UNITED STATES SECURITIES AND EXCHANGE COMMISSION


WASHINGTON, D.C. 20549





Form 10-Q





(MARK ONE)





R
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE QUARTERLY PERIOD ENDED June 30, 2010£
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934FOR THE TRANSITION PERIOD FROM____________TO____________.





Commission File No. 001-33078





EXTERRAN PARTNERS, L.P.


(Exact name of registrant as specified in its charter)





Delaware
22-3935108(State or Other Jurisdiction of
(I.R.S. EmployerIncorporation or Organization)
Identification No.)





16666 Northchase DriveHouston, Texas
77060(Address of principal executive offices)
(Zip Code)





(281) 836-7000


(Registrant’s telephone number, including area code)





Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £





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





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





Large accelerated filer £
Accelerated filer R
Non-accelerated filer £
Smaller reporting company £(Do not check if a smaller reporting company)





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





As of July 30, 2010, there were 17,559,582 common units and 6,325,000 subordinated units outstanding.














TABLE OF CONTENTS





PagePART I.  FINANCIAL INFORMATIONItem 1.  Financial Statements
3Condensed Consolidated Balance Sheets
3Condensed Consolidated Statements of Operations
4Condensed Consolidated Statements of Comprehensive Income (Loss)
5Condensed Consolidated Statements of Partners’ Capital
6Condensed Consolidated Statements of Cash Flows
7Notes to Unaudited Condensed Consolidated Financial Statements
8Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
18Item 3.  Quantitative and Qualitative Disclosures About Market Risk
28Item 4.  Controls and Procedures
28PART II.  OTHER INFORMATIONItem 1.  Legal Proceedings
29Item 1A.  Risk Factors
29Item 6.  Exhibits
31SIGNATURES
32








2


PART I.  FINANCIAL INFORMATION





ITEM 1.  Financial Statements





EXTERRAN PARTNERS, L.P.


CONDENSED CONSOLIDATED BALANCE SHEETS


(in thousands, except for unit amounts)


(unaudited)





June 30, 2010


December 31, 2009ASSETSCurrent assets:Cash and cash equivalents

$
64


$
203Restricted cash


971



431Accounts receivable, trade, net of allowance of $174 and $714, respectively


23,370



23,210Total current assets


24,405



23,844Compression equipment


790,850



770,703Accumulated depreciation


(237,250
)


(212,776
)Net compression equipment


553,600



557,927Goodwill


124,019



124,019Interest rate swaps


—



262Intangibles and other assets, net


10,078



11,174Total assets

$
712,102


$
717,226LIABILITIES AND PARTNERS’ CAPITALCurrent liabilities:Accounts payable, trade

$
5


$
—Due to affiliates, net


8,584



1,293Accrued liabilities


8,946



7,198Accrued interest


1,947



2,030Current portion of interest rate swaps


9,514



9,229Total current liabilities


28,996



19,750Long-term debt


430,500



432,500Interest rate swaps


5,202



6,668Total liabilities


464,698



458,918Commitments and contingencies (Note 10)Partners’ capital:Limited partner units:Common units, 17,575,338 and 17,541,965 units issued and outstanding


288,126



298,010Subordinated units, 6,325,000 units issued and outstanding


(34,833
)


(33,194
)General partner units, 2% interest with 486,243 units issued and outstanding


8,323



8,457Accumulated other comprehensive loss


(13,938
)


(14,857
)Treasury units, 15,756 and 8,426 common units, respectively


(274
)


(108
)Total partners’ capital


247,404



258,308Total liabilities and partners’ capital

$
712,102


$
717,226





The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.





3


EXTERRAN PARTNERS, L.P.


CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS


(in thousands, except per unit amounts)


(unaudited)








Three Months Ended June 30,


Six Months Ended June 30,2010


2009


2010


2009Revenue

$
53,790


$
45,077


$
106,500


$
93,310Costs and expenses:Cost of sales (excluding depreciation and amortization expense)


29,126



20,176



54,977



42,358Depreciation and amortization


11,763



8,678



23,641



17,012Long-lived asset impairment


—



2,995



231



2,995Selling, general and administrative


8,519



5,551



16,214



11,552Interest expense


5,724



4,805



11,416



9,624Other (income) expense, net


(170
)


—



(406
)


27Total costs and expenses


54,962



42,205



106,073



83,568Income (loss) before income taxes


(1,172
)


2,872



427



9,742Income tax expense


173



134



346



283Net income (loss)

$
(1,345
)

$
2,738


$
81


$
9,459General partner interest in net income (loss)

$
285


$
304


$
625


$
687Common units interest in net income (loss)

$
(1,198
)

$
1,628


$
(400
)

$
5,867Subordinated units interest in net income (loss)

$
(432
)

$
806


$
(144
)

$
2,905Weighted average common units outstanding:Basic


17,560



12,782



17,553



12,768Diluted


17,560



12,788



17,553



12,771Weighted average subordinated units outstanding:Basic


6,325



6,325



6,325



6,325Diluted


6,325



6,325



6,325



6,325Earnings (loss) per common unit:Basic

$
(0.07
)

$
0.13


$
(0.02
)

$
0.46Diluted

$
(0.07
)

$
0.13


$
(0.02
)

$
0.46Earnings (loss) per subordinated unit:Basic

$
(0.07
)

$
0.13


$
(0.02
)

$
0.46Diluted

$
(0.07
)

$
0.13


$
(0.02
)

$
0.46





The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.





4


EXTERRAN PARTNERS, L.P.


CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)


(in thousands)


(unaudited)





Three Months Ended June 30,

Six Months Ended June 30,2010


2009


2010


2009Net income (loss)

$
(1,345
)

$
2,738


$
81


$
9,459Other comprehensive income:Interest rate swap gain


1,093



2,319



919



1,791Comprehensive income (loss)

$
(252
)

$
5,057


$
1,000


$
11,250





The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.





5


EXTERRAN PARTNERS, L.P.


CONDENSED CONSOLIDATED STATEMENTS OF PARTNERS’ CAPITAL


(in thousands, except for unit amounts)


(unaudited)





Partners’ Capital





AccumulatedGeneral Partner


Treasury


OtherCommon Units


Subordinated Units


Units


Units


Comprehensive$


Units



$


Units



$


Units



$


Units


Loss


TotalBalance, December 31, 2008

$
221,090



12,767,462


$
(35,518
)


6,325,000


$
6,805



389,642


$
—



—


$
(16,909
)

$
175,468Issuance of units for vesting of phantom units






26,150































—Transaction costs for registration of units


174



































174Contribution of capital


2,586







3,696







188



















6,470Excess of purchase price of equipment over Exterran Holdings’ cost of equipment


(53
)






(75
)






(5
)


















(133
)Cash distributions


(11,816
)






(5,851
)






(868
)


















(18,535
)Unit based compensation expense


511



































511Interest rate swap gain


































1,791



1,791Net income


5,867







2,905







687



















9,459Balance, June 30, 2009

$
218,359



12,793,612


$
(34,843
)


6,325,000


$
6,807



389,642


$
—



—


$
(15,118
)

$
175,205





Partners’ Capital





AccumulatedGeneral Partner


Treasury


OtherCommon Units


Subordinated Units


Units


Units


Comprehensive$


Units



$


Units



$


Units



$


Units


Loss


TotalBalance, December 31, 2009

$
298,010



17,541,965


$
(33,194
)


6,325,000


$
8,457



486,243


$
(108
)


(8,426
)

$
(14,857
)

$
258,308Issuance of units for vesting of phantom units






33,373































—Treasury units purchased


























(166
)


(7,330
)






(166
)Transaction costs for registration of units


(4
)






(2
)


























(6
)Contribution of capital


6,873







4,742







356



















11,971Excess of purchase price of equipment over Exterran Holdings’ cost of equipment


(558
)






(385
)






(29
)


















(972
)Cash distributions


(16,233
)






(5,850
)






(1,086
)


















(23,169
)Unit based compensation expense


438



































438Interest rate swap gain


































919



919Net income (loss)


(400
)






(144
)






625



















81Balance, June 30, 2010

$
288,126



17,575,338


$
(34,833
)


6,325,000


$
8,323



486,243


$
(274
)


(15,756
)

$
(13,938
)

$
247,404








The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.





6


EXTERRAN PARTNERS, L.P.


CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS


(in thousands)


(unaudited)





Six Months Ended June 30,2010


2009Cash flows from operating activities:Net income

$
81


$
9,459Adjustments to reconcile net income to cash provided by operating activities:Depreciation and amortization


23,641



17,012Long-lived asset impairment


231



2,995Amortization of debt issuance cost


471



186Amortization of fair value of acquired interest rate swaps


74



75Unit based compensation expense


448



365Provision for doubtful accounts


32



376Gain on sale of compression equipment


(417
)


—Changes in assets and liabilities:Accounts receivable, trade


(192
)


3,013Other assets


—



94Accounts payable, trade


5



(90
)Other liabilities


1,648



510Net cash provided by operating activities


26,022



33,995Cash flows from investing activities:Capital expenditures


(17,541
)


(11,353
)Proceeds from the sale of compression equipment


793



—Increase in restricted cash


(540
)


—Decrease in amounts due from affiliates, net


—



108Net cash used in investing activities


(17,288
)


(11,245
)Cash flows from financing activities:Borrowings under long-term debt


7,000



6,500Repayments on long-term debt


(9,000
)


(17,500
)Distributions to unitholders


(23,169
)


(18,535
)Purchase of treasury units


(166
)


—Capital contribution from limited and general partner


9,171



4,105Increase in amounts due to affiliates, net


7,291



—Net cash used in financing activities


(8,873
)


(25,430
)Net decrease in cash and cash equivalents


(139
)


(2,680
)Cash and cash equivalents at beginning of period


203



3,244Cash and cash equivalents at end of period

$
64


$
564Supplemental disclosure of cash flow information:Non-cash capital contribution (distribution) from limited and general partner

$
198


$
(703
)Compression equipment acquired/exchanged, net

$
2,602


$
3,068





The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.





7


EXTERRAN PARTNERS, L.P.


NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS





1.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES





Organization





The accompanying unaudited condensed consolidated financial statements of Exterran Partners, L.P. (“we,” “us” or “our”) included herein have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S.”) for interim financial information and the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the U.S. (“GAAP”) are not required in these interim financial statements and have been condensed or omitted. It is the opinion of management that the information furnished includes all adjustments, consisting only of normal recurring adjustments, that are necessary to present fairly our consolidated financial position, results of operations and cash flows for the periods indicated. The accompanying unaudited condensed consolidated financial statements should be read in conjunction with the consolidated financial statements presented in our Annual Report on Form 10-K for the year ended December 31, 2009. That report contains a more comprehensive summary of our accounting policies. These interim results are not necessarily indicative of results for a full year.





Exterran General Partner, L.P. is our general partner and an indirect wholly-owned subsidiary of Exterran Holdings, Inc. (individually, and together with its wholly-owned subsidiaries, “Exterran Holdings”). As Exterran General Partner, L.P. is a limited partnership, its general partner, Exterran GP LLC, conducts our business and operations, and the board of directors and officers of Exterran GP LLC make decisions on our behalf.





Fair Value of Financial Instruments





Our financial instruments consist of cash, restricted cash, trade receivables and payables, interest rate swaps and long-term debt. At June 30, 2010 and December 31, 2009, the estimated fair values of such financial instruments, except for debt, approximated their carrying values as reflected in our condensed consolidated balance sheets. As a result of the current market conditions, we believe that the fair value of our debt does not approximate its carrying value as of June 30, 2010 and December 31, 2009 because the applicable margin on our debt was below the market rates as of these dates. The fair value of our debt has been estimated based on similar debt transactions that occurred near June 30, 2010 and December 31, 2009, respectively. A summary of the fair value and carrying value of our debt is shown in the table below (in thousands):





As of June 30,2010


As of December 31,2009Carrying

Amount


Fair

Value


Carrying

Amount


Fair

ValueLong-term debt

$
430,500


$
421,000


$
432,500


$
418,000





Earnings Per Common and Subordinated Unit





The computations of earnings per common and subordinated unit are based on the weighted average number of common and subordinated units, respectively, outstanding during the applicable period. Our subordinated units meet the definition of a participating security and therefore we are required to use the two-class method in the computation of earnings per unit. Basic earnings per common and subordinated unit are determined by dividing net income allocated to the common units and subordinated units, respectively, after deducting the amount allocated to our general partner (including distributions to our general partner on its incentive distribution rights), by the weighted average number of outstanding common and subordinated units, respectively, during the period.





When computing earnings per common and subordinated unit under the two-class method in periods when earnings are greater than distributions, earnings are allocated to the general partner, common and subordinated units based on how our partnership agreement would allocate earnings if the full amount of earnings for the period had been distributed. This allocation of net income does not impact our total net income, consolidated results of operations or total cash distributions; however, it may result in our general partner being allocated additional incentive distributions for purposes of our earnings per unit calculation, which could reduce net income per common and subordinated unit. However, as defined in our partnership agreement, we determine cash distributions based on available cash and determine the actual incentive distributions allocable to our general partner based on actual distributions. When computing earnings per common and subordinated unit, the amount of the assumed incentive distribution rights is deducted from net income and allocated to our general partner for the period to which the calculation relates. The remaining amount of net income, after deducting


8





the assumed incentive distribution rights, is allocated between the general partner, common and subordinated units based on how our partnership agreement allocates net income.





When computing earnings per common and subordinated unit under the two-class method in periods when distributions are greater than earnings, the excess of distributions over earnings is allocated to the general partner, common and subordinated units based on how our partnership agreement allocates net losses. The amount of the incentive distribution rights is deducted from net income and allocated to our general partner for the period to which the calculation relates. The remaining amount of net income, after deducting the incentive distribution rights, is allocated between the general partner, common and subordinated units based on how our partnership agreement allocates net losses.





The potentially dilutive securities issued by us include unit options and phantom units, neither of which requires an adjustment to the amount of net income (loss) used for dilutive earnings (loss) per unit purposes. The table below indicates the potential common units that were included in computing the dilutive potential common units used in diluted income (loss) per common unit (in thousands):





Three Months Ended June 30,


Six Months Ended June 30,2010


2009


2010


2009Weighted average limited partner units outstanding — used in basic income (loss) per common unit


17,560



12,782



17,553



12,768Net dilutive potential common units issuable:Unit options


—



**



—



**Phantom units


**



6



**



3Weighted average limited partner units and dilutive potential limited partner units — used in diluted income (loss) per limited partner unit


17,560



12,788



17,553



12,771


____________





**
Excluded from diluted income (loss) per limited partner unit as the effect would have been anti-dilutive.





The table below indicates the potential number of limited partner units that were excluded from net dilutive potential units of limited partner units as their effect would have been anti-dilutive (in thousands):





Three Months Ended June 30,


Six Months Ended June 30,2010


2009


2010


2009Net dilutive potential common units issuable:Unit options


—



581



—



581Phantom units


85



—



76



—Net dilutive potential common units issuable


85



581



76



581





Reclassifications





Certain amounts in the prior financial statements have been reclassified to conform to the 2010 financial statement classification. These reclassifications have no impact on our consolidated results of operations, cash flows or financial position.





2.  NOVEMBER 2009 CONTRACT OPERATIONS ACQUISITION





In November 2009, we acquired from Exterran Holdings contract operations customer service agreements with 18 customers and a fleet of approximately 900 compressor units used to provide compression services under those agreements having a net book value of $137.2 million, net of accumulated depreciation of $47.2 million, and comprising approximately 270,000 horsepower, or 6% (by then available horsepower) of the combined U.S. contract operations business of Exterran Holdings and us (the “November 2009 Contract Operations Acquisition”) for approximately $144.0 million. In connection with this acquisition, we assumed $57.2 million of long-term debt from Exterran Holdings and issued to Exterran Holdings approximately 4.7 million common units and approximately 97,000 general partner units. Concurrent with the closing of the November 2009 Contract Operations Acquisition, we borrowed $28.0 million and $30.0 million under our revolving credit facility and asset-backed securitization facility, respectively, which together were used to repay the debt assumed from Exterran Holdings in the acquisition and to pay other costs incurred in the acquisition.





In connection with this acquisition, we were allocated $4.4 million finite life intangible assets of Exterran Holdings’ North America contract operations segment. The amounts allocated were based on the ratio of fair value of the net assets transferred to us to the total


9





fair value of Exterran Holdings’ North America contract operations segment. The amount of finite life intangible assets included in the November 2009 Contract Operations Acquisition is comprised of $4.2 million associated with customer relationships and $0.2 million associated with customer contracts. These intangible assets are being amortized through 2024 and 2016, respectively, based on the present value of expected income to be realized from these intangible assets.





An acquisition of a business from an entity under common control is generally accounted for under GAAP by the acquirer with retroactive application as if the acquisition date was the beginning of the earliest period included in the financial statements. Giving retroactive effect to the November 2009 Contract Operations Acquisition was impracticable because such retroactive application would have required significant assumptions in a prior period that cannot be substantiated. Accordingly, our financial statements include the assets acquired, liabilities assumed, revenues and direct operating expenses associated with the acquisition beginning on the date of such acquisition. However, the preparation of pro forma financial information allows for certain assumptions that do not meet the standards of financial statements prepared in accordance with GAAP.





Unaudited Pro Forma Financial Information





Pro forma financial information for the three and six months ended June 30, 2009 has been included to give effect to the significant expansion of our compressor fleet and service contracts as a result of the November 2009 Contract Operations Acquisition. The transactions are presented in the pro forma financial information as though the transactions had occurred as of January 1, 2009.





The unaudited pro forma financial information for the three and six months ended June 30, 2009 reflects the following transactions:





•
the contribution of customer service contracts and equipment used to provide compression services under those contracts transferred in the November 2009 Contract Operations Acquisition from Exterran Holdings to us;





•
our assumption of $57.2 million of Exterran Holdings’ debt;





•
the issuance of our common units and general partner units to Exterran Holdings’ wholly-owned subsidiaries; and





•
our borrowing of $28.0 million and $30.0 million under our senior secured credit facility and asset-backed securitization facility, respectively, and use of those proceeds to repay the debt assumed from Exterran Holdings and to pay other costs incurred in the acquisition.





The unaudited pro forma financial information below is presented for informational purposes only and is not necessarily indicative of the results of operations that would have occurred had the transaction been consummated at the beginning of the period presented, nor is it necessarily indicative of future results. The unaudited pro forma consolidated financial information below was derived by adjusting our historical financial statements.





The following table presents pro forma financial information for the three and six months ended June 30, 2009 (in thousands, except per unit amounts):





Three MonthsEnded

June 30, 2009


Six MonthsEnded

June 30, 2009Total revenues

$
60,342


$
124,669Net income

$
6,035


$
16,786Basic earnings per common and subordinated limited partner unit

$
0.23


$
0.66Diluted earnings per common and subordinated limited partner unit

$
0.23


$
0.66





Pro forma net income per limited partner unit is determined by dividing the pro forma net income that would have been allocated to the common and subordinated unitholders by the weighted average number of common and subordinated units expected to be outstanding after the completion of the transactions included in the pro forma consolidated financial statements. All units were assumed to have been outstanding since the beginning of the periods presented. Pursuant to our partnership agreement, to the extent that the quarterly distributions exceed certain targets, our general partner is entitled to receive certain incentive distributions that will result in more net income proportionately being allocated to our general partner than to the holders of our common and subordinated units. The pro forma net earnings per limited partner unit calculations reflect pro forma incentive distributions to our general partner, including an additional reduction of net income allocable to our limited partners of approximately $63,000 and $0.1 million for the three and six months ended June 30, 2009, respectively, which includes the amount of additional incentive distributions that would have occurred during the period.


10





3.  RELATED PARTY TRANSACTIONS





We are a party to an omnibus agreement with Exterran Holdings and others (as amended and restated, the “Omnibus Agreement”), the terms of which include, among other things:





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





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





•
the terms under which we, Exterran Holdings, and our respective affiliates may transfer compression equipment among one another to meet our respective contract operations services obligations;





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





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





•
Exterran Holdings’ obligation to indemnify us for certain liabilities and our obligation to indemnify Exterran Holdings for certain liabilities.





The Omnibus Agreement will terminate upon a change of control of our general partner or the removal or withdrawal of our general partner, and certain provisions of the Omnibus Agreement will terminate upon a change of control of Exterran Holdings.





During the six months ended June 30, 2010, pursuant to the terms of the Omnibus Agreement, we transferred ownership of 65 compressor units, totaling approximately 35,700 horsepower with a net book value of approximately $16.2 million, to Exterran Holdings. In exchange, Exterran Holdings transferred ownership to us of 134 compressor units, totaling approximately 31,500 horsepower with a net book value of approximately $18.8 million. During the six months ended June 30, 2009, pursuant to the terms of the Omnibus Agreement, we transferred ownership of 48 compressor units, totaling approximately 24,000 horsepower with a net book value of approximately $12.0 million, to Exterran Holdings. In exchange, Exterran Holdings transferred ownership to us of 108 compressor units, totaling approximately 27,100 horsepower with a net book value of approximately $15.1 million. During the six months ended June 30, 2010 and 2009, we recorded equity contributions of approximately $2.6 million and $3.1 million, respectively, related to the differences in net book value on the compression equipment that was exchanged with us. No customer contracts were included in the transfers. Under the terms of the Omnibus Agreement, such transfers must be of equal appraised value, as defined in the Omnibus Agreement, with any difference being settled in cash. As a result, we paid a nominal amount to Exterran Holdings for the difference in fair value of the equipment in connection with the transfers. We recorded the compressor units received at the historical book basis of Exterran Holdings. The units we received from Exterran Holdings were being utilized to provide services to our customers on the date of the transfers and, prior to the transfers, had been leased by us from Exterran Holdings. The units we transferred to Exterran Holdings were being utilized to provide services to customers of Exterran Holdings on the date of the transfers, and prior to the transfers had been leased by Exterran Holdings from us.





Under the Omnibus Agreement, Exterran Holdings has agreed that, for a period that will terminate on December 31, 2010, our obligation to reimburse Exterran Holdings for (i) any cost of sales that it incurs in the operation of our business will be capped (after taking into account any such costs we incur and pay directly); and (ii) any cash selling, general and administrative (“SG&A”) costs allocated to us will be capped (after taking into account any such costs we incur and pay directly). Cost of sales were capped at $21.75 per operating horsepower per quarter from July 30, 2008 through June 30, 2010. SG&A costs were capped at $6.0 million per quarter from July 30, 2008 through November 9, 2009, and at $7.6 million per quarter from November 10, 2009 through June 30, 2010. These caps may be subject to future adjustment or termination in connection with expansions of our operations through the acquisition or construction of new assets or businesses.





For the three months ended June 30, 2010 and 2009, our cost of sales exceeded the cap provided in the Omnibus Agreement by $5.7 million and $1.5 million, respectively. For the six months ended June 30, 2010 and 2009, our cost of sales exceeded the cap provided in the Omnibus Agreement by $8.5 million and $4.1 million, respectively. For both the three and six months ended June 30, 2010, our SG&A expenses exceeded the cap provided in the Omnibus Agreement by $0.7 million. For the three and six months ended June 30,


11





2009, our SG&A expenses did not exceed the cap provided in the Omnibus Agreement. The excess amounts over the caps are included in the consolidated statements of operations as cost of sales or SG&A expense. The cash received for the amounts over the caps has been accounted for as a capital contribution in our consolidated balance sheets and consolidated statements of cash flows.




Pursuant to the Omnibus Agreement, we are permitted to purchase newly fabricated compression equipment from Exterran Holdings or its affiliates at Exterran Holdings’ cost to fabricate such equipment plus a fixed margin of 10%, which may be modified with the approval of Exterran Holdings and the conflicts committee of our board of directors. During the six months ended June 30, 2010 and 2009, we purchased $9.8 million and $1.3 million, respectively, of new compression equipment from Exterran Holdings. Under GAAP, transfers of assets and liabilities between entities under common control are to be initially recorded on the books of the receiving entity at the carrying value of the transferor. Any difference between consideration given and the carrying value of the assets or liabilities is treated as an equity distribution or contribution. Transactions between us and Exterran Holdings and its affiliates are transactions between entities under common control. As a result, the equipment purchased during the six months ended June 30, 2010 and 2009 was recorded in our consolidated balance sheet as property, plant and equipment of $8.8 million and $1.2 million, respectively, which represents the carrying value of the Exterran Holdings affiliates that sold it to us, and as a distribution of equity of $1.0 million and $0.1 million, respectively, which represents the fixed margin we paid above the carrying value in accordance with the Omnibus Agreement. During the six months ended June 30, 2010 and 2009, Exterran Holdings contributed to us $0.2 million and $1.1 million, respectively, primarily related to the completion of overhauls on compression equipment that was exchanged with us or contributed to us and where overhauls were in progress on the date of exchange or contribution.





Pursuant to the Omnibus Agreement, in the event that Exterran Holdings determines in good faith that there exists a need on the part of Exterran Holdings’ contract operations services business or on our part to lease compression equipment between Exterran Holdings and us to fulfill the compression services obligations of either Exterran Holdings or us, such equipment may be leased if it will not cause us to breach any existing compression services contracts or to suffer a loss of revenue under an existing compression services contract or to incur any unreimbursed costs. At June 30, 2010, we had equipment on lease to Exterran Holdings with an aggregate cost and accumulated depreciation of $8.2 million and $1.8 million, respectively.





For the six months ended June 30, 2010 and 2009, we had revenues of $0.6 and $0.5 million, respectively, from Exterran Holdings related to the lease of our compression equipment. For the six months ended June 30, 2010 and 2009, we had cost of sales of $6.7 million and $5.4 million, respectively, with Exterran Holdings related to the lease of Exterran Holding’s compression equipment.





4.  DEBT





Long-term debt consisted of the following (in thousands):





June 30, 2010


December 31, 2009Revolving credit facility due October 2011

$
283,000


$
285,000Term loan due October 2011


117,500



117,500Asset-backed securitization facility due July 2013


30,000



30,000Long-term debt

$
430,500


$
432,500





As of June 30, 2010, we had undrawn capacity of $32.0 million and $120.0 million under our revolving credit facility and our asset-backed securitization facility, respectively. Under our senior secured credit facility, we have limitations on our Total Debt to EBITDA ratio as discussed below. Due to this limitation, only $79.3 million of the combined $152.0 million of undrawn capacity under both facilities would have been available for additional borrowings as of June 30, 2010.





Our senior secured credit facility contains various covenants with which we must comply, including restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional debt or sell assets, make certain investments and acquisitions, grant liens and pay dividends and distributions. We must maintain various consolidated financial ratios, including a ratio of EBITDA (as defined in the credit agreement) to Total Interest Expense (as defined in the credit agreement) of not less than 2.5 to 1.0, and a ratio of Total Debt (as defined in the credit agreement) to EBITDA of not greater than 5.0 to 1.0. Our senior secured credit facility allows for our Total Debt to EBITDA ratio to be increased from 5.0 to 1.0 to 5.5 to 1.0 during a quarter when an acquisition closes meeting certain thresholds and for the following two quarters after the acquisition closes. Therefore, because the November 2009 Contract Operations Acquisition closed in the fourth quarter of 2009, the maximum allowed ratio of Total Debt to EBITDA was increased from 5.0 to 1.0 to 5.5 to 1.0 for the quarters ending December 31, 2009, March 31, 2010 and June 30, 2010, and is scheduled to revert back to 5.0 to 1.0 for the quarter ending September 30, 2010. However, assuming we are able to close the August 2010 Contract Operations Acquisition (as defined in Note 11) in the third quarter of 2010 as planned, we expect that the maximum allowed ratio of Total Debt to


12





EBITDA will remain at 5.5 to 1.0 for the quarters ending September 30, 2010, December 31, 2010 and March 31, 2011, reverting back to 5.0 to 1.0 for the quarter ending June 30, 2011. As of June 30, 2010, we maintained a 4.3 to 1.0 EBITDA to Total Interest Expense ratio and a 4.7 to 1.0 Total Debt to EBITDA ratio. If we experience a deterioration in the demand for our services, and we are unable to consummate further acquisitions from Exterran Holdings, including the August 2010 Contract Operations Acquisition in the third quarter of 2010, amend our senior secured credit facility or restructure our debt, we estimate that we could be in violation of the maximum Total Debt to EBITDA covenant ratio contained in our senior secured credit facility as early as 2010. In addition, if we experienced a material adverse effect on our assets, liabilities, financial condition, business, operations or prospects that, taken as a whole, impact our ability to perform our obligations under our senior secured credit facility, this could lead to a default under that facility. As of June 30, 2010, we were in compliance with all financial covenants under the senior secured credit facility.





5.  CASH DISTRIBUTIONS





We will make distributions of available cash (as defined in our partnership agreement) from operating surplus for any quarter during any subordination period in the following manner:





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





•
second, 98% to the common unitholders, pro rata, and 2% to our general partner, until we distribute for each outstanding common unit an amount equal to any arrearages in payment of the minimum quarterly distribution on the common units for any prior quarters during the subordination period;





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





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





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





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





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





The following table summarizes our distributions per unit for 2008, 2009 and 2010:





Period Covering
Payment Date

Distribution per

Limited Partner Unit

Total Distribution (1)1/1/2008 – 3/31/2008
May 14, 2008

$
0.4250

$  7.3 million4/1/2008 – 6/30/2008
August 14, 2008


0.4250

8.3 million7/1/2008 – 9/30/2008
November 14, 2008


0.4625

9.3 million10/1/2008 – 12/31/2008
February 13, 2009


0.4625

9.3 million1/1/2009 – 3/31/2009
May 15, 2009


0.4625

9.3 million4/1/2009 – 6/30/2009
August 14, 2009


0.4625

9.3 million7/1/2009 – 9/30/2009
November 13, 2009


0.4625

9.3 million10/1/2009 – 12/31/2009
February 12, 2010


0.4625

11.6 million1/1/2010 – 3/31/2010
May 11, 2010


0.4625

11.6 million


____________





(1)
Including distributions to our general partner on its incentive distribution rights.





On July 26, 2010, the board of directors of Exterran GP LLC approved a cash distribution of $0.4625 per limited partner unit, or approximately $11.6 million, including distributions to our general partner on its incentive distribution rights. The distribution covers the time period from April 1, 2010 through June 30, 2010. The record date for this distribution is August 10, 2010 and payment is expected to occur on August 13, 2010.


13





6.  UNIT-BASED COMPENSATION





Long-Term Incentive Plan





We have a long-term incentive plan that was adopted by Exterran GP LLC, the general partner of our general partner, in October 2006 for employees, directors and consultants of us, Exterran Holdings or our respective affiliates. The long-term incentive plan currently permits the grant of awards covering an aggregate of 1,035,378 common units, common unit options, restricted units and phantom units. The long-term incentive plan is administered by the board of directors of Exterran GP LLC or a committee thereof (the “Plan Administrator”).





Unit options have an exercise price that is not less than the fair market value of the units on the date of grant and become exercisable over a period determined by the Plan Administrator. We have the option to settle any exercised unit option in a cash payment equal to the fair market value of the number of common units that we would otherwise issue upon exercise of such unit option less the exercise price and any amounts required to meet withholding requirements. Phantom units are notional units that entitle the grantee to receive a common unit upon the vesting of the phantom unit or, at the discretion of the Plan Administrator, cash equal to the fair value of a common unit.





Phantom Units





Exterran GP LLC’s practice is to grant equity-based awards (i) to its officers once a year, in late February or early March around the time the compensation committee of the board of directors of Exterran Holdings grants equity-based awards to Exterran Holdings’ officers, and (ii) to its directors once a year in October or November, around the anniversary of our initial public offering. The schedule for making equity-based awards is typically established several months in advance and is not set based on knowledge of material nonpublic information or in response to our unit price. This practice results in awards being granted on a regular, predictable annual cycle. Equity-based awards are occasionally granted at other times during the year, such as upon the hiring of a new employee or following the promotion of an employee. In some instances, Exterran GP LLC’s board of directors may be aware, at the time grants are made, of matters or potential developments that are not ripe for public disclosure at that time but that may result in public announcement of material information at a later date.





The following table presents phantom unit activity for the six months ended June 30, 2010:





Phantom

Units


Weighted

Average

Grant-Date

Fair Value

per UnitPhantom units outstanding, December 31, 2009


91,124


$
17.06Granted


29,634



22.88Vested


(33,373
)


18.18Cancelled


(2,065
)


17.26Phantom units outstanding, June 30, 2010


85,320


$
18.60





As of June 30, 2010, $1.6 million of unrecognized compensation cost related to unvested phantom units is expected to be recognized over the weighted-average period of 2.1 years.





Unit Options





As of June 30, 2010 and December 31, 2009, we had no unit options outstanding.





14


7.  ACCOUNTING FOR INTEREST RATE SWAP AGREEMENTS





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





Interest Rate Risk





At June 30, 2010, we were party to interest rate swaps pursuant to which we pay fixed payments and receive floating payments on a notional value of $285.0 million. We entered into these swaps to offset changes in expected cash flows due to fluctuations in the associated variable interest rates. Our interest rate swaps expire over varying dates through July 2013. The weighted average effective fixed interest rate payable on our interest rate swaps was 4.5% as of June 30, 2010. We have designated these interest rate swaps as cash flow hedging instruments so that any change in their fair values is recognized as a component of comprehensive income (loss) and is included in accumulated other comprehensive income (loss) to the extent the hedge is effective. The swap terms substantially coincide with the hedged item and are expected to offset changes in expected cash flows due to fluctuations in the variable rate, and, therefore, we currently do not expect a significant amount of ineffectiveness on these hedges. We perform quarterly calculations to determine whether the swap agreements are still effective and to calculate any ineffectiveness.For the three and six months ended June 30, 2010 and 2009, there was no ineffectiveness related to these swaps. We estimate that $9.5 million of deferred pre-tax losses from the interest rate swaps will be realized as an expense during the next twelve months. Cash flows from derivatives designated as hedges are classified in our condensed consolidated statements of cash flows under the same category as the cash flows from the underlying assets, liabilities or anticipated transactions.





The following tables present the effect of derivative instruments on our consolidated financial position and results of operations (in thousands):





June 30, 2010Balance Sheet Location

Fair Value

Asset (Liability)Derivatives designated as hedging instruments:Interest rate hedges
Current portion of interest rate swaps

$
(9,514
)Interest rate hedges
Interest rate swaps


(5,202
)Total derivatives


$
(14,716
)





December 31, 2009Balance Sheet Location

Fair Value

Asset (Liability)Derivatives designated as hedging instruments:Interest rate hedges
Interest rate swaps

$
262Interest rate hedges
Current portion of interest rate swaps


(9,229
)Interest rate hedges
Interest rate swaps


(6,668
)Total derivatives


$
(15,635
)





Three Months Ended June 30, 2010


Six Months Ended June 30, 2010Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)

Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)


Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)

Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)Derivatives designated as cash flow hedges:Interest rate hedges

$
(1,884
)
Interest expense

$
(2,977
)

$
(4,963
)
Interest expense

$
(5,882
)





15





Three Months Ended June 30, 2009


Six Months Ended June 30, 2009Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)

Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)


Gain (Loss) Recognized in Other Comprehensive Income (Loss) on Derivatives

Location of Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)

Gain (Loss) Reclassified from Accumulated Other Comprehensive Income (Loss) into Income (Loss)Derivatives designated as cash flow hedges:Interest rate hedges

$
138

Interest expense

$
(2,181
)

$
(2,171
)
Interest expense

$
(3,962
)





The counterparties to our derivative agreements are major international financial institutions. We monitor the credit quality of these financial institutions and do not expect non-performance by any counterparty, although such non-performance could have a material adverse effect on us. We have no specific collateral posted for our derivative instruments. The counterparties to our interest rate swaps are also lenders under our credit facility and, in that capacity, share proportionally in the collateral pledged under the credit facility.





8.  FAIR VALUE OF INTEREST RATE SWAP AGREEMENTS





The Financial Accounting Standards Board (“FASB”) accounting standard for fair value measurements and disclosures establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into the following three broad categories.





•
Level 1— Quoted unadjusted prices for identical instruments in active markets to which we have access at the date of measurement.





•
Level 2— Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 inputs are those in markets for which there are few transactions, the prices are not current, little public information exists or prices vary substantially over time or among brokered market makers.





•
Level 3— Model derived valuations in which one or more significant inputs or significant value drivers are unobservable. Unobservable inputs are those inputs that reflect our own assumptions regarding how market participants would price the asset or liability based on the best available information.





The following table summarizes the valuation of our interest rate swaps and impaired long-lived assets as of and for the six months ended June 30, 2010 with pricing levels as of the date of valuation (in thousands):





Total


Quoted Market

Prices in Active

Markets

(Level 1)


Significant Other

Observable Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Interest rate swaps asset (liability)

$
(14,716
)

$
—


$
(14,716
)

$
—Impaired long-lived assets


21



—



—



21





The following table summarizes the valuation of our interest rate swaps and impaired long-lived assets as of and for the six months ended June 30, 2009 with pricing levels as of the date of valuation (in thousands):





Total


Quoted Market

Prices in Active

Markets

(Level 1)


Significant Other

Observable Inputs

(Level 2)


Significant

Unobservable

Inputs

(Level 3)Interest rate swaps asset (liability)

$
(15,896
)

$
—


$
(15,896
)

$
—Impaired long-lived assets


197



—



—



197





16


Our interest rate swaps are recorded at fair value utilizing a combination of the market and income approach to fair value. We use discounted cash flows and market based methods to compare similar interest rate swaps. Our estimate of the fair value of the impaired long-lived assets was based on the estimated component value of the equipment that we plan to use.





9.  LONG-LIVED ASSET IMPAIRMENT





As a result of a decline in market conditions during 2010 and 2009, we reviewed the idle compression fleet used in our business for units that are not of the type, configuration, make or model that are cost effective to maintain and operate.  We performed a cash flow analysis of the expected proceeds from the disposition of these units to determine the fair value of the assets. For the first quarter of 2010 and the second quarter of 2009, the net book value of these assets exceeded the fair value by $0.2 million and $3.0 million, respectively, and was recorded as a long-lived asset impairment.





10.  COMMITMENTS AND CONTINGENCIES





In the ordinary course of business, we are 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 our consolidated financial position, results of operations or cash flows; however, because of the inherent uncertainty of litigation, we cannot provide assurance that the resolution of any particular claim or proceeding to which we are a party will not have a material adverse effect on our consolidated financial position, results of operations or cash flows for the period in which that resolution occurs.





11.  SUBSEQUENT EVENTS





All of our 6,325,000 subordinated units are owned by a wholly-owned subsidiary of Exterran Holdings.  As of June 30, 2010, we met the requirements under our partnership agreement for early conversion of 25% of those subordinated units into common units.  Accordingly, we expect that 1,581,250 of our subordinated units will convert to common units on August 17, 2010.





In July 2010, we and Exterran Holdings announced a transaction, which is expected to close in August 2010, pursuant to which we have agreed to acquire from Exterran Holdings contract operations customer service agreements with 43 customers and a fleet of approximately 580 compressor units used to provide compression services under those agreements, comprising approximately 254,000 horsepower, or approximately 6% (by available horsepower) of the combined U.S. contract operations business of Exterran Holdings and us (the “August 2010 Contract Operations Acquisition”). Total consideration for the transaction is approximately $214 million, excluding estimated transaction costs. In connection with this acquisition, we intend to issue to Exterran Holdings’ wholly-owned subsidiaries approximately 8.21 million common units and approximately 167,000 general partner units.





Also, in connection with the closing of the August 2010 Contract Operations Acquisition, we intend to amend our existing Omnibus Agreement with Exterran Holdings. The amendment will, among other things, extend the term of the caps on our obligation to reimburse Exterran Holdings for SG&A costs and operating costs Exterran Holdings allocates to us based on such costs it incurs on our behalf for an additional year such that the caps will terminate on December 31, 2011.





17


ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations





DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS





All statements other than statements of historical fact contained in this report are forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You can identify many of these statements by looking for words such as “believes,” “expects,” “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;





•
our ability to comply with financial covenants contained in our credit agreements;





•
our ability to refinance existing debt or incur additional indebtedness at an acceptable cost;





•
the expected timing and 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; and





•
any potential contribution of additional assets from Exterran Holdings, Inc. (individually, and together with its wholly-owned subsidiaries, “Exterran Holdings”) to us.





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 described in our Annual Report on Form 10-K for the year ended December 31, 2009, and those set forth from time to time in our filings with the Securities and Exchange Commission (“SEC”), which are available through our website at www.exterran.com and through the SEC’s Electronic Data Gathering and Retrieval System 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, which could cause a decline in the demand for our compression services;





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





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





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





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





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





18


•
the financial condition of our customers;





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





•
growing our asset base and asset utilization, particularly our fleet of compressors;





•
integrating acquired businesses;





•
generating sufficient cash;





•
accessing the capital markets at an acceptable cost;





•
purchasing additional contract operations contracts and equipment from Exterran Holdings; and





•
refinancing existing or incurring additional indebtedness to fund our business;





•
liability related to the provision of our services;





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





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





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





GENERAL





We are a publicly held Delaware limited partnership formed on June 22, 2006 to acquire certain contract operations customer service agreements and a compressor fleet used to provide compression services under those agreements. We completed our initial public offering in October 2006.





November 2009 Contract Operations Acquisition





In November 2009, we acquired from Exterran Holdings contract operations customer service agreements with 18 customers and a fleet of approximately 900 compressor units used to provide compression services under those agreements having a net book value of $137.2 million, net of accumulated depreciation of $47.2 million, and comprising approximately 270,000 horsepower, or 6% (by then available horsepower) of the combined U.S. contract operations business of Exterran Holdings and us (the “November 2009 Contract Operations Acquisition”) for approximately $144.0 million. In connection with this acquisition, we assumed $57.2 million of long-term debt from Exterran Holdings and issued to Exterran Holdings approximately 4.7 million common units and approximately 97,000 general partner units. Concurrent with the closing of the November 2009 Contract Operations Acquisition, we borrowed $28.0 million and $30.0 million under our revolving credit facility and our $150.0 million asset-backed securitization facility (the “2009 ABS Facility”), respectively, which together were used to repay the debt assumed from Exterran Holdings in the acquisition and to pay other costs incurred in the acquisition.





In connection with the closing of the November 2009 Contract Operations Acquisition, we amended and restated the Omnibus Agreement (as defined below) to, among other things, increase the cap on the amount we must reimburse Exterran Holdings for cash selling, general and administrative (“SG&A”) expenses it incurs on our behalf from $6.0 million per quarter to $7.6 million per quarter (after taking into account any such costs that we incur and pay directly) and to extend the duration of the cap on our reimbursement of SG&A expenses and cost of sales for an additional year such that the caps would terminate on December 31, 2010. The amount of the cost of sales cap remained unchanged at $21.75 per operating horsepower per quarter (after taking into account any such costs that we incur and pay directly) on our reimbursement of cost of sales Exterran Holdings incurs on our behalf.


19





August 2010 Contract Operations Acquisition





In July 2010, we and Exterran Holdings announced a transaction, which is expected to close in August 2010, pursuant to which we have agreed to acquire from Exterran Holdings contract operations customer service agreements with 43 customers and a fleet of approximately 580 compressor units used to provide compression services under those agreements, comprising approximately 254,000 horsepower, or approximately 6% (by available horsepower) of the combined U.S. contract operations business of Exterran Holdings and us (the “August 2010 Contract Operations Acquisition”). Total consideration for the transaction is approximately $214 million, excluding estimated transaction costs. In connection with this acquisition, we intend to issue to Exterran Holdings’ wholly-owned subsidiaries approximately 8.21 million common units and approximately 167,000 general partner units.





Also, in connection with the closing of the August 2010 Contract Operations Acquisition, we intend to amend our existing Omnibus Agreement with Exterran Holdings. The amendment will, among other things, extend the term of the caps on our obligation to reimburse Exterran Holdings for cash selling, general and administrative (“SG&A”) costs and operating costs Exterran Holdings allocates to us based on such costs Exterran Holdings incurs on our behalf for an additional year such that the caps will now terminate on December 31, 2011.





Omnibus Agreement





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





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





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





•
the terms under which we, Exterran Holdings, and our respective affiliates may transfer compression equipment among one another to meet our respective contract operations services obligations; and





•
the terms under which we may purchase newly-fabricated contract operations equipment from Exterran Holdings’ affiliates.





For further discussion of the Omnibus Agreement, please see Note 3 to the Consolidated Financial Statements included in Part I, Item 1 (“Financial Statements”) of this report.





OVERVIEW





Industry Conditions and Trends





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





Natural gas consumption in the U.S. for the twelve months ended April 30, 2010 increased by approximately 1% compared to the twelve months ended April 30, 2009. Total U.S. natural gas consumption is projected by the Energy Information Administration (“EIA”) to increase by 3.5% in 2010 and by 0.1% in 2011, and is expected to increase by an average of 0.3% per year thereafter until 2035. For 2008, the U.S. accounted for an estimated annual production of approximately 21 trillion cubic feet of natural gas. The EIA expects total U.S. marketed natural gas production to increase by 2.2% in 2010. The EIA estimates that the natural gas production level in the U.S. will be approximately 23 trillion cubic feet in calendar year 2035.





20


Our Performance Trends and Outlook





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





Our revenue, earnings, financial position and capital spending are affected by, among other things, (i) market conditions that impact demand and pricing for natural gas compression, (ii) our customers’ decisions to utilize our services rather than utilize products or services from our competitors, and (iii) the timing and consummation of acquisitions of additional contract operations customer contracts and equipment from Exterran Holdings. In particular, many of our contracts with customers have short initial terms; we cannot be certain that these contracts will be renewed after the end of the initial contractual term, and any such nonrenewal, or renewal at a reduced rate, could adversely impact our results of operations and cash available for distribution.





In the six months ended June 30, 2010, we began to see an increase in overall natural gas activity and an increase in our compression order activity. Our total operating horsepower increased approximately 4% during the six months ended June 30, 2010. We believe that uncertainty around natural gas supply and demand and natural gas prices, along with the current available supply of idle and underutilized compression equipment owned by our customers and competitors may negatively impact our ability to improve our horsepower utilization and pricing and therefore revenues in the near term (excluding the impact of potential transfers of additional contract operations customer contracts and equipment from Exterran Holdings to us). Our contract operations services business has historically experienced more stable demand than that of certain other energy service products and services. A 1% decrease in average utilization of our contract operations fleet would result in a decrease in our revenue and gross margin (defined as revenue less cost of sales, excluding depreciation and amortization expense) for the six months ended June 30, 2010 of approximately $1.1 million and $0.5 million, respectively.





Pursuant to the Omnibus Agreement between us and Exterran Holdings, our obligation to reimburse Exterran Holdings for cost of sales and SG&A expenses is capped through December 31, 2010, which will be extended through December 31, 2011 if the August 2010 Contract Operations Acquisition closes as expected (see Notes 3 and 11 to the Financial Statements). During the three months ended June 30, 2010 and 2009, our cost of sales exceeded this cap by $5.7 million and $1.5 million, respectively. During the six months ended June 30, 2010 and 2009, our cost of sales exceeded this cap by $8.5 million and $4.1 million, respectively. For both the three and six months ended June 30, 2010, our SG&A expenses exceeded the cap provided in the Omnibus Agreement by $0.7 million. For the three and six months ended June 30, 2009, our SG&A expenses did not exceed the cap provided in the Omnibus Agreement.





Our senior secured credit facility matures in October 2011. If we were to replace this facility, based on current market conditions, we expect that the interest rate under any replacement facility would be higher than in our current facility and therefore would lead to higher interest expense in future periods.





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





21


Operating Highlights





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





Three Months Ended June 30,


Six Months Ended June 30,2010


2009


2010


2009Total Available Horsepower (at period end)


1,366



1,034



1,366



1,034Total Operating Horsepower (at period end)


1,092



840



1,092



840Average Operating Horsepower


1,076



859



1,069



878Horsepower Utilization:Spot (at period end)


80
%


81
%


80
%


81
%Average


80
%


83
%


80
%


85
%





FINANCIAL RESULTS OF OPERATIONS





The three months ended June 30, 2010 compared to the three months ended June 30, 2009





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





Three Months Ended June 30,2010


2009Revenue

$
53,790


$
45,077Gross margin (1)


24,664



24,901Gross margin percentage


46
%


55
%Expenses:Depreciation and amortization

$
11,763


$
8,678Long-lived asset impairment


—



2,995Selling, general and administrative


8,519



5,551Interest expense


5,724



4,805Other (income) expense, net


(170
)


—Income tax expense


173



134Net income (loss)

$
(1,345
)

$
2,738





____________





(1)
For a reconciliation of gross margin to net income (loss), its most directly comparable financial measure, calculated and presented in accordance with accounting principles generally accepted in the U.S. (“GAAP”), please read Part I, Item 2 (“Management’s Discussion and Analysis of Financial Condition and Results of Operations – Non-GAAP Financial Measure”) of this report.





Revenue.Average monthly operating horsepower was approximately 1,076,000 and 859,000 for the three months ended June 30, 2010 and 2009, respectively. The increase in revenue and average monthly operating horsepower was primarily due to the inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition. The inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition was partially offset by a 3% decrease in average operating horsepower utilization and a 5% decrease in revenue per average operating horsepower for the three months ended June 30, 2010 compared to the three months ended June 30, 2009. The decrease in horsepower utilization and pricing was due to the continued challenging market conditions in the U.S natural gas energy industry.





Gross Margin.  The decrease in gross margin (defined as revenue less cost of sales, excluding depreciation and amortization expense) was primarily due to a decrease in average operating horsepower utilization and lower pricing for the three months ended June 30, 2010 compared to the three months ended June 30, 2009, significantly offset by the inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition. Gross margin was also impacted by a reduction in our average horsepower utilization not matched by a corresponding decrease in overhead costs.


22





Depreciation and Amortization.The increase in depreciation and amortization expense during the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was primarily due to the additional depreciation on compression equipment additions, including the assets acquired in the November 2009 Contract Operations Acquisition.





Long-lived Asset Impairment.Long-lived asset impairments in the three months ended June 30, 2009 were $3.0 million and resulted from a decline in market conditions.  See Note 9 to the Financial Statements for further discussion of the long-lived asset impairments.





SG&A.  SG&A expenses are primarily comprised of an allocation of expenses, including costs for personnel support and related expenditures, from Exterran Holdings. The increase in SG&A expense was primarily due to increased costs associated with the increase in revenues after the November 2009 Contract Operations Acquisition. In addition, SG&A expenses for the three months ended June 30, 2010 increased due to $0.8 million in additional sales taxes as a result of a state tax ruling received in June 2010 that applies retroactively back to July 2007 to certain contract compression transactions. SG&A expenses represented 16% and 12% of revenues for the three months ended June 30, 2010 and 2009, respectively. The increase in SG&A expense as a percentage of revenues was primarily due to the decrease in revenue per operating horsepower without a corresponding reduction in SG&A expense.





Interest Expense.  The increase in interest expense was primarily due to a higher average balance of long-term debt for the second quarter of 2010 compared to the second quarter of 2009 resulting from the additional debt incurred for the November 2009 Contract Operations Acquisition. This increase was also partially caused by an increase in our weighted average effective interest rate, including the impact of interest rate swaps, to 5.1% for the three months ended June 30, 2010 from 4.7% for the three months ended June 30, 2009.





Other (Income) Expense, Net.The change in other (income) expense, net was due to a $0.2 million gain on the sale of used compression equipment during the three months ended June 30, 2010.





Income Tax Expense.  Income tax expense primarily reflects taxes recorded under the Texas margins tax and the Michigan business tax. The increase in income tax expense for the three months ended June 30, 2010 compared to the three months ended June 30, 2009 was primarily due to an increase in our revenue earned within the state of Texas.





The six months ended June 30, 2010 compared to the six months ended June 30, 2009





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





Six Months Ended June 30,2010


2009Revenue

$
106,500


$
93,310Gross margin (1)


51,523



50,952Gross margin percentage


48
%


55
%Expenses:Depreciation and amortization

$
23,641


$
17,012Long-lived asset impairment


231



2,995Selling, general and administrative


16,214



11,552Interest expense


11,416



9,624Other (income) expense, net


(406
)


27Income tax expense


346



283Net income

$
81


$
9,459


____________





(1)
For a reconciliation of gross margin to net income, 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 Measure”) of this report.





Revenue.Average monthly operating horsepower was approximately 1,069,000 and 878,000 for the six months ended June 30, 2010 and 2009, respectively. The increase in revenue and average monthly operating horsepower was primarily due to the inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition. The inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition was partially offset by a 5% decrease in average operating horsepower utilization and a 6% decrease in revenue per average operating horsepower for the six months ended June 30, 2010


23





compared to the six months ended June 30, 2009. The decrease in horsepower utilization and pricing was due to the continued challenging market conditions in the U.S natural gas energy industry.





Gross Margin.  The increase in gross margin for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was primarily due to the inclusion of the results from the assets acquired in the November 2009 Contract Operations Acquisition, significantly offset by a decrease in average operating horsepower utilization and lower pricing for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Gross margin was also impacted by a reduction in our average horsepower utilization not matched by a corresponding decrease in overhead costs.





Depreciation and Amortization.The increase in depreciation and amortization expense during the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was primarily due to the additional depreciation on compression equipment additions, including the assets acquired in the November 2009 Contract Operations Acquisition.





Long-lived Asset Impairment.Long-lived asset impairments in the six months ended June 30, 2010 and 2009 were $0.2 million and $3.0 million, respectively, and resulted from a decline in market conditions. See Note 9 to the Financial Statements for further discussion of the long-lived asset impairments.


SG&A.SG&A expenses are primarily comprised of an allocation of expenses, including costs for personnel support and related expenditures, from Exterran Holdings. The increase in SG&A expense was primarily due to increased costs associated with the increase in revenues after the November 2009 Contract Operations Acquisition. In addition, SG&A expenses for the six months ended June 30, 2010 increased due to $0.8 million in additional sales taxes as a result of a state tax ruling received in June 2010 that applies retroactively back to July 2007 to certain contract compression transactions. SG&A expenses represented 15% and 12% of revenues for the six months ended June 30, 2010 and 2009, respectively. The increase in SG&A expense as a percentage of revenues was primarily due to the decrease in revenue per operating horsepower without a corresponding reduction in SG&A expense.





Interest Expense.  The increase in interest expense was primarily due to a higher average balance and an increase in our weighted average effective interest rate on long-term debt for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 resulting from the additional debt incurred for the November 2009 Contract Operations Acquisition. Our weighted average effective interest rate, including the impact of interest rate swaps, was 5.1% for the six months ended June 30, 2010 compared to 4.7% for the six months ended June 30, 2009.





Other (Income) Expense, Net.The change in other (income) expense, net was due to $0.4 million of gains on the sale of used compression equipment during the six months ended June 30, 2010.





Income Tax Expense.  Income tax expense primarily reflects taxes recorded under the Texas margins tax and the Michigan business tax. The increase in income tax expense for the six months ended June 30, 2010 compared to the six months ended June 30, 2009 was primarily due to an increase in our revenue earned within the state of Texas.





LIQUIDITY AND CAPITAL RESOURCES





The following tables summarize our sources and uses of cash for the six months ended June 30, 2010 and 2009, and our cash and working capital as of the end of the periods presented (in thousands):





Six Months Ended June 30,2010


2009Net cash provided by (used in):Operating activities

$
26,022


$
33,995Investing activities


(17,288
)


(11,245
)Financing activities


(8,873
)


(25,430
)Net change in cash and cash equivalents

$
(139
)

$
(2,680
)





June 30, 2010


December 31, 2009Cash and cash equivalents

$
64


$
203Working capital


(4,591
)


4,094





24


Operating Activities.  The decrease in net cash provided by operating activities was primarily due to a reduction in results from operating activities caused by a deterioration in economic conditions. In addition, the six months ended June 30, 2009 included a cash flow benefit from a $3.0 million reduction in accounts receivable trade.





Investing Activities.The increase in cash used in investing activities was primarily attributable to an increase in capital expenditures for the six months ended June 30, 2010 compared to the six months ended June 30, 2009. Capital expenditures for the six months ended June 30, 2010 were $17.5 million, consisting of $11.0 million for fleet growth capital and $6.5 million for compressor maintenance activities. We purchased $9.8 million of new compression equipment from Exterran Holdings during the six months ended June 30, 2010.





Financing Activities.  The decrease in cash used in financing activities was the result of a decrease in net repayments under our debt facilities and an increase in amounts due to affiliates during the six months ended June 30, 2010 compared to the six months ended June 30, 2009.





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





We currently plan to spend approximately $15 million to $18 million on equipment maintenance capital during 2010.





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





Our Ability to Grow Depends on Our Ability to Access External ExpansionCapital.  We expect that we will rely primarily upon external financing sources, including our revolving credit facility and our 2009 ABS Facility and the issuance of debt and equity securities, rather than cash reserves established by our general partner, to fund our acquisitions and expansion capital expenditures. Our ability to access the capital markets may be restricted at a time when we would like, or need, to do so, which could have an impact on our ability to grow. Additionally, our ability to utilize the issuance of equity securities as a source of expansion capital is currently limited by our credit agreement, which requires us to use the net cash proceeds from any equity offering first to repay our $117.5 million term loan facility in full.





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


25





Long-term Debt.  We, as guarantor, and EXLP Operating LLC, our wholly-owned subsidiary, are parties to a senior secured credit agreement that provides for a five-year, $315 million revolving credit facility.





In May 2008, we entered into an amendment to our senior secured credit facility that increased the aggregate commitments under that facility to provide for a $117.5 million term loan that matures in October 2011. Concurrent with the closing of our July 2008 acquisition from Exterran Holdings of certain contract operations customer service agreements and compressor units, the $117.5 million term loan was funded and $58.3 million was drawn on our revolving credit facility, which together were used to repay the debt assumed from Exterran Holdings in the acquisition and to pay other costs incurred in the acquisition. The $117.5 million term loan is non-amortizing but must be repaid with the net cash proceeds from any future equity offerings until paid in full. Subject to certain conditions, at our request, and with the approval of the lenders, the aggregate commitments under the senior secured credit facility may be increased by an additional $17.5 million. This amount will be increased on a dollar-for-dollar basis with each repayment under the term loan.





As of June 30, 2010, we had approximately $283.0 million outstanding under our revolving credit facility and $117.5 million of long-term debt outstanding under the term loan. All amounts under the revolving credit facility and term loan mature in October 2011.





Our revolving credit facility bears interest at a base rate, or LIBOR, at our option, plus an applicable margin, as defined in the credit agreement. At June 30, 2010, all amounts outstanding were LIBOR loans and the applicable margin was 1.75%. The weighted average interest rate on the outstanding balance at June 30, 2010, excluding the effect of interest rate swaps, was 2.2%.





The term loan bears interest at a base rate or LIBOR, at our option, plus an applicable margin. At June 30, 2010, all amounts outstanding were LIBOR loans and the applicable margin was 2.25%. Borrowings under the term loan are subject to the same credit agreement covenants as our revolving credit facility, except for an additional covenant requiring mandatory prepayment of the term loan from net cash proceeds of any future equity offerings, on a dollar-for-dollar basis. The weighted average interest rate on the outstanding balance of the term loan at June 30, 2010, excluding the effect of interest rate swaps, was 2.7%.





As of June 30, 2010, we had undrawn capacity of $32.0 million and $120.0 million under our revolving credit facility and 2009 ABS Facility, respectively. Under our senior secured credit facility, we have limitations on our Total Debt to EBITDA ratio as discussed below. Due to this limitation, only $79.3 million of the combined $152.0 million of undrawn capacity under both facilities would have been available for additional borrowings as of June 30, 2010.





Our senior secured credit facility contains various covenants with which we must comply, including restrictions on the use of proceeds from borrowings and limitations on our ability to incur additional debt or sell assets, make certain investments and acquisitions, grant liens and pay dividends and distributions. We must maintain various consolidated financial ratios, including a ratio of EBITDA (as defined in the credit agreement) to Total Interest Expense (as defined in the credit agreement) of not less than 2.5 to 1.0, and a ratio of Total Debt (as defined in the credit agreement) to EBITDA of not greater than 5.0 to 1.0. Our senior secured credit facility allows for our Total Debt to EBITDA ratio to be increased from 5.0 to 1.0 to 5.5 to 1.0 during a quarter when an acquisition closes meeting certain thresholds and for the following two quarters after the acquisition closes. Therefore, because the November 2009 Contract Operations Acquisition closed in the fourth quarter of 2009, the maximum allowed ratio of Total Debt to EBITDA was increased from 5.0 to 1.0 to 5.5 to 1.0 for the quarters ending December 31, 2009, March 31, 2010 and June 30, 2010, and is scheduled to revert back to 5.0 to 1.0 for the quarter ending September 30, 2010. However, assuming we are able to close our recently announced August 2010 Contract Operations Acquisition in the third quarter of 2010 as planned, we expect that the maximum allowed ratio of Total Debt to EBITDA will remain at 5.5 to 1.0 for the quarters ending September 30, 2010, December 31, 2010 and March 31, 2011, reverting back to 5.0 to 1.0 for the quarter ending June 30, 2011. As of June 30, 2010, we maintained a 4.3 to 1.0 EBITDA to Total Interest Expense ratio and a 4.7 to 1.0 Total Debt to EBITDA ratio. If we experience a deterioration in the demand for our services, and we are unable to consummate further acquisitions from Exterran Holdings, including our recently announced August 2010 Contract Operations Acquisition, amend our senior secured credit facility or restructure our debt, we estimate that we could be in violation of the maximum Total Debt to EBITDA covenant ratio contained in our senior secured credit facility as early as 2010. In addition, if we experienced a material adverse effect on our assets, liabilities, financial condition, business, operations or prospects that, taken as a whole, impacted our ability to perform our obligations under our senior secured credit facility, this could lead to a default under this facility. As of June 30, 2010, we were in compliance with all financial covenants under the senior secured credit facility.





In connection with the November 2009 Contract Operations Acquisition, we entered into the 2009 ABS Facility, a portion of which was used to fund the November 2009 Contract Operations Acquisition. The 2009 ABS Facility notes are revolving in nature and are payable in July 2013. Interest and fees payable to the noteholders will accrue on these notes at a variable rate consisting of an applicable margin of 3.5% plus, at our option, either LIBOR or a base rate. The weighted average interest rate on the outstanding


26





balance of the 2009 ABS Facility at June 30, 2010, excluding the effect of interest rate swaps, was 3.9%. Repayment of the 2009 ABS Facility notes has been secured by a pledge of all of the assets of EXLP ABS 2009 LLC consisting primarily of specified compression services contracts and a fleet of natural gas compressor units. The amount outstanding at any time is limited to the lower of (i) 75% of the value of the natural gas compression equipment owned by EXLP ABS 2009 LLC (as defined in the agreement), (ii) 4.0 times free cash flow or (iii) the amount calculated under an interest coverage test. Additionally, the senior secured credit facility’s credit agreement limits the amount we can borrow under the 2009 ABS Facility to two times our EBITDA (as defined in the credit agreement). As of June 30, 2010, we had $30.0 million outstanding under the 2009 ABS Facility.





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





On July 26, 2010, our board of directors approved a cash distribution of $0.4625 per limited partner unit, or approximately $11.6 million, including distributions to our general partner on its incentive distribution rights. The distribution covers the time period from April 1, 2010 through June 30, 2010. The record date for this distribution is August 10, 2010 and payment is expected to occur on August 13, 2010.





NON-GAAP FINANCIAL MEASURE





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





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





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





Three Months Ended June 30,


SixMonths Ended June 30,2010



2009



2010


2009Net income (loss)

$
(1,345
)

$
2,738


$
81


$
9,459Depreciation and amortization


11,763



8,678



23,641



17,012Long-lived asset impairment


—



2,995



231



2,995Selling, general and administrative


8,519



5,551



16,214



11,552Interest expense


5,724



4,805



11,416



9,624Other (income) expense, net


(170
)


—



(406
)


27Income tax expense


173



134



346



283Gross margin

$
24,664


$
24,901


$
51,523


$
50,952





OFF-BALANCE SHEET ARRANGEMENTS





We have no material off-balance sheet arrangements.


27





ITEM 3.  Quantitative and Qualitative Disclosures About Market Risk





Variable Rate Debt





We are exposed to market risk due to variable interest rates under our financing arrangements.





As of June 30, 2010, after taking into consideration interest rate swaps, we had approximately $145.5 million of outstanding indebtedness that was effectively subject to floating interest rates. A 1% increase in the effective interest rate would result in an annual increase in our interest expense of approximately $1.5 million.





For further information regarding our use of interest rate swap agreements to manage our exposure to interest rate fluctuations on a portion of our debt obligations, see Note 7 to the Financial Statements.





ITEM 4.  Controls and Procedures





Management’s Evaluation of Disclosure Controls and Procedures





As of June 30, 2010, our principal executive officer and principal financial officer evaluated the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Exchange Act), which are designed to provide reasonable assurance that we are able to record, process, summarize and report the information required to be disclosed in our reports under the Exchange Act within the time periods specified in the rules and forms of the Securities and Exchange Commission. Based on the evaluation, our principal executive officer and principal financial officer have concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed in reports that we file or submit under the Exchange Act is accumulated and communicated to management, and made known to our principal executive officer and principal financial officer, on a timely basis to ensure that it is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.





Changes in Internal Control over Financial Reporting





There were no changes in our internal control over financial reporting during the last fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.





28


PART II.  OTHER INFORMATION





ITEM 1.  Legal Proceedings





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





ITEM 1A.  Risk Factors





There have been no material changes in our risk factors that were previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, except as follows:





New proposed regulations and proposed modifications to existing regulations under the Clean Air Act (“CAA”), if implemented, could result in increased compliance costs.





In March 2009, the EPA formally proposed new regulations under the CAA to control emissions of hazardous air pollutants from existing stationary reciprocal internal combustion engines. The rule, when finalized by the EPA, may require us to undertake significant expenditures, including expenditures for purchasing and installing emissions control equipment such as oxidation catalysts or non-selective catalytic reduction equipment, imposing more stringent maintenance practices, and implementing additional monitoring practices on a potentially significant percentage of our natural gas compressor engine fleet. At this point, we cannot predict the final regulatory requirements or the cost to comply with such requirements. The comment period on the proposed regulation ended on June 3, 2009, and the EPA has signed a consent decree requiring it to promulgate a final rule no later than August 10, 2010. Under the proposal, compliance will be required by three years from the effective date of the final rule. In addition, the Texas Commission on Environmental Quality has recently proposed updates to certain of its permit programs that, if enacted as proposed, would significantly tighten current emissions standards, which could impact the operation of specific categories of engines by requiring the use of alternative engines, compressor packages, or the installation of aftermarket emissions control equipment. These proposed rules, when finalized, and any other new regulations requiring the installation of more sophisticated emissions control equipment could have a material adverse impact on our business, financial condition, results of operations and ability to make cash distributions to our unitholders.





In June 2010, the EPA formally proposed modifications to existing regulations under the CAA that established new source performance standards for manufacturers, owners and operators of new, modified and reconstructed stationary internal combustion engines.  The proposed rule modifications, if adopted as drafted by the EPA, may require us to undertake significant expenditures, including expenditures for purchasing, installing, monitoring and maintaining emissions control equipment on a potentially significant percentage of our natural gas compressor engine fleet. At this point, we cannot predict the final regulatory requirements or the cost to comply with such requirements. The comment period on the proposed regulation is scheduled to end on August 9, 2010. It is currently unclear when the proposed regulation will be finalized and become effective.





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





The U.S. Congress is considering new legislation to restrict or regulate emissions of greenhouse gases, such as carbon dioxide and methane, that are understood to contribute to global warming. For example, the American Clean Energy and Security Act of 2009 could, if enacted by the full Congress, require greenhouse gas emissions reductions by covered sources of as much as 17% from 2005 levels by 2020 and by as much as 83% by 2050. Recent reports suggest that comprehensive climate legislation is unlikely to be passed by the U.S. Senate in 2010, although energy legislation and other initiatives are expected to be proposed that may be relevant to greenhouse gas emissions issues. In addition, almost half of the states, either individually or through multi-state regional initiatives, have begun to address greenhouse gas emissions, primarily through the planned development of emission inventories or regional greenhouse gas cap and trade programs. Although most of the state-level initiatives have to date been focused on large sources of greenhouse gas emissions, such as electric power plants, it is possible that smaller sources such as our gas-fired compressors could become subject to greenhouse gas-related regulation. Depending on the particular program, we could be required to control emissions or to purchase and surrender allowances for greenhouse gas emissions resulting from our operations.
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Also, as a result of the U.S. Supreme Court’s decision in April 2007 in Massachusetts, et al. v. EPA, the EPA is beginning to adopt regulations controlling greenhouse gas emissions under its existing CAA authority. For example, in September 2009, the EPA adopted a new rule requiring approximately 13,000 facilities comprising a substantial percentage of annual U.S. greenhouse gas emissions to inventory their emissions starting in 2010 and to report those emissions to the EPA beginning in 2011. On April 12, 2010, the EPA proposed additional portions of this inventory rule relating to petroleum and natural gas systems that, if adopted, would require inventorying for that category of facilities beginning in January 2011 and reporting of those inventories beginning in March 2012. Also, on December 15, 2009, the EPA officially published its finalized determination that emissions of carbon dioxide, methane and other greenhouse gases present an endangerment to human health and the environment because emissions of such gases are, according to the EPA, contributing to warming of the earth’s atmosphere and other climatic changes. These findings by the EPA pave the way for the agency to adopt and implement regulations that would restrict emissions of greenhouse gases under existing provisions of the CAA. Further, the EPA in June 2010 published a final rule providing for the tailored applicability of criteria that determine which stationary sources and modification projects become subject to permitting requirements for greenhouse gas emissions under two of the agency’s major air permitting programs.  The EPA reported that the rulemaking was necessary because without it certain permitting requirements would apply as of January 2011 at an emissions level that would have greatly increased the number of required permits and, among other things, imposed undue costs on small sources and overwhelmed the resources of permitting authorities.  In the rule, the EPA established two initial steps of phase-in to minimize those burdens, excluding certain smaller sources from greenhouse gas permitting until at least April 30, 2016.  In January 2011, the first step of the phase-in will apply only to new projects at major sources (as defined under those CAA permitting programs) that, among other things, increase net greenhouse gas emissions by 75,000 tons per year. In July 2011, the second step of the phase-in will capture sources that have the potential to emit at least 100,000 tons per year of greenhouse gases.  This new permitting program may affect some of our customers’ largest new or modified facilities going forward.





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


30


ITEM 6.  Exhibits








Exhibit No.

Description2.1

Contribution, Conveyance and Assumption Agreement, dated October 2, 2009, by and among Exterran Holdings, Inc., Exterran Energy Corp., Exterran General Holdings, LLC, Exterran Energy Solutions, L.P., EES Leasing LLC, EXH GP LP LLC, Exterran GP LLC, EXH MLP LP LLC, Exterran General Partner, L.P., EXLP Operating LLC, EXLP Leasing LLC and Exterran Partners, L.P., incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on October 5, 20093.1

Certificate of Limited Partnership of Universal Compression Partners, L.P., incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1 filed on June 27, 20063.2

Certificate of Amendment to Certificate of Limited Partnership of Universal Compression Partners, L.P. (now Exterran Partners, L.P.), dated as of August 20, 2007, incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on August 24, 20073.3

First Amended and Restated Agreement of Limited Partnership of Exterran Partners, L.P., as amended, incorporated by reference to Exhibit 3.3 to the Registrant’s Quarterly Report on form 10-Q for the quarter ended March 31, 20083.4

Certificate of Partnership of UCO General Partner, LP, incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form S-1 filed on June 27, 20063.5

Amended and Restated Limited Partnership Agreement of UCO General Partner, LP, incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on October 26, 20063.6

Certificate of Formation of UCO GP, LLC, incorporated by reference to Exhibit 3.5 to the Registrant’s Registration Statement on Form S-1 filed June 27, 20063.7

Amended and Restated Limited Liability Company Agreement of UCO GP, LLC, incorporated by reference to Exhibit 3.3 to the Registrant’s Current Report on Form 8-K filed on October 26, 20064.1

Indenture, dated as of October 13, 2009, by and between EXLP ABS 2009 LLC, as Issuer, EXLP ABS Leasing 2009 LLC and Wells Fargo Bank, National Association, as Indenture Trustee, with respect to the $150,000,000 ABS facility consisting of $150,000,000 of Series 2009-1 Notes, incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on October 19, 20094.2

Series 2009-1 Supplement, dated as of October 13, 2009, to Indenture dated as of October 13, 2009, by and between EXLP ABS 2009 LLC, as Issuer, EXLP ABS Leasing 2009 LLC and Wells Fargo Bank, National Association, as Indenture Trustee, with respect to the $150,000,000 of Series 2009-1 Notes, incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed on October 19, 200931.1
*
Certification of the Chief Executive Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 193431.2
*
Certification of the Chief Financial Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 193432.1
*
Certification of the Chief Executive Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
*
Certification of the Chief Financial Officer of Exterran GP LLC (as general partner of the general partner of Exterran 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.





31


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.





Exterran Partners, L.P.





August 5, 2010                                                                  By: EXTERRAN GENERAL PARTNER, L.P.


its General Partner





By: EXTERRAN GP LLC


its General Partner





By: /s/ DAVID S. MILLER


David S. Miller


Vice President and Chief Financial Officer


(Principal Financial Officer)





By: /s/ KENNETH R. BICKETT


Kenneth R. Bickett


Vice President, Finance and Accounting


(Principal Accounting Officer)


32


Index to Exhibits








Exhibit No.

Description2.1

Contribution, Conveyance and Assumption Agreement, dated October 2, 2009, by and among Exterran Holdings, Inc., Exterran Energy Corp., Exterran General Holdings, LLC, Exterran Energy Solutions, L.P., EES Leasing LLC, EXH GP LP LLC, Exterran GP LLC, EXH MLP LP LLC, Exterran General Partner, L.P., EXLP Operating LLC, EXLP Leasing LLC and Exterran Partners, L.P., incorporated by reference to Exhibit 2.1 to the Registrant’s Current Report on Form 8-K filed on October 5, 20093.1

Certificate of Limited Partnership of Universal Compression Partners, L.P., incorporated by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1 filed on June 27, 20063.2

Certificate of Amendment to Certificate of Limited Partnership of Universal Compression Partners, L.P. (now Exterran Partners, L.P.), dated as of August 20, 2007, incorporated by reference to Exhibit 3.1 to the Registrant’s Current Report on Form 8-K filed on August 24, 20073.3

First Amended and Restated Agreement of Limited Partnership of Exterran Partners, L.P., as amended, incorporated by reference to Exhibit 3.3 to the Registrant’s Quarterly Report on form 10-Q for the quarter ended March 31, 20083.4

Certificate of Partnership of UCO General Partner, LP, incorporated by reference to Exhibit 3.3 to the Registrant’s Registration Statement on Form S-1 filed on June 27, 20063.5

Amended and Restated Limited Partnership Agreement of UCO General Partner, LP, incorporated by reference to Exhibit 3.2 to the Registrant’s Current Report on Form 8-K filed on October 26, 20063.6

Certificate of Formation of UCO GP, LLC, incorporated by reference to Exhibit 3.5 to the Registrant’s Registration Statement on Form S-1 filed June 27, 20063.7

Amended and Restated Limited Liability Company Agreement of UCO GP, LLC, incorporated by reference to Exhibit 3.3 to the Registrant’s Current Report on Form 8-K filed on October 26, 20064.1

Indenture, dated as of October 13, 2009, by and between EXLP ABS 2009 LLC, as Issuer, EXLP ABS Leasing 2009 LLC and Wells Fargo Bank, National Association, as Indenture Trustee, with respect to the $150,000,000 ABS facility consisting of $150,000,000 of Series 2009-1 Notes, incorporated by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K filed on October 19, 20094.2

Series 2009-1 Supplement, dated as of October 13, 2009, to Indenture dated as of October 13, 2009, by and between EXLP ABS 2009 LLC, as Issuer, EXLP ABS Leasing 2009 LLC and Wells Fargo Bank, National Association, as Indenture Trustee, with respect to the $150,000,000 of Series 2009-1 Notes, incorporated by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K filed on October 19, 200931.1
*
Certification of the Chief Executive Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 193431.2
*
Certification of the Chief Financial Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to Rule 13a-14 under the Securities Exchange Act of 193432.1
*
Certification of the Chief Executive Officer of Exterran GP LLC (as general partner of the general partner of Exterran Partners, L.P.) pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200232.2
*
Certification of the Chief Financial Officer of Exterran GP LLC (as general partner of the general partner of Exterran 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.


33