USA Compression Partners LP

NYSE:USAC

Earnings Call Transcript 2022-Q3

[Operator]

Good morning. Welcome to USA Compression Partners LP Third Quarter 2022 Earnings Conference Call. [Operator Instructions] 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 and Secretary.

[Christopher Porter, executive]

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 earnings release as well as a recording of this call in the Investor Relations section of our website at usacompression.com. The recording will be 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 measures in earnings release. 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 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, executive]

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 Liuzzi 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 macroenvironment have not changed, and we continue to believe that we're in the early innings of a commodity price super cycle. IEA Executive Director, Fatih Birol, stated last week, the tightening markets for LNG worldwide and major producers cutting overly, have put the world in the middle of the first truly global energy crisis.

We believe that the oil and gas industry is disciplined in capital investment approach that focuses 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, and 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 Basin, natural gas takeaway capacity continues as 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 likely will 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 an 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, 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 there from, provide USA Compression 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 redeployment of existing compression as well as organically with new compression deployed at attractive rates. Our current focus remains 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%, 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 net. In addition to increasing utilization, we also 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 demands 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 perceive 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 recently 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 of additional horsepower. By locking in unit delivery slots that now approach a full year's lead time, we expect to secure multi-year 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 had signed multi-year 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 the 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 demands 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 see 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 effort. 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 13th, 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 4th. 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 the lengthening contract tenders 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 0 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.

[Michael Pearl, executive]

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 [ utilization ] 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 allow 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 near state 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 third quarter of 2022. Expansion capital spending consisted of reconfiguration and makeready of idle units, the delivery of 4 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 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.

[Eric Long, executive]

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 in resilience and strengthening for natural gas compression services, and in particular, for the large horsepower offerings that our fleet features.

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 reemphasize 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 and our 2023 outlook with you in several months' time.

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

[Operator]

[Operator Instructions] We will take our first question from Selman Akyol from Stifel.

[Selman Akyol, analyst]

In terms of fleet utilization now being -- or exiting at a 90% run rate, should we expect pricing to improve, and I mean, sort of accelerate from here in terms of what you're able to push through?

[Eric Long, executive]

When you think about 10% of our fleet being idle, that's still several hundred thousand horsepower. When we look at the mix of the equipment, we continue to deploy our largest of horsepower, I'd say, in greater percentages than the smaller horsepower, but everything is in demand right now.

Clearly, with inflationary pressures, both on OpEx as well as CapEx costs and new unit acquisitions, we continue to reprice our existing book. A compression -- a compressor that's 10 years old or 20 years old provides the same service that a brand new one does. So the beauty of our business, since we don't have technological obsolescence is, 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 terming up. And when we do term them up, we reprice.

Unlike a company that's got 3 large LNG tankers or 5 large LNG tankers, we have over 4,000 individual units, each of which has a separate contract. So it's kind of 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, and it will vary as things roll off a contract over time.

[Selman Akyol, analyst]

And then, in terms of your dual drives -- and you anticipate getting more calls in putting more deployed out there, is there any supply chain limitations for getting more of those in the field?

[Eric Long, executive]

So there are various components that go into these things. Electric motors that you have to source, which have in excess of a year's lead time -- We've got some gear mechanisms that have an excess of a year's lead time. But we haven't just waited around a year ago to start 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, we'll 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.

[Selman Akyol, analyst]

And then last one for me. You noted the improvement in your leverage ratio for the business, and I'm just sort of curious kind of giving a right 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 at in terms of leverage as we exit?

[Michael Pearl, executive]

I think in terms of thinking about the leverage, I mean -- first and foremost, I am a strong balance sheet enthusiast. I think a strong balance sheet and very manageable leverage contributes to the overall story, equity included. Having said that, I think, as we look forward, it will be a combination -- if you look at it, consider a debt-to-EBITDA metric, it's -- we want to grow the denominator, obviously, to do what we can to reduce the numerator. I think Stage 1 is let's get close to 4.5 in terms of a leverage metric, and then let's assess the opportunity set that's ahead of us in terms of what do we have in terms of opportunity to secure new units, et cetera, and make a decision from there.

I think the capital discipline that you see in the E&P industry is very much bleeding over to the services sector. And so we're not going to spend money, grow for growth's sake. I mean we're committed to capital discipline. And so, I think, once we visit the 4.5 type neighborhood, we'll think about additional opportunities to get closer to 4.

[Eric Long, executive]

And Selman, one other comment. When you think about our capital structure, we've got a pretty large tranche of fixed rate debt, 2 tranches of notes that are out there are preferred as 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 1 percentage point of increase in interest would do to you under that floating rate debt. So it's pretty manageable in the world that we're living in today.

[Operator]

We'll take our next question from Gabe Moreen from Mizuho.

[Gabriel Moreen, analyst]

Maybe I could start off by asking about the new units that you ordered here for deployment. Can you just talk about actually kind of where you see CapEx going in '23 versus this year? Is there a trade-off, I guess, between redeploying idle CapEx -- sorry, idle units versus these new units you're ordering? So should we take that into account when we consider kind of overall CapEx? 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.

[Eric Long, executive]

Yes. I guess the first part of the question is, these are the largest units that we typically deploy in our fleet. It's the -- what we call the CAT 3608 product. 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 with. If you look at our idle fleet today, we have 0 of those. So when we look at our capital program, clearly, the cost to redeploy existing assets and spend a little make-ready capital, generally is significantly less than buying a brand-new asset. That said, these large assets are highly, highly, highly accretive. These are things that are -- we're being opportunistic on. We've got extremely strong demand signals from long-term existing customers, and there's not a lot of capacity to build these assets on a new basis. So we're able to lock in multi-year contracts -- significantly long multi-year contracts with extremely strong creditworthy customers.

So what we look at is, where can we get the biggest bang for our buck? And the reason we've committed to add 50 new ones for next year, and then we've got some carryover from this year, is that these are unbelievably accretive. And when you look at after we deploy the capital, the cash flow that is created and what this does from continuing to help us delever our balance sheet and improve our coverage, and these are the kind of things you want to deploy. That said, we do continue to deploy stuff out of our idle fleet this year, and on into next year, we'll continue that activity. But I think the trajectory of that -- once 2023 has passed, maybe a little on into 2024, we're basically going to be close to running out of, idle assets can be redeployed.

[Gabriel Moreen, analyst]

And then maybe if you can talk about -- I guess, it sounds like customer demand is real high. Just the balance between sign that customer demand, how much you feel you're pushing it versus, I guess, manufacturing and fabrication slots to get these units built, kind of where things stand within those trade-offs basically? Are you actually meeting, I guess, as much customer demand as you think is out there at this point?

[Eric Long, executive]

I would say that between all of us and the industry, there remains more demand than there is 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. Supply chain continues to have some bottlenecks and implications, and it's weird things. It's everything from bolts that attach flywheels to an engine to various subcomponents to wiring harnesses. You've got some labor bottlenecks. So it's kind of -- we're still seeing supply chain bottlenecks and limitations out there. So I think we're in a little bit of a perfect storm.

We could actually commit to spend additional capital, but we're balancing leverage. We're balancing coverage. And clearly, we don't want to get skis. We want to continue to delever the balance sheet, as Mike indicated, to continue to improve our coverage metrics. So we actually are using this as an opportunity to high grade our customer list rather than chasing growth for the sake of growth. We're going to grow where it makes the most sense from a profitable perspective, focused only on highly accretive opportunities, and again, kind of redeploy some of that idle fleet.

[Gabriel Moreen, analyst]

And maybe just for -- the last one for me, shifting gears a little bit on of the cost side of things. Clearly, there's some stuff which is out of your control like vehicle fuel costs, but things like labor, for example, any deceleration you're seeing at this point in terms of staff or just no change as far as what you've kind of seen in the last couple of quarters?

[Eric Long, executive]

Yes. I would say the trajectory is starting to flatten a little bit. We're not seeing service technicians commit to make moves in the field to chase $1 an hour higher here or $0.50 an hour higher there. We're seeing moderation, obviously, transportation fuel costs. We're doing some creative things on our large volume lube oil purchasing programs to take advantage of some basis differential from a supply perspective. So we're actively managing our supply chain. And frankly, that's one of the reasons we made the commitment that we did with the 50-unit order. We said that we could get it ahead of the food chain, take advantage of some of our relationships and some -- what we see is impending bottlenecks in 2023 with supply. So I think we've done a very good job of locking in as many OpEx and CapEx cost variables as we can coming into 2023. So we feel pretty good about the inflationary pressures, kind of managing and controlling that on our end while we continue to capitalize on the lack of capacity and lack of supply and compression assets that exist out there.

[Operator]

We'll take our next question from Jeremy Tonet from JPMorgan.

[Jeremy Tonet, analyst]

Just want to kind of start off on a higher macro level question, and thank you for all the commentary that you provided. So I'm just wondering if you might be able to frame for us, I guess, where USAC's market share has been in large compression historically, how that's trended, and where you see that going forward?

[Eric Long, executive]

Yes. It's an interesting question because people talk about market share as company A gaining, as company B losing. I think in my -- to Gabe's question on, there's more demand than there is supply. So I think when you look at USA's customer mix and one of our publicly traded competitors' customer mix and some private guys' customer mix, we all have different customers that are kind of our core. So we continue to meet the needs and demands of our core customers, and our competitors continue to meet and supply the needs and demands of their customers.

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, natural gas pie, as pressures decline, it takes an exponential increase in compression horsepower to move the same amount of volume, and the volumes been getting bigger. We got in the business in 1995, we produced somewhere in the low 50 Bcf a day range. And today, we're over 100 Bcf a day. So the pie is getting bigger, more compressions needed, and the pressures in fields continue to come down. You need even more compression on top of it. So the pie is getting bigger, and there's just a few folks who continue to feed the pie. So there's enough market share for all of us to go around, Jeremy.

[Operator]

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