USA Compression Partners LP

NYSE:USAC

Earnings Call Transcript 2023-Q2

[Operator]

Good morning. Welcome to USA Compression Partners Second Quarter 2023 Earnings Conference Call. During today's call, all parties will be in a listen-only mode. [Operator Instructions] This conference is being recorded today, August 1, 2023.

I would now like to turn the call over to Chris Porter, Vice President, General Counsel and Secretary.

[Christopher Porter, Vice President, General Counsel and Secretary]

Good morning, everyone, and thank you for joining us. This morning, we released our operational and financial results for the quarter ending June 30, 2023. You can find a copy of our earnings release as well as a recording of this call in the Investor Relations section of our website at usacompression.com.

During this call, our management will reference certain non-GAAP measures. You will find definitions and reconciliations of these non-GAAP measures to the most comparable U.S. GAAP measures in our earnings release. As a reminder, our conference call will include forward-looking statements. These statements are based on management's current beliefs and include projections and expectations regarding our future performance and other forward-looking matters. Actual results may differ materially from these statements. Please review the risk factors included in this morning's earnings release and in our other public filings. Please note that information provided on this call speaks only to management views as of today, August 1, 2023, and may no longer be accurate at the time of a replay.

I'll now turn the call over to Eric Long, President and CEO of USA Compression.

[Eric Long, President and Chief Executive Officer]

Thank you, Chris. Good morning, everyone, and thanks for joining our call. I am joined on the call today by Eric Scheller, our COO; and Mike Pearl, our CFO. This morning, we released exceptional second quarter 2023 results that were attributable to our ability to opportunistically procure and deploy new compression units, convert idle units to active status and secure attractive pricing for new and legacy units in an extremely tight compression market.

Our directed efforts in each of these areas have allowed us to create meaningful stakeholder value through the delivery of our best-in-class compression service offering under our disciplined capital management and organic growth compression-as-a-service business model. We continue to exercise capital discipline to returns-based capital allocations that direct capital expenditures to optimize returns, resulting in continued improvements to our balance sheet and progressing us closer to a state of financial optionality that affords us greater flexibility to deploy free cash flow to further reduce debt, make changes to our distribution policy, or pursue other strategic long-term investments and initiatives.

Our second quarter 2023 results again featured consecutive quarterly record revenues, adjusted EBITDA and distributable cash flow. Demand driven pricing for our services in an extremely tight compression market continues to underpin our up into the right operational and financial performance. During the second quarter, we continue to place units under contract for extended tenors and at attractive pricing compared to prior market cycles, while increasing the size of our active fleet through new unit additions and continued conversions of legacy units from idle to active status. A revenue generating horsepower exit rate for the second quarter came in at approximately 3.35 million horsepower, a record for USA Compression.

Our second quarter growth in active horsepower was achieved alongside further quarter-over-quarter improvements in utilization, which averaged over 93% during the second quarter. Our improved utilization was accompanied by record setting quarterly average per horsepower revenue, which came in at $18.65, and which represents our sixth consecutive quarterly average rate improvement. Our increased active fleet size and improved utilization and pricing, enabled record setting distributable cash flow coverage of 1.3x.

We are extremely pleased with our second quarter results and believe that our continued operational and financial improvements speak to the value of the services that we provide, the reliability and predictability of our cash flow stream, and the benefits of our returns-based and disciplined organic growth model. Each of which represents a significant catalyst for continued improvements to our balance sheet and provides ongoing financial flexibility that inures to the benefit of all of our stakeholders.

Over the past several quarters, we have discussed our bullishness on long-term commodity prices and on the broader energy industry, and our views have not changed. We view meaningful transitions to alternative energy sources and electrification as multi-decade undertakings that will require extraordinary levels of capital investment and we'll experience many starts and stops as economic, social, and political factors continue to affect the pace of transition and change.

As these unpredictable dynamics play out over the coming years, the oil and gas production cycle will continue, which we believe provides USA Compression with sustained demand for its natural gas compression services. Hydrocarbons will remain critical to the current and future health, wealth and wellbeing of society, and USA Compression's vital compression services will be required to move hydrocarbons to the marketplace.

The production-centric nature of the services that we provide, and the mission-critical role that natural gas compression services play within the broader energy value chain provides USA Compression with durable baseline demand for our services. We have emphasized many times that demand for our services is linked directly to domestic hydrocarbon production, which the EIA currently forecasts at record levels for 2023 and 2024 with incremental production growth continuing for years to come. We also anticipate significant incremental demand for natural gas compression as production ratios of associated gas to oil continue to increase in domestic shale oil plays, lingering U.S. LNG export delays abate and additional takeaway capacity is added to increase the flow of Permian gas volumes into Mexico in advance of re-exporting these volumes from highly anticipated and planned investments in Mexican LNG facilities. Although our term-based take or pay revenue model provides us with secure long-term recurring fees that are unaffected by lower natural gas prices, improved demand and pricing for U.S. natural gas provides an advantageous backdrop for USA Compression to capitalize on future organic growth opportunities.

We are seeing producers increasingly opt to outsource compression services in favor of directing their capital spending closer to the wellhead. We believe that trend will continue as they seek to improve their overall capital investment metrics and continue to focus on their core competencies of improving drilling and well completion efficiency. We expect domestic oil drilling activity to continue into the foreseeable future as forecasted crude oil prices remain above industry cited breakeven WTI prices for new drilling and remain elevated as worldwide inventories continue to decline significantly and crude oil demand continues to grow as worldwide economies continue their post-pandemic recoveries and expansions.

To summarize, we are extremely pleased with our current market position and our compression-as-a-service delivery model that features a growing active fleet that remains highly utilized under attractively priced long-term take or pay contracts. Our in-place business model provides us with a durable and predictable cash flow stream that runs consistent with a sustained domestic hydrocarbon production cycle that relies on natural gas compression to deliver hydrocarbons to market centers and ultimately to end users.

Furthermore, we expect commodity prices to remain supportive of incremental drilling with demand oil and natural gas continuing to increase over time as the transition toward alternative energy sources progresses at what we believe will be a slower than expected pace and additional use cases for domestic natural gas evolve. These market dynamics apply incremental pressure to what already is a constrained market for the compression services that we provide. And position USA Compression to grow its active fleet strategically and through returns-based capital investments that augment USA Compression's take or pay recurring revenue stream and improve its overall financial position.

Before turning the call over to Eric Scheller to discuss second quarter operating results, I would like to stress that the most important thing we do as a company is to ensure that our employees, contractors, and customers return home safely each day. Through the first two quarters of 2023, we maintained a total recordable incident rate of zero, which is well below the industry average of 0.9 and is attributable to our employees' continual focus on safety. We are extremely proud of this accomplishment and thank every USA Compression employee for their continued commitment to our safety policies and procedures.

With that, I will turn the call over to Eric Scheller, our COO to discuss our second quarter operating results.

[Eric Scheller, Chief Operating Officer]

Thanks, Eric, and good morning all. As Eric noted, the strong results we reported this morning once again reflect our exceptional customer service, our high-quality compression assets, and our demonstrated ability to enhance the performance and profitability of the business. At the same time, we will continue balancing our opportunity set from commitments to pursue capital discipline, reduce leverage and improve distribution coverage. We continue to message our positive industry outlook for 2023 and beyond, and focus on expanding the size of our active fleet to meet the demands of what continues to be a hungry compression market.

During the second quarter and throughout 2023, we have been successful in growing our active fleet to all-time highs in terms of revenue generating horsepower with approximately 3.35 million of currently deployed horsepower generating revenue at quarter end. Likewise, our utilization statistics continue to improve with our second quarter exit rate utilization clocking in at 93.7%, a 4 percentage point improvement over the prior quarter.

As our active fleet size utilization continue to improve, we also continue to capture extended contract tenors across the entire portfolio, which is the direct result of an extremely tight market for natural gas compression and the quality of service that we deliver to our customers. We expect our active fleet and company-wide utilization to continue increasing as market tightness persists. We believe that existing and pronounced tightness in the compression market will continue for years to come, as forecasted commodity prices support continued domestic drilling, new unit orders slow as new unit construction costs escalate significantly, lead times for new unit deliveries for past 70 weeks, and available component manufacturing capacity is consumed by numerous companies seeking gas-driven backup power solutions for data centers.

Our capital investment strategy has evolved over the last few years in anticipation of and in response to compression market dynamics. Irrespective of the prevailing market backdrop, our approach to capital investment has remained disciplined and our capital investment decisions will continue to be returns-based, while available capital dollars being directed to their highest and best use, which at times may cause us to moderate our capital investments in favor of funding other initiatives such as debt reduction. For example, in 2022, our capital investment strategy focused on converting already owned equipment from idle to active status. As a result, we curtailed our 2022 capital spending, focusing on making the nominal capital investments necessary to redeploy a higher than usual idle asset fleet in a recovering economic environment.

For 2023, in response to increasing market tightness and the high utilization of our large horsepower fleet, we increased our capital spending on new unit orders, which we currently expect to result in the addition of 140,000 of large horsepower capacity throughout 2023, and 25,000 of large horsepower capacity in 2024. For the 2023 new unit program, we have taken delivery of 45,000 horsepower as of the end of the second quarter. Our initial cost for all new unit orders was set at the time of ordering, and therefore is not affected by continued inflationary pressures. In addition to these new unit orders, we have continued to direct capital spending to bring existing idle units to active status.

In retrospect, our new unit orders were extremely timely from cost and demand perspectives. Since we placed the orders, manufacturing costs have continued to escalate as input cost inflation and limited manufacturing capacity have increased new unit prices by approximately 20% compared to the new unit pricing that we were able to lock in for our existing 2023 and 2024 new unit orders. Also, we are pleased to report that all new units are spoken for and are currently under or subject to pending contracts with longer tenors.

Given current market conditions, including delivery times that exceed 70 weeks, we currently expect that our 2024 capital investment strategy will shift back to converting already owned equipment from idle to active status, utilizing our inventory of idle units and component parts inventory. Returning to an idle to active conversion strategy will allow us to moderate year-over-year capital expenditures and improve our overall returns by directing our capital to its highest and best use.

To close, we expect our full year 2023 results to reflect the benefits of our directed efforts to increase our active fleet size and utilization, and to practice returns-based capital investing. As we look out into the foreseeable future, we currently expect to continue harvesting cash flow from our active fleet, and expect to moderate capital spending as we focus on unlocking the incremental return potential of our in demand, yet idle horsepower that we can deploy efficiently and effectively at a comparatively lower capital burden.

We remain extremely bullish on compression market fundamentals, and view our continued operational and financial performance as firm validation of our investment strategy, and compression-as-a-service revenue model.

With that, I'll turn the call over to Mike Pearl, our CFO to discuss our second quarter financial results.

[Michael Pearl, Chief Financial Officer]

Thanks, Eric Scheller, and good morning. As Eric Long mentioned, our second quarter results featured consecutive quarter record revenue, adjusted EBITDA, and distributable cash flow. Our second quarter distribution coverage of 1.3x represents an all-time high for USA Compression, and is directly attributable to pronounced and continued demand for our services, which play a pivotal long-term role in delivering hydrocarbons to market centers. Our operations and commercial teams continue to manage our fleet efficiently so that we remain positioned to grow our active fleet's compression capacity, while capitalizing on attractive contract pricing that we continue securing under long-term take or pay styled contracts.

Our quarterly utilization exit rate continued to improve, and was complimented by further increases to our quarterly average revenue per revenue generating horsepower, which came in at another all-time high of $18.65. Our second quarter 2023 results revealed a 5% increase in sequential quarter revenues, and a 21% increase in revenues compared to the year ago period. This revenue growth was driven by improved utilization and pricing with margins largely remaining intact despite pronounced and persistent input cost inflation.

We continue to experience comparatively higher prices for parts, supplies, and labor in all regions. The bulk of our customer contracts allow for CPI-U rate adjustments at contract anniversary dates, and these rate adjustments can help to mitigate the adverse economic impact of input cost inflation. However, there is a lag effect associated with realizing the economic benefit of CPI-U rate adjustments as the immediacy of input cost inflation tends to front run the dates at which CPI-U rate adjustments can be applied. Furthermore, inflation related to some of our significant input costs such as labor remains sticky and elevated compared to the CPI-U, which is affected by a broader market basket of consumer goods and services that have continued down a disinflationary path since mid-2022. Notwithstanding, we do expect that inflationary pressures will abate over time and that CPI-U rate adjustments will provide increased margin support, thereby allowing our adjusted gross margin percentages to revert toward historic levels.

Our total fleet horsepower at the end of the quarter remained essentially flat to the previous quarter at approximately 3.7 million horsepower. However, our revenue generating horsepower increased by 2.6% on a sequential quarter basis. Second quarter 2023 expansion capital expenditures were $71.6 million and our maintenance capital expenditures were $6.4 million. Expansion capital spending during the quarter primarily consisted of reconfiguration and make-ready of idle units, the delivery of 27,500 of incremental large horsepower and the procurement of compression station components.

Second quarter 2023 net income was $23.6 million. Operating income was $51.4 million. Net cash provided by operating activities was $87.9 million, and cash interest expense net was $40.2 million. Cash interest expense increased by approximately $2.2 million on a sequential quarter basis, primarily due to higher interest rates applicable to outstanding borrowings on our floating rate credit facility. However, this increase was offset by $1.2 million of cash payments received under our $700 million notional principal fixed rate interest rate swap that we executed in early April and that locks in 30-days SOFR for a two year period at 3.875% compared to current 30-day SOFR that exceeds 5%.

Approximately nine months ago, we identified a near term bank covenant leverage ratio target of 4.5x, which we are pleased to report that we have achieved as of the end of the second quarter. As we continue to exercise capital discipline and reap the benefits of our stable and existing book of business, we anticipate further leverage reductions over time and will work toward achieving a terminal leverage target of 4x. We believe that further leverage reductions provide tremendous financial flexibility to responsibly consider strategic alternatives, adjust distribution levels, and make opportunistic capital investments. We will remain committed to achieving our terminal leverage target and believe that improving market conditions, operational and contract pricing improvements and continued capital discipline will allow us to achieve our leverage objectives.

Finally, we expect to file our Form 10-Q with the SEC as early as this afternoon.

And with that, I will turn the call back to Eric Long for concluding remarks.

[Eric Long, President and Chief Executive Officer]

The second quarter of 2023 provided us with further confirmation regarding our optimism regarding the long-term demand for our services and our ability to further cement our status as the premier third-party compression service provider in the industry. For the balance of 2023, we will continue focusing on maintaining capital discipline as we satisfy market demands for our services, increasing our durable and predictable cash flow stream by opportunistically contracting our services under longer termed contracts that feature attractive and demand-driven market rates and deploying new large horsepower units, and transitioning legacy units from idle to active status. We look forward to sharing the results from of ongoing operations and investments strategy in the periods to come and firmly believe that USA Compression is positioned to improve its financial positioning, as we continue to realize the benefits of our commercial and operational efforts.

On August 4th, we will make our 42nd consecutive quarterly distribution payment. The $0.525 per unit distribution is flat to the previous quarter's distribution. Continued improvements to our active fleet size, utilization, contract tenors and contract pricing will increase our financial optionality for further capital investment, leverage reductions and distribution policy changes.

To conclude, we are extremely pleased with our second quarter results, highlighted again by record quarterly revenues, adjusted EBITDA, distributable cash flow and distribution coverage, in which also is featured continued improvements to utilization and leverage.

Finally, I would like to recognize USA Compression's 25th anniversary, which we celebrated in July. On behalf of our Board of Directors and senior management, I emphatically thank each member of the USA Compression family for their respective contributions to making USA Compression the industry's premier provider of natural gas compression services. Your commitment to delivering first class service to our customers, while safely pursuing operational excellence has enabled USA Compression to deliver exceptional value to all stakeholders for more than 25 years. Reflecting on the last 25 years, I can't help but be amazed that USA Compression has distributed more than $1.5 billion over the past decade to its equity holders, while growing its business exponentially. We have enjoyed many successes throughout our journey and look forward to the opportunities that lie ahead.

In closing, we would like to thank our employees, customers, suppliers, investors, and founders for contributing to USA Compression's pronounced success, and we look forward to discussing our third quarter 2023 results with you in a few months' time.

And with that, we will open the call to questions.

[Operator]

[Operator Instructions] Our first question comes from the line of Gabe Moreen from Mizuho. Please go ahead.

[Gabriel Moreen, Mizuho Securities USA LLC]

Good morning, everyone. I just wanted to ask about, I guess, the shift and pivot back to trying to bring idle units back into service versus ordering new units. Can you just talk about the dynamics, I guess, out there with your customer relationships? The market is still really tight. I assume some of your customers are still clamoring for incremental horsepower. Is there a risk that I guess maybe you seed market share if you are not out there ordering despite these really, really long lead times and inflated costs for new compression?

[Eric Long, President and Chief Executive Officer]

Yes. Great question. This is Eric. I mean, what we are seeing is that there is more demand than there is goods and services and mechanics to go around for all of us in the industry. So I think the way we look at it is, we control, we can control, the incremental cost of redeploying some of our idle equipment is significantly less than building brand new. So to the extent we've got decent equipment that has useful life remaining, we'd rather spend a little bit of make-ready capital rather than spending and some incremental additional capital at costs that we see that if -- as we pointed out, cost of organic assets are up 20% year-over-year. So, we're less concerned about market share than we are about optimizing our own financial health, our own balance sheet, our own leverage and coverage profiles. But again, there's more than enough business for all of us to go around.

[Gabriel Moreen, Mizuho Securities USA LLC]

Thanks, Eric. And maybe as a follow up, can I ask about sort of the decent equipment as I guess you termed it, it's still idle out there. Can you help us kind of frame up how much of the unutilized stuff out there can be refurbished and redeployed, sort of what your timing is on that? And then maybe sort of framing up, I think you had $250 million-ish in CapEx this year, framing up sort of what '24 CapEx can look like?

[Eric Scheller, Chief Operating Officer]

Hey, this is Scheller, Gabe. So the vast majority of the idle equipment that remains is in really good condition. We've done a hard review of all of the assets. We're starting to refurbish the component, and it's begun to assemble units to start going out here for the back half of the year, and especially more so in the first half, first three quarters of next year. I think, the capital burn on that is going to be substantially less than it is going to be this year. But nonetheless, we'll be able to supply units for all of the customers who've already expressed an interest as they're doing their forecast for 2024.

[Gabriel Moreen, Mizuho Securities USA LLC]

Thanks, Eric. And then I guess just hypothetically, you're approaching 94% utilization right now. Do you think you could get another 1% or 2% next year as you redeploy all that stuff?

[Eric Scheller, Chief Operating Officer]

I do. I think the stuff that's what's left, and what it looks like is in good condition, it -- we're very confident we can get utilization higher.

[Operator]

Our next question comes from a line of Selman Akyol from Stifel.

[Selman Akyol, Stifel, Nicolaus & Company, Inc.]

So first question, just on gross margins, improved very nicely sequentially, and I think all times high has been around 65%. So is this sustainable? Can it go higher? What is your thought on gross margins on a go forward basis?

[Eric Scheller, Chief Operating Officer]

Selman, this is Scheller. Gross margins, we've been always hard focused on it. Good times, bad times, always been able to make margin to the right number. I think, there's not going to be degradation. There's always upside as we're managing the cost. So, given all the components that go into it, I think that the numbers are still good, and I'm not worried about making those numbers going forward.

[Selman Akyol, Stifel, Nicolaus & Company, Inc.]

Okay. And then are you guys having discussions on 2025 yet, given how tight the marketplace is?

[Eric Long, President and Chief Executive Officer]

We've had some preliminary discussions with folks. If you think about the norm in our industry, the contracting points tend to have historically been kind of six months to nine months in advance. And I think it's caught some of our customers somewhat by surprise when they hear 2024 as an industry is basically spoken for, and now it's time to start thinking about 2025. That tends to be longer than the normal planning cycles, when you think about our independent and large independent, and even the major oil guys tend to look at things about a year in advance. That said, we are working with some of this corp dev and strategic planning folks who have a little bit longer time perspective to inform and educate, “Hey, gang, if you want to get into the queue, so to speak, for equipment, it is time to start thinking about 2025.”

And I think people are starting to noodle on that and recognize that with the supply chain bottlenecks, Jim Umpleby was on Squawk Box this morning from Caterpillar talking about how they're hitting on 8 cylinders out of 8 on all of their business fronts, but they've got some continued supply chain issues, in particular, related to the large engine manufacturing, which obviously is compression in prime power and standby power. So I think people are starting to acknowledge and recognize that it's a longer term and longer time cycle than things have historically been in the past.

[Selman Akyol, Stifel, Nicolaus & Company, Inc.]

Got it. And then if I can just squeeze one more in here. I thought I heard you mention something about gas-driven power for backup to data centers, which kind of sounds like a new market to me. Is there any color you could provide on that?

[Eric Long, President and Chief Executive Officer]

No, I think the concept was made that, that's a competitive source to compression engines that Caterpillar is allocating equipment to standby data centers. And that was, again, one of the things Umpleby spoke to this morning, big demand for standby units going into data centers for backup electrical purposes. As we bring more and more renewables online, wind and solar, which tend to be intermittent in their ability to provide power to the grid, it makes some of these must-run [Five9's] mission-critical applications require additional backup power to assure that the data centers don't go down during a ground out or a blackout.

[Selman Akyol, Stifel, Nicolaus & Company, Inc.]

And so that's what's really leading to sort of the 70-week lead time out there.

[Eric Long, President and Chief Executive Officer]

Among other things, we've got a combination of demand for compression and data centers and prime power and standby power and marine and all these large industrial engine applications, coupled with the point where you've got some continued supply chain bottlenecks, wiring harnesses that come from the Ukraine, aren't coming from the Ukraine anymore. We still have some continued issues with parts and pieces, not clearing ports in a timely manner. So there's a whole bunch of drivers that impact Caterpillar, impact, fabricators, impact parts and component pieces throughout the supply chain. So yes, it's 70 months and hopefully, there's some improvement, but we're in pretty close contact with Caterpillar. It appears that the 70 weeks rather is not really coming back in on itself. It's continuing to expand.

[Operator]

Thank you, ladies and gentlemen. This does conclude today's call. Thank you for your participation. You may now disconnect.