predecessor for the following reasons:

A significant majority of our production enhancement services is being performed by our non-corporate subsidiary, Compressco Partners Operating, LLC, pursuant to contracts that our counsel has concluded generate qualifying income under Section 7704 of the Internal Revenue Code, or "qualifying income". Our corporate subsidiary, Compressco Partners Sub, Inc., conducts substantially all of our operations that our counsel has not concluded generate qualifying income, and it pays U.S. federal income tax with respect to such operations. We strive to ensure that all new domestic contracts are entered into by our Operating LLC and generate qualifying income. Our international compression services operations are conducted primarily through foreign subsidiaries that are subject to local country taxation.


The contracts pursuant to which we provide production enhancement services that our counsel has concluded generate qualifying income generally require us to pay related ad valorem taxes and insurance expenses related to the equipment utilized in such services.

The results of our Predecessor's operations include an allocation of certain general and administrative expenses from TETRA. We are charged for certain general and administrative costs in accordance with the Omnibus Agreement we entered into with TETRA and our General Partner on June 20, 2011, and the amount of such charges reflected in our financial results could vary from the amounts of similar allocations included in our Predecessor's historical results of operations.

The results of our Predecessor's operations include interest expense associated with revolving credit indebtedness owed to an affiliate of TETRA. Under this indebtedness, which was refinanced in December 2010, our Predecessor could borrow up to $150 million at an interest rate of 7.5% per annum. The outstanding principal balance prior to the completion of the Offering was $145.1 million. We assumed approximately $32.2 million of this indebtedness (as partial consideration for the assets we acquired from TETRA in connection with the Offering), and this $32.2 million balance was repaid in full from the proceeds of the Offering. The balance of this intercompany indebtedness was repaid prior to the Offering.

On June 24, 2011, we entered into a credit agreement, and we borrowed $10.1 million under that credit agreement during the second half of 2012. As of December 31, 2012, we have availability under our revolving credit facility of $9.6 million, based upon a $19.6 million borrowing capacity and the $10.1 million outstanding balance, and the credit agreement includes an uncommitted $20,0 million expansion feature. Borrowings bear interest at a rate equal to three month British Bankers Association LIBOR (adjusted to reflect any required bank reserves) plus a margin of 2.25% per annum. The weighted average interest rate on outstanding borrowings at December 31, 2012, was 2.5986% per annum.

We incur additional 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 our unitholders, annual financial audits, Schedule K-1 preparation and distribution, investor relations activities, registrar and transfer agent fees, legal fees, director and executive officer liability insurance costs, and director compensation.

Given our partnership structure and cash distribution policy, we distribute all of our "available cash" from "operating surplus" or "capital surplus" (as such terms are defined in our partnership agreement) at the end of each quarter.

We are not a restricted subsidiary of TETRA for purposes of TETRA's credit facility with J.P. Morgan Chase Bank, N.A., as Administrative Agent, which we refer to as the "TETRA Credit Facility," or under several series of notes that TETRA has issued pursuant to certain note purchase agreements in April 2006, April 2008, and October 2010, which we collectively refer to as the "TETRA Senior Notes." As such, our ability to take certain actions, including incurring indebtedness, granting liens on our assets, and making acquisitions and capital expenditures, will not be restricted by the TETRA Credit Facility and the TETRA Senior Notes.

Critical Accounting Policies and Estimates

This discussion and analysis of our financial condition and results of operations is based upon our consolidated financial statements. We prepared these financial statements in conformity with United States generally accepted accounting principles. In preparing our consolidated financial statements, we make assumptions, estimates, and judgments 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 these estimates on historical experience, available information, and various other assumptions that we believe are reasonable under the circumstances. We periodically evaluate these estimates and judgments, including those related to potential impairments of long-lived assets (including goodwill), the useful life of long-lived assets, the collectability of accounts receivable, and the allocation of certain parent company administrative costs. These judgments and estimates may change as new events occur, as new information is acquired, and with changes in our operating environment. Actual results are likely to differ from current estimates, and those differences may be material. The following critical accounting policies reflect the most significant judgments and estimates used in the preparation of our financial statements.


Impairment of Long-Lived Assets

We conduct a determination of impairment of long-lived assets periodically whenever indicators of impairment are present. If such indicators are present, the determination of the amount of impairment is based on our judgments as to the future operating cash flows to be generated from these assets throughout their estimated useful lives. If an impairment of a long-lived asset is warranted, we estimate the fair value of the asset based on a present value of these cash flows or the value that could be realized from disposing of the asset in a transaction between market participants. The estimation of future operating cash flows is inherently imprecise, and, if our estimates are materially incorrect, it could result in an overstatement or understatement of our financial position and results of operations. In particular, the oil and gas industry is cyclical, and estimates of the period over which future cash flows will be generated, as well as the predictability of these cash flows, can have an additional significant impact on the carrying value of these assets and, particularly in periods of prolonged down cycles, may result in impairment charges. Historically, our business has not experienced significant impairments of its long-lived compressor assets, as utilized compressor units generate cash flows sufficient to support their carrying values. Unutilized assets are well maintained and evaluated on a regular basis. Serviceable compressor units that are currently unutilized are anticipated to be placed in service in future years as demand increases or as fully depreciated units in service are replaced. Sales of compressor units have historically been at selling prices in excess of asset cost. While we have not experienced significant impairments in the past, impairments of our long-lived assets could occur in the future, particularly in the event of a significant and sustained deterioration of natural gas production.

Impairment of Goodwill

Goodwill represents the excess of cost over the fair value of the net assets of businesses acquired in purchase transactions. We perform a goodwill impairment test on an annual basis or whenever indicators of impairment are present. We perform the annual test of goodwill impairment following the fourth quarter of each year. Our annual assessment for goodwill impairment begins with a qualitative assessment of whether it is "more likely than not" that the fair value of our business is less than its carrying value. This qualitative assessment requires the evaluation, based on the weight of evidence, of the significance of all identified events and circumstances. Based on this qualitative assessment, we determined that it was not "more likely than not" that the fair value of our business was less than its carrying values as of December 31, 2012. If the qualitative analysis indicates that it is "more likely than not" that our business' fair value is less than its carrying value, the resulting goodwill impairment test would consist of a two-step accounting test being performed. The first step of the impairment test, if required, is to compare the estimated fair value with the recorded net book value (including goodwill) of our business. If the estimated fair value is higher than the recorded net book value, no impairment is deemed to exist and no further testing is required. If, however, the estimated fair value is below the recorded net book value, then a second step must be performed to determine the goodwill impairment required, if any. In this second step, the estimated fair value from the first step is used as the purchase price in a hypothetical acquisition. Purchase business combination accounting rules are followed to determine a hypothetical purchase price allocation to assets and liabilities. The residual amount of goodwill that results from this hypothetical purchase price allocation is compared to the recorded amount of goodwill, and the recorded amount is written down to the hypothetical amount, if lower.

Bad Debt Reserves

We calculate reserves for bad debts on a specific identification basis, by estimating whether or not specific accounts receivable will be collected. Such estimates of future collectability may be incorrect, which could result in the recognition of unanticipated bad debt expenses in future periods. A significant portion of our revenues come from oil and gas exploration and production companies, and, historically, our estimates of uncollectible receivables have proven reasonably accurate. However, if due to adverse circumstances, certain customers are unable to repay some or all of the amounts owed us, an additional bad debt allowance may be required, and such amount may be material.

Depreciation

Property and equipment are carried at cost. We compute depreciation for financial reporting purposes on the straight-line basis using estimated useful lives and salvage values. Estimates of the useful lives and salvage values of our property and equipment, including our compressor fleet, are inherently imprecise and subject to errors in judgment, particularly due to unexpected operating conditions, quality of materials and components, and changing market conditions. Although our estimates of useful lives and salvage values have proven reasonably


accurate in the past, if the actual useful life of property and equipment is less than the estimate used for purposes of computing depreciation expense, we could experience an acceleration in depreciation expense, which could result in a negative impact in our results of operations.

Equity-Based Compensation

Our general partner adopted the Compressco Partners, L.P. 2011 Long Term Incentive Plan, which provides for the granting of restricted units and other equity-based awards. The compensation cost for all equity-based grants under the 2011 Long Term Incentive Plan is based on the grant date fair value estimated in accordance with Accounting Standards Codification 718 -"Compensation - Stock Compensation." We estimate expected pre-vesting forfeitures based on actual historical pre-vesting forfeitures over the most recent periods for the expected term. Prior to the Offering, TETRA made grants to certain of our Predecessor's employees of stock options and restricted shares of TETRA common stock. Compensation cost associated with such outstanding awards to our Predecessor's employees was included in the financial statements of our Predecessor. All of these estimates are inherently imprecise and may result in compensation cost being recorded that is materially different from the actual fair value of the awards granted. While the assumptions for volatility and pre-vesting forfeiture rate are updated with each year's option-valuing process, there have not been significant revisions made in these estimates to date.

Methodologies Used to Allocate Parent Company Administrative Costs

TETRA provides us with centralized corporate functions such as legal, accounting and financial reporting, treasury, insurance administration, claims processing, risk management, health, safety and environmental, information technology, human resources, credit, payroll, internal audit, taxes and other corporate services. Since the Offering, these services are performed pursuant to the Omnibus Agreement between us and TETRA. Prior to June 20, 2011, our Predecessor's financial statements reflected an estimated allocation of the cost of TETRA's general and administrative costs incurred on our behalf. TETRA employed various allocation methodologies to determine the general and administrative costs incurred by TETRA and recorded in our Predecessor's financial statements presented herein. The allocation methodologies were based on an estimate by each TETRA corporate function of the time spent on behalf of our business. While the use of incorrect cost allocation estimates could significantly impact the levels of general and administrative expenses of our Predecessor, we believe that the methodologies and estimates used to allocate indirect costs were reasonable. If certain general and administrative expenses were allocated using different methodologies, the results of our Predecessor's operations could have been significantly different from those presented herein.


Results of Operations

The following data should be read in conjunction with the Consolidated Financial Statements and the associated Notes contained elsewhere in this document.

                                Year Ended December 31,                  Period-to-Period Change
Combined Results of
Operations                 2012           2011           2010        2012 vs. 2011     2011 vs. 2010
                                                       (In Thousands)
Revenues:
Compression and other
services               $ 102,260      $  81,979      $  77,396      $    20,281       $       4,583
Sales of compressors
and parts                  6,322         13,200          4,017           (6,878)              9,183
Total revenues         $ 108,582      $  95,179      $  81,413      $    13,403       $      13,766
Cost of revenues:
Cost of compression
and other
services               $  52,330      $  42,087      $  35,424      $    10,243       $       6,663
Cost of compressors
. . .
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