USA Compression Partners, LP Q3 FY2022 Earnings Call

Good morning. Welcome to USA Compression Partners of Third Quarter 2021 Earnings Conference Call. Today's conference call, all parties will be in listen-only mute and following the conference will be open for questions. This conference is being recorded today, November 1st, 2022. I would now like to turn the call over to Chris Porter - Vice President, General Counsel & Secretary.

Good morning, everyone, and thank you for joining us. This morning, we released our financial results for the quarter ended September 30, 2022. You can find the earnings release as well as a recording of this call in the Investor Relations section of our website at usacompression.com. They were quarter-on- available through November 11, 2022. During this call, our management will discuss certain non-GAAP measures. You will find definitions and reconciliations of these non-GAAP measures to the most comparable GAAP measure in earnings. As a reminder, our conference call will include forward-looking statements. These statements include projections and expectations of our performance and represent our current beliefs. Actual results may differ materially. Please review the statements of risk included in this morning's release and in our filings. Please note that information provided on this call speaks only to management's views as of today, November 1st, and may no longer be active at the time of a replay. I'll now turn the call over to Eric Long, President and CEO of USA Compression.

Thank you, Chris. Good morning, everyone, and thanks for joining our call. I would like to begin today's call by introducing our new CFO, Mike Pearl. Mike joined us in early August and brings a wealth of finance experience to USA Compression. Mike spent approximately 17 years as a finance executive at Anadarko Petroleum and Western Midstream Partners, most recently serving as Western's CFO. We are happy to welcome Mike aboard, and we sincerely thank Matt for his valuable contributions to USA Compression during his tenure as our CFO. Last quarter, we highlighted industry dynamics that we believe are driving increased demand for natural gas in a supply-constrained environment. Our views on the energy macro environment have not changed, and we continue to believe that we're in the early innings of a commodity price super cycle. The IEA's Executive Director stated last week that tightening markets for LNG worldwide and major producers cutting back have put the world in the middle of the first truly global energy crisis. We believe that the oil and gas industry's disciplined capital investment approach—focusing on free cash flow generation and returns-based investing—further underpins the existing tightness in energy markets and will contribute significantly to continued market tightness into the foreseeable future. We also expect the commodity price backdrop to remain supportive of production growth, which in turn will drive increased demand for our natural gas compression services. Our customers remain active across our operating regions. The primary basins in our largest operating areas have all registered year-over-year production increases ranging from modest single-digit to close to mid-teen growth percentages, leading to continued levels of expanding natural gas production. Our increasing activity levels in these regions have kept pace with our customers' production activities. Generally, these regions have benefited from proximity to export markets and ample transportation and takeaway availability. However, in the Permian and Delaware, natural gas takeaway capacity continues to be a future challenge for the industry, and we believe that this challenge will persist for the next several years. Based on anticipated Permian and Delaware growth, we believe increased tightness in natural gas takeaway capacity is likely to occur in late 2023 and into early 2024, necessitating additional demand for compression services. In the Northeast, natural gas production growth has been more modest as operators in the region continue to work through adequate pipeline capacity due to regulatory roadblocks. Compression has been used by several of USA Compression's Northeast customers as a means to arrest production declines and is a cost-effective alternative to drilling additional wells. We believe it is important to recognize that USA Compression's operational and financial performance is more dependent on the production cycle than the drilling cycle that correlates more closely with near- to medium-term commodity prices. In short, the compression services that we currently provide within most of the significant U.S. onshore basins serve as a vital component necessary to deliver natural gas from the wellhead to processing facilities and ultimately to market centers. Given our current contracts and contracting strategy, we view our ability to continue to generate a meaningful and reliable stream of cash flow as durable irrespective of the drilling cycle. We believe the current drilling supportive commodity price levels and the expected production increases thus provide us with readily achievable opportunities to drive operational efficiencies, grow organically, and ultimately secure financial optionality. Achieving the financial optionality will allow USA Compression to deploy free cash flow to support incremental capital investment, debt reduction, distribution increases, or a combination thereof. We believe that the observed current trajectory of production growth in the basins that we serve will contribute significantly to our ability to grow through our existing compression as well as organically with new compression deployed at attractive rates. Our current focus remains on converting already owned equipment from idle to active status, and therefore, to cash flow-generating status. During the third quarter, we continued to increase our service position with our major customers through improved fleet utilization. Our third quarter utilization exit rate was 90.9% and up from 88.4% on a sequential quarter basis and up from 83% for the year-ago comparable period. During the third quarter, we redeployed over 60,000 of currently owned and idle horsepower. In addition to increasing utilization, we realized increased average revenue per revenue-generating horsepower per month on a sequential and year-over-year comparable period basis. We are also witnessing meaningful increases in average contract tenor from the redeployment of idle units as well as from contract renewals of currently deployed units. Current negotiations with our customers center on 30-month average renewal tenors with new equipment deployments attracting contract tenors in excess of 60 months. We manage our contract portfolio returns and margins so that we are positioned to satisfy market demand for desirable service and equipment, protecting our cash flow during volatile and inflationary periods through CPI-based rate resets. We have seen market increases in the prices of fuel fluids and labor, and although our contract-based CPI adjustments allow us to mitigate this cost inflation, we did see a modest decline in margins resulting from input cost inflation that tends to precede the date that we are able to execute contract rate adjustments. Notwithstanding, we expect inflationary pressures to abate eventually, and our adjusted gross margins to remain at or near the historic levels normalizing around 68%. In addition to our increased utilization for the current fleet, we expect to improve our market share in key production basins in which we operate through our commitment to an additional 50 large horsepower compression units that we made in September of this year. These planned purchases were driven by pronounced demand from our major customers for compression and station services and will bring our committed new unit order for 2023 to 66 units for a total of 165,000 additional horsepower. By locking in unit delivery slots that now approach a full year's lead time, we expect to secure multiyear contracts with our customers for the deployment of this additional compression by year-end 2023. As we have previously discussed and announced publicly, we have been working on a dual drive compressor unit design that takes advantage of the gradual transition to electrification as the country's electric grid expands and ultimately gets built out. During last quarter's call, I mentioned that we have signed multiyear contracts to deploy our dual drive units out in the field. These units have been installed at Callon Petroleum sites and commenced operations the first week of August. We continue to be excited about this service offering as it allows our customers to further mitigate greenhouse gas emissions in a pragmatic, reliable, and economic manner. This ESG-friendly initiative is centered around retrofitting existing compression units for dual drive capability. The dual drive concept combines a natural gas-driven engine and an electric-driven motor to quickly and reliably switch from natural gas to electricity to compress natural gas depending on operating constraints and conditions. This technology results in decreased emissions while maintaining the flexibility and redundancy to switch to gas when weather conditions or grid demand make natural gas-powered compression preferable. Economically, our dual drive initiative makes a lot of financial sense for USA Compression's customers that will benefit from lower operating expenses, increased reliability, 99% run times, substantially lower greenhouse gas emissions, and the mitigation of interconnect delays. As these units get up and running and demonstrate their expected operational performance, reliability, and flexibility, we anticipate that we will continue to field an increasing number of indications of interest from customers that are seeking to deploy this cost-efficient and more environmentally friendly solution to compressing natural gas. We believe that the migration to electrification will be a multi-decade evolution, and as customers realize that the dual drive offering provides the reliability and redundancy of a natural gas backup driver with the advantage of electricity as a prime power source, we believe the demand for this service offering will continue to increase over time. On October 13, and based on our third quarter results, our Board maintained this quarter's distribution consistent at $0.525 per unit, which will be paid this Friday, November 4. This distribution represents the 39th quarter of consecutive distribution payments and corresponds to a distributable cash flow coverage ratio of 1.07x. In addition to maintaining a healthy coverage ratio, we reduced our bank covenant leverage ratio from 4.9x to 4.84x on a sequential quarter basis, consistent with our commitment to reduce leverage over time while providing meaningful returns to all of our stakeholders, with lengthening contract tenors for new equipment deployments and contract renewals of existing active assets. Absent unexpected events, such as further supply chain disruptions or major geopolitical events, we remain encouraged that both leverage and coverage metrics will continue to improve. Finally, before Mike discusses our third quarter results, I would like to make a few comments regarding safety. As a company, the most important thing we can do is ensure that our employees return home safely each day. We are extremely proud of our relentless focus on safety that has resulted in zero year-to-date recordable incidents for our last 1.2 million hours worked—this is a significant accomplishment, and I thank each and every USA Compression employee for their commitment and strict adherence to our safety policies and procedures. With that, I will turn the call over to Mike to discuss our third quarter 2022 results.

Thanks, Eric, and good morning. Before walking through our third quarter results, I would like to thank Eric and our Board for this opportunity at USA Compression. What intrigued me most about this opportunity was the unique positioning of USA Compression within the production cycle, which provides stable and predictable cash flows from currently deployed compression assets that are situated in most of the significant U.S. onshore plays. As U.S. onshore production continues to ramp up, USA Compression remains positioned to continue harvesting cash flow from its existing highly utilized compression fleet while maintaining clear visibility in terms of making incremental and strategic capital investments that will support returns-based organic growth into the foreseeable future. With that, I will discuss USA Compression's third quarter financial results. Today, we reported our third quarter results, which again featured sequential quarter increases in revenue and adjusted EBITDA, driven primarily by improved inflation and pricing, with our third quarter utilization exit rate increasing by nearly 3% on a sequential quarter basis, while maintaining our current trajectory of improving average revenue per revenue-generating horsepower per month, which increased approximately 2% to $17.53. Pricing improvements were driven by CPI price escalators for currently contracted services and improving supply and demand dynamics that allowed for improved pricing for newly contracted compression services. We did see a modest decline in our adjusted gross margin percentage that ticked down 0.9%, attributable largely to price increases in vehicle fuel, compressor fleet lubrication fluids, and labor. While our contracts allow for CPI-adjusted rates, there is a lag effect associated with these rate resets where input cost inflation predates effective rate resets. Nevertheless, we expect these inflationary pressures to abate over time, and we still have maintained our margins at or near our historic averages. Finally, our distributable cash flow declined by just under 1% on a sequential quarter basis as a result of higher interest costs associated with borrowings under our floating rate credit facility. Notably, most of USA Compression's debt is fixed-rate debt, and although higher interest rates persist, our nearest debt maturity is not until December 31, 2025. Our total fleet horsepower at the end of the quarter remained flat to the previous quarter at approximately 3.7 million horsepower. Expansion capital spending for the third quarter was $46.7 million, and our maintenance capital expenditures were $8.1 million for the third quarter of 2022. The expansion capital spending consisted of reconfiguration and make-ready of idle units, the delivery of four large horsepower units and associated components at a compressor station in the Delaware Basin, and down payments on our 2023 new unit orders. Our maintenance capital spending was approximately $2 million higher on a sequential quarter basis, attributable to a higher level of maintenance activities. For the third quarter, net income was $9.6 million. Operating income was $45.1 million. Net cash provided by operating activities was $49.2 million, and cash interest expense net was $33.3 million. Again, interest expense increased by approximately $2 million on a sequential quarter basis as a result of higher interest rates applicable to outstanding borrowings on our floating rate credit facility. Notwithstanding, the Board kept our quarterly distribution flat at $0.525 per unit based on a relatively flat coverage ratio that came in at 1.07x. Our bank covenant leverage ratio was 4.84x, representing yet another sequential quarter decline. We continue to believe that with an improved outlook for the industry, the previously discussed metrics should improve over time. Improved market conditions, coupled with our anticipated operational improvements and continued capital discipline, provide an ideal set of circumstances for USA Compression to continue delivering predictable, reliable, and durable returns for all stakeholders. Finally, we have narrowed our full-year 2022 guidance. We expect adjusted EBITDA between $420 million and $430 million and distributable cash flow between $215 million and $225 million. We expect to file our Form 10-Q with the SEC as early as this afternoon. And with that, I'll turn the call back to Eric for concluding remarks.

Thanks, Mike. As we close out 2022 and look forward to 2023, we are very encouraged by what we see in a market that contributes to resilience and strengthening. Industry dynamics are proving conducive to improvements in price discovery and contract tenor. These factors, along with our demonstrated ability to build long-term relationships with our customers through the provision of high-quality service, position USA Compression to continue delivering meaningful investment returns to its stakeholders. We would like to re-emphasize our track record of 39 consecutive quarterly distributions and our expectations of continuing to deliver best-in-class compression services to our customers. Our ability to deliver high-quality service to our customers while maintaining capital discipline should continue driving financial performance that we expect will afford us the flexibility to dedicate future cash flows to further capital investment, debt reduction, distribution increases, or a combination of the foregoing items. To conclude, we are extremely pleased with our third quarter results that featured quarter-over-quarter improvements in utilization and operational performance, financial results, and leverage metrics. We look forward to discussing our full-year 2022 results in our 2023 outlook with you in several months' time. And with that, we will open the call to questions.

Thank you. Good morning. In terms of fleet utilization now being at a 90% run rate, should we expect pricing to improve and accelerate from here in terms of what you're able to push through?

Selman, this is Eric. When you think about 10% of our fleet being idle, and that's still several hundred thousand horsepower. When we look at the mix of the equipment, we continue to deploy our largest horsepower, and greater percentages than the smaller horsepower, but everything is in demand right now. Clearly, with inflationary pressures, both on operating expenses as well as capital expenditures and new unit acquisitions, we continue to reprice our existing book. Compression equipment that is 10 or 20 years old provides the same service that a brand-new one does, so the beauty of our business is that we don't have technological obsolescence; older assets can perform the same service as a new asset, which allows us in a market like this to continue to reprice. So we do have some month-to-month assets that we have been turning up, and when we do turn them up, we reprice. Unlike a company that's got three large LNG tankers, we have over 4,000 individual units, each of which has a separate contract. So it's a methodical repricing over time, and we look at it by horsepower class. So it's a long-winded way to say we anticipate continued upward movement in our pricing capacity in the upcoming year, which will vary by horsepower type as different contracts roll off over time.

Understood, thank you. And then in terms of your dual drives, do you anticipate getting more calls and deploying more units out there? Is there any supply chain limitations for getting more of those in the field?

You know, there are various components that go into these units, you know, electric motors that you have to source which have, you know, in excess of a year's lead time. We've got some gear mechanisms that have in excess of a year's lead time as well. But we haven't just waited around; a year ago we started making commitments for the supply chain. So we do have continued dual drive components that will be coming over the course of 2023. We do have some units that we recently completed that we are quoting for deployment in the field. So over the course of 2023, you know, we will probably have completed somewhere in the range between 20 to 50 of the dual drive machines that will be able to be deployed out in the field.

Great. And then last one for me. In it, you noted the improvement in your leverage ratio for the business. And I'm just sort of curious, given the ride rate environment now, what is the appropriate leverage for the business in your eyes as you go forward? And you kind of go through the cycle? Where would you like to end up?

Thanks for the question. This is Mike. I think in terms of thinking about the leverage, I mean, first and foremost, I'm a strong balance sheet enthusiast. I think a strong balance sheet and very manageable leverage contributes to the overall story, including equity. Having said that, as we look forward, it will be a combination; consider a debt-to-EBITDA metric, you know, we want to grow the denominator, obviously, to do what we can to reduce the numerator. I think stage one is let's get close to 4.5 in terms of a leverage metric, and then let's assess the opportunity set that is ahead of us in terms of what we have in terms of opportunity to secure new units, etc., and make a decision from there. I think the capital discipline that you see in the EMP industry is very much bleeding over to the services sector. And so we're not going to spend money to grow for growth's sake; we're committed to capital discipline. And I think once we visit the 4.5 type neighborhood, we'll think about additional opportunities to get closer to that.

When you think about our capital structure, we've got a pretty large tranche of fixed-rate debt, two tranches of notes that are out there; our preferred is fixed. So we've got floating rate debt under our ABL, and we're just north of $600 million taken down under that facility today. So you can take a look at what every one percentage point increase in interest would do to that floating rate debt. So it's pretty manageable in the world that we're living in today.

Thank you very much.

We'll take our next question from Gabe Moreen from Mizuho, your line is open. Please go ahead.

Hey, good morning, guys. Maybe I could start off by asking you about the new units that you ordered for deployment. Can you just talk about where you see CapEx going in '23 versus this year? Is there a trade-off, I guess, between redeploying idle CapEx versus these new units you're ordering? So should we take that into account when we consider kind of overall cutbacks? And then also, I think, Mike, you mentioned prepaying some of this in '22 with deposits? Is that going to be significant? So sorry, a multi-part question there.

Hey, this is Eric. I guess the first part of the question is that these are the largest units that we typically deploy in our fleet. It's the product we call the cat 3608; we have one of the largest, if not the largest, 3608 fleet in the world today. So that's kind of our leading product that we offer. If you look at our idle fleet today, we have zero of these units available. When we look at our capital program, clearly, the cost to redeploy existing assets and spend a little make-ready capital is generally significantly less than buying a brand-new asset. That said, these large assets are highly accretive. We're being opportunistic on them because we've got extremely strong demand signals from long-term existing customers, and there's not a lot of capacity to build these assets anew. So we're able to lock in multi-year contracts, significantly long contracts with extremely creditworthy customers. So we look at where we can get the biggest bang for our buck. The reason we've committed to add 50 new units for next year and carry over some from this year is that these are unbelievably accretive. With the cash flow they create, this helps us deliver our balance sheet and improve our coverage. That said, we will continue deploying from our idle fleet this year and into next year; we'll continue that activity. But the trajectory of that, you know, once we get past 2023 may be a little longer into 2024, as we will be running close to out of idle assets that can be redeployed.

Great, and thanks, Eric. And then maybe if we can talk about the balance between demand and how much you feel you're pushing it versus manufacturing and fabrication slots to get these units built, kind of where things stand within those trade-offs, basically, are you actually meeting as much customer demand as you think is out there at this point?

I would say that between all of us in the industry, there remains more demand than there are existing assets in fleets that can be deployed or redeployed, as well as capacity from various manufacturers. So there's more demand than there is available product. The supply chain continues to have some bottlenecks and implications in various areas, including everything from the bolts that attach flywheels to engines to various subcomponents and wiring harnesses. You have some labor bottlenecks. So we're still seeing supply chain bottlenecks and limitations out there. I think we're in a little bit of a perfect storm; we can actually commit to spend additional capital, but we're balancing leverage, we're balancing coverage. And clearly, we don't want to get ahead of ourselves; we want to continue to deliver the balance sheet, as Mike indicated, to continue to improve our coverage metrics. So rather than chasing growth just for growth's sake, we're looking to grow where it makes the most sense from a profitable perspective.

Great. Thanks, Eric. Appreciate it.

We'll take our next question from Jeremy Tonin from JPMorgan, your line is open.

Jeremy, just want to kind of start off with a higher macro-level question. Thank you for all the commentary that you've provided. Just wondering if you might be able to frame for us where USA sees market share has been in large-cap compression historically, how that's trended, and where you see that going forward.

It's an interesting question because people talk about market shares; is company A gaining at the expense of company B? You know, as I gauge the question on, there's more demand than there is supply. So I think when you look at our customer mix and that of one of our publicly traded competitors, we all have different core customers. So we continue to meet the needs and demands of our core customer base, and our competitors do the same. So I wouldn't say that one company is gaining market share at the expense of the other. If you go back years, we've been talking about the compression pie and natural gas pie. As pressures decline, it takes an exponential increase in compression horsepower to move the same amount of volume. The volumes have been getting bigger; in 1995, we produced around 50 BCF a day, and today we're over 100 BCF a day. The pie is getting bigger, and as pressures in the fields continue to come down, you need even more compression on top of that. So the pie is getting bigger, and there are just a few companies that continue to feed the pie. So there's enough market share for all of us to go around.

Got it. I'll leave it there. Thank you very much.

There are no further questions on the line. Thank you everyone for joining today's call. You may now disconnect.