USA Compression Partners LP

Good morning. Welcome to USA Compression Partners' third quarter 2023 earnings conference call. During today's call, all parties will be in a listen-only mode. At the conclusion of management's prepared remarks, the call will be opened for Q&A. To ask a question, you'll need to press star 1 on your telephone keypad. This conference is being recorded today, October 31, 2023. I would now like to turn the call over to Chris 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 September 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's views as of today, October 31, 2023, and may no longer be accurate at the time of a replay. I will 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 am joined on the call today by Eric Schiller, our COO. This morning, we released our third quarter 2023 results which highlight the continued improvement in our financial and operational results as we continue to focus on capital discipline and maximizing return on our assets. Eric Scheller will provide more detail on our results, but I would like to highlight our third quarter distribution coverage, which grew to 1.39 times, continuing our trend of increasing distribution coverage this year. In addition, our leverage ratio was 4.21 times, Continuing progress towards our previously mentioned goal of 4.0 times. A welcome improvement in both metrics. Methodical delivering of our balance sheet over the coming quarters positions us well for when our senior notes mature, which is not until Q2 2026 and Q3 2027. Our unit price this past year has trended up from the $18 range to recently over $26, levels last seen in 2014. We attribute this to the recent addition of compression as a qualifying activity in the Vetify Alerian MLP Infrastructure Index, AMZI, as well as what we believe is a show of confidence by investors in the historical stability and sustainability of USA Compression's revenues, EBITDA, DCF, and distributions. Long-term investors have seen that since we became a public company over 10 years ago in 2013, we have provided stability and growth across numerous energy, macroeconomic, and interest rate cycles and have never reduced our quarterly distribution. In fact, we have proactively returned over $1.6 billion to our unit holders through distributions reflecting a history of capital discipline, that returns value to unit holders that extends well before that concept became a core focus for our industry by the investment community. Switching gears, I would like to reaffirm some of the drivers supporting our business. As we have mentioned in the past, we believe the macro environment in our industry remains supportive for the continued improvement of our financial and operational results. The IEA and OPEC are both forecasting a very tight global crude oil market for the remainder of the year and into 2024. OPEC recently updated its global outlook, projecting continued increase in oil demand through the end of its forecast period in 2045, as rising energy demand in emerging markets offsets any demand declines in the developed world. In addition to the continued need for crude oil, U.S. natural gas exports are expected to reach record levels in 2023 and continue to grow in 2024, especially as major new LNG facilities are scheduled to come on stream in the U.S. over the next few years. These factors, combined with the capital discipline seen throughout the industry, we believe provides a solid and sustainable base for the demand of our compression services. As we reflect more on the natural gas compression industry in particular, we continue to believe there will be an industry-wide shortage of large horsepower compression units of the type that make up the bulk of our fleet horsepower. We believe this shortage will persist for the foreseeable future as recent inflation has caused new equipment costs to reach levels that make new unit purchases economically less attractive for natural gas compression service providers. As a result, we are experiencing a continued tightening in the compression market. Our customers and others in the industry have just begun to digest and wrap their heads around this continued tightening and inevitable substantial increases in monthly service fees required to justify the construction of new equipment due to the large increases in new equipment costs. We believe continued equipment shortages will provide us the ability to both high-grade our customer base to larger customers who understand and value the exemplary levels of compression services provided by USA Compression, as well as the opportunity to capture expanded economic margins and maintain our high fleet utilization rates. We envision continued improvements to our balance sheet and financial condition consistent with what was shown by our most recent results. As an example, continued development of demand-driven pricing for our services increased average revenue per horsepower per month to $19.10 during the third quarter, while we also successfully increased our exit rate fleet utilization to 94%. As we have mentioned in the past, we have always endeavored to modify our capital investment strategy to maximize the value of USA compression in response to then current market dynamics. Given the current tightening in the natural gas compression space, the substantially higher cost of new compression units requiring dramatically higher monthly service fees to maintain our historical margins, and the current geopolitical uncertainty, We believe the best way to maximize stakeholder value in the current market is to direct capital in 2024 primarily to the conversion of idle units to active status and limiting the acquisition of new organic growth compression units. Recall that we have about 100,000 horsepower being delivered during Q4 2023 and into the first half of 2024. Acquisition costs for these units were locked in at the time of order back in late 2022 and at capital costs substantially below those now being quoted by our equipment manufacturers and fabricators for 2025 deliveries. As our customers and others in the industry digest the higher contract pricing that is required to justify the substantial increase in the cost of new compression units while maintaining our historical margins, we will continue our focus on demand driven pricing for the compression services we provide across our existing active fleet. As price discovery in the coming quarters for new units continues and reaches levels that support new compression unit cost, we will then of course reevaluate our capital investment strategy as we have always done. Before turning the call over to Eric Scheller to discuss third quarter operating and financial results, I would like to express my unwavering support to all of our employees for embracing and living our culture of safety here at USA Compression. The safety of our employees, contractors, and customers is absolutely the most important thing we do as a company. I am pleased that our safety performance is outperforming the industry average and that our employees continue to focus on being safe in all we do each and every day. We are extremely proud of our employees 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 third quarter highlights.

Thanks, Eric, and good morning, all. As Eric noted, the strong results we reported this morning once again reflect our employees' continued commitment to creating value for USA Compression and its stakeholders. In addition to our increased utilization and pricing Eric mentioned, we also continued to capture extended contract tenors for both new unit contract activity and renewal contracts for existing fleet assets. Given the durability these extended contract tenors provide and the continued market tightness, we believe the underlying fundamentals of our business will remain supportive for the foreseeable future. Our third quarter 2023 results revealed a 5% increase in sequential quarter revenues and a 21% increase in revenues compared to the year-ago period. While revenue growth was driven by continued utilization and pricing improvements, margins remained relatively steady on a sequential quarter basis as we continue to offset our increased inflationary costs through both productivity improvements and contractual inflation and CPI pass-through adjustments. Although we continue to experience inflation in parts, supplies, and labor, we believe the continued demand-driven pricing discovery occurring for our services, along with the CPI-U rate adjustments provided for in the bulk of our customer contracts, will continue to support adjusted gross margins in line with our historical averages closer to 67%. Third quarter 2023 net income was $20.9 million, operating income was $61 million, net cash provided by operating activities was $50.1 million, and cash interest expense, net, was $41.4 million. Cash interest expense increased by approximately $1.2 million on a sequential quarter basis due to higher average outstanding borrowings and higher interest rates applicable to outstanding borrowings on our floating rate credit facility. However, this increase was more than offset by $2.5 million of cash payments received under our $700 million notional principal fixed rate interest rate swap. Turning to operational results, our total fleet horsepower at the end of the quarter remained essentially flat for the previous quarter at approximately 3.7 million horsepower. Our revenue generating horsepower increased by 1% on a sequential quarter basis, due to a combination of converting idle units to active status, as well as the addition of new large horsepower units. Third quarter 2023 expansion capital expenditures were $62.5 million, and our maintenance capital expenditures were $7.2 million. Expansion capital spending continues to consist of reconfiguration and make ready of idle units, along with accepting delivery of 20,000 horsepower of new large horsepower units during the quarter. We currently expect to take delivery of an additional 62,500 horsepower of new large horsepower units during the fourth quarter, plus additional and ongoing conversion of current wheat idle units to active status. During the first half of 2024, we expect to take delivery of 37,500 horsepower, which is the remainder of our late 2022 order. Additionally, throughout 2024, We anticipate the conversion from idle to active status of about 100,000 horsepower of existing fleet assets at capital costs substantially below those of new organic growth equipment bills. Finally, I am pleased to share that on November 3rd, we will make our 43rd consecutive quarterly distribution payment. The 52.5 cents per unit distribution is flat to the previous quarter's distribution. And with that, I will turn the call back to Eric Long for concluding remarks.

Thank you, Eric. Our third quarter reflects our employees' ability to continue to deliver meaningful value to our stakeholders. Given the continued tightness in crude oil markets, the increasing use of natural gas globally, and the shrinking supply of available large horsepower natural gas compression domestically, we firmly believe that USA Compression is well positioned to improve our financial metrics in the future. 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 third quarter results, highlighted again by record quarterly revenues, adjusted EBITDA, distributable cash flow, and distribution coverage and which also featured continued improvements to utilization and contract pricing. We expect to file our Form 10-Q with the SEC as early as this afternoon. And with that, we will open the call to questions.

If you would like to ask a question, please press star followed by the number 1 on your telephone keypad. To withdraw your question, please press star 1 again. We'll pause for just a moment to compile the Q&A roster. Our first question comes from Selman Akyol from Stiefel. Please go ahead. Your line is open.

Thank you. Good morning. I guess, first of all, can you just talk about lead times for new equipment? Is it still about a year out, or is it getting longer?

Selman, this is Eric. Really good question in light of the market environment we're living in. Things have actually lengthened on the delivery of major components from our largest manufacturer, Caterpillar. they've got a pretty nice order book, but they continue to have rolling supply chain issues. And it's not any one thing, it's multiple things that are occurring. So we're substantially in excess of a year for orders that would be placed today.

Got it. And then in terms of just when you're speaking with your customers, are you seeing any changes in the tenor of contracting? Are you being able to do longer than three to five years, or is it still – sort of in that period?

Yeah, so I'm going to hit that two ways. The first thing would be kind of the original primary term. We're routinely seeing five-year contracts. We really don't go much beyond five. We have a few instances throughout the history of the company where we'd see some things longer than that. At the end of the primary term, when things do revert to a 30-day month-to-month, either party can terminate Evergreen. The only thing that changes literally would be the ability to terminate a contract. It's those renegotiated, re-extended tenors that we're seeing clients are signing up these renewal contracts sooner than normal. They're extending the term for longer than normal. Historically, a five-year primary term contract, you might see folks going with a one or two or two or three-year contract extension. We're now routinely seeing kind of two to five years, so the tenor is getting longer. All of our contracts have CPI escalators on the things we enter into today. The vast majority of Even our older MSAs provide for CPI escalators. So if you think about it, we have a natural inflation hedge. You look at new builds versus repricing of our existing book. We will have substantially more uplift on repricing the existing asset book over the coming years than we will from the incremental organic growth capex, even if it was mash the accelerator and go back to the go-go days, deploy excess amounts of growth capex. So what really is going to move our dial going forward is to continue to reprice our book. We have significantly extended our tenor. We have reduced the number of month-to-month contracts by terming up with these five-year type terms. And I think we're setting ourselves very well up for a very durable and sustainable focus over the coming years from the bottom left of the page to the top of the right of the page on revenue growth.

Yeah, it sounds like a really strong outlook. Can you maybe just talk about the price increases you're seeing? And I guess I'm thinking in terms of maybe spot to where your book is or maybe what you ended up contracting over the last quarter or two.

It's Scheller. You know, the book's been really strong growing up at a pretty stout rate since we started to see the return to the market all the way back in 2022 and The tightness that Eric just talked about and as people are trying to figure out how to manage the greater than 12-month deliveries is bringing people to the table at a very regular rate. People aren't letting stuff get to the end of the term. People are coming to our regional vice presidents early to discuss their position. So we continue to see the growth in the existing revenue for renewals as well as for the new units that are coming on now and into the first quarter of 2022.

Yes, how about Eric? One other comment on that too. You know, we mentioned in our comments that we're seeing rate increase. We're seeing CapEx cost increase, substantial CapEx cost increase. And we're not about growth for the sake of growth. We've had some competitors in the past who were private, didn't live in the public world scrutiny, and they were willing to take a dive on gross margins and utilization and other things. And we looked at it and said, our job is to maintain return on capital that we invest and capital that we deploy. So we look at the contracts we entered into to source new equipment, two, three years ago, what those things were deployed at. We look at maintaining those margins. And looking then at 2025, 2026, when equipment costs go up 30% or 40%, you've got to have a commensurate increase in your monthly service fees. So my comment of, hey, we've got our customers are trying to wrap their head around just what this means. Our assets are must-run assets. People can't drill, can't produce natural gas, oil production, et cetera, without compression. So when they're looking at $80 oil, $90 oil, you know, whatever it is in excess of 30 or 40 bucks a barrel, it's highly profitable. And you're starting to see some push up in natural gas prices. You're starting to see some LNG facilities that will be coming on screen in the next 18, 24, 36 months. exactly at a point in time where there's not a lot of available equipment and cost of the equipment are going up. So that's why we look at it. We've always been a story of stability and growth. Right now is a time for us to focus on stability. There's a lot of uncertainty and turmoil in the world, increasing interest rates. Let's control the things that we can control, and to the extent we've got key customers who recognize the value proposition, understand the value of what we bring to the table and what's going to be required with the increase in capital cost and labor cost and inflationary pressures, then we'll go ahead and methodically commit to build some incremental equipment on their behalf. To the extent that the value proposition isn't recognized or people say, whoa, the cost of the new car is awfully expensive here, What can I do as an alternative? And we'll slow that growth, and we'll continue to focus on pushing our existing asset valuations up, push the monthly service fees up as these things roll off of primary term and get repriced in excess of CPI escalators. So your commentary on, hey, it sounds like things are pretty good, things are really good, and I think there's just a few of us in the industry who have this type of equipment that's necessary. There's more demand for our goods and services than there are available goods and services. So in the environment we're living in with new capital costs going through the roof, shortages of equipment, better discipline in the industry, I think it bodes well for all of us for durability and sustainability over the coming quarters and coming years.

Got it. And then just one last one for me as I think about the model. SG&A upticked, and I'm Pretty confident that's driven by the unit-based comp expense, but can you just give any thought on that? Was that just like something that occurred this quarter, or is it due to the higher unit price, or how maybe should we be thinking about that going forward?

Yeah, you hit the nail on the head. That basically was stock-based comp, and that was a quarterly aberration, and I think you'll see that on a once-a-year basis as things vest over time and do some things along that line.

Got it. All right. Thank you very much.

As a reminder, to ask a question, please press star followed by one. Our next question comes from Robert Mosca from Mizuho. Please go ahead. Your line is open.

Hi. Good morning, everyone. I'm wondering if you could maybe expand on how you plan to go about hybriding your customer base, just what those conversations look like, and is that more of an area of focus than it had been in the past, just given the tightness and compression that you're seeing?

Yeah, Robert, this is Eric. And, you know, we've been in business 25 years and we've been through ups and down cycles and, you know, we've seen customers that we add and grow with and we've seen customers who over time have retrenched with. With the book of business that we have in our broad geographic footprint, you know, we have concentrations of assets with key customers in certain geographic areas. And then we have, you know, fringe geographic areas or smaller customers. And as things come off of those primary term for the type of equipment that some of our larger customers see in demand, a discussion would go like this. Hey, you've had a machine for three years. Your rate is X. It's time for you to sign up a new five-year contract at a rate of substantially higher than X. Well, we don't want to do that. We'd like to sign a one-year contract. And we're like, well, here's kind of what the rate is. Take it or leave it. And we're not being cavalier about it. You know, we're working with our customers. But I think observation number one, some of the smaller customers and fringe areas, we are repatriating those assets to redeploy. There are certain geographic areas where you have a little bit slower activity. So when you think of the Permian and Delaware basins, which are really, really hot, the Eagleford remains fairly active. Then you think about North Louisiana, the Haynesville, it's slowed down a little bit. You think about Appalachia, it's also slowed down a little bit. The Mid-Continent area and the Rockies are kind of steady-eddy, but again, within any particular basin, you'll see some areas where assets are underutilized and we'll rationalize and take a bigger machine that five smaller machines could do the job of one big machine, but if conditions have changed, maybe only need two or three intermediate size machines. So we're always looking to optimize our book geographically on a customer by customer and then kind of subsets within the region. And it's just kind of part of the customer high grading and asset geographical high grading, so to speak.

Got it. That's all really helpful. And maybe following up on some of the earlier questions, just wondering if you have a sense of, and I understand that some of these compression contracts, they have the inflation escalators, but as far as the proportion of your fleet that you deem to still be below market in terms of rates, is that still a decent chunk to work through? I know you referred to having perhaps more torque, upside torque, just from the repricing than the organic capex, and I was hoping you could expand on that.

Yeah, and I think obviously you're trying to fine-tune your model a little bit. I would, from a modeling perspective, just kind of focus on CPI type escalation. It's not as if we have half of our units that are a third below market rate or 25% below market rate. Scheller and his team have done an excellent job over the last few years of, as we've worked off primary term, terming things back up. So I would wager an estimate that not that much of our current book would be at rates that were back in the middle of COVID arena three, four years ago type. I think we didn't chase the market down. We maintained our pricing during that time, which is why our utilization dribbled down. So I think commensurately with where we are in the world today, looking at that 3% to 5% to 7% escalation range over the coming years, Our book is not lumpy. It's not like we bought five LNG tankers and deployed them all at one given point in time. We've got 4,500 some odd assets that all of those assets have staggered initial terms, staggered primary terms. So in any given month, any given quarter, any given year, we're continually having things come off a primary term. And then we look at the market at that point in time. We look at who the customer is, what the rates are, here's what the current rate is and what the spot rate at that point in time is. So to the extent spot rates continue to increase in excess of inflationary environments, then we'll take that into consideration over the course of the coming months and quarter and year. as we reprice things. So I think to be conservative, look at CPI and then assume that we'll probably do a little better than CPI.

Understood. Thanks for that, Eric. And maybe just a quick last one from me. I know in your prepared remarks you referenced just your increased valuation. And would there be any interest in perhaps seeing if there's a bit in equity markets if you guys were to do an issuance or is that just Can you get to those leverage targets just with the strength of your operational tailwinds?

You know, from USA's perspective, you know, we're happy with where we are. You know, we're continuing to delever the balance sheet. You know, we look at our debt costs. Now, we've done a great job of locking in. Our floating rate debt with some swaps, we've locked in substantially below market rates over the 2024-2025 range to make sure that we've got certainty of pricing to match our budget estimates. I don't know. I look at it and going forward, I don't think anything materially changing. You know, company doesn't need to issue equity. Energy transfer seems to be be pretty happy with where they sit on things. So from the company's perspective, I don't see any need to accelerate issuing equity that historically has had a little bit higher cost than our cost of debt or equity. And if we can continue to methodically de-lever to our target of 4X or drop below 4X, I don't think we need to really worry about issuing any equity and going down that trail.

Got it. Appreciate it. And thanks for the time, everyone.

We have no further questions in Keele. This will conclude today's conference call. Thank you for your participation.