USA Compression Partners LP (USAC) 2014 Q2 法說會逐字稿

Please stand by, we are about to begin. Good day and welcome to the USA Compression Partners second-quarter earnings conference call. Today's conference is being recorded. There will be a question-and-answer session at the conclusion of the prepared remarks and instructions will be given at that time. Now I would like to turn the conference over to Mr. Greg Holloway, Vice President, General Counsel and Secretary. Please go ahead sir.

Thanks Chanel. Good morning, everyone, and thank you for joining us. This morning, as you know, we released our financial results for the quarter ended June 30, 2014. You can find our earnings release in the Investor Relations section of our website at USACpartners.com.

During this call, our management will discuss certain non-GAAP measures. You will find definitions and a reconciliation of these measures to GAAP measures in the earnings release.

As a reminder, our conference call will include certain 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 latest filings with the SEC. Please note that information provided on this call speaks only to management's views as of today, August 12, and may no longer be accurate at the time of a replay.

I will now turn the call over to Eric Long, President and Chief Executive Officer of USA Compression.

Thank you, Greg, and good morning everyone. Also with me is Jody Tusa, our CFO. We are very excited to report earnings this morning as the second quarter was another record quarter for USA Compression. The favorable market environment led to strong demand for our compression services, resulting in record levels of revenue, adjusted EBITDA and adjusted distributable cash flow. We are executing our business plan ahead of our expectations and, as noted in our press release this morning, expect to be at the high end of our guidance range for the full year.

The partnership's high growth rate has been reflected in our ability to continually grow our distribution. For the quarter, we announced a distribution of $0.50 per limited partner unit, which reflects an increase of 13.6% over the last 12 months. We have increased the distribution in each of the five quarters since our IPO, and this year-over-year growth rate puts us well above the average for the broader MLP sector and at the top of the group of our direct peers in the compression sector.

Including the distribution for the second quarter and the mere 18 months we've been public, we have achieved a total return of about 52% to our initial unitholders. We believe our strong track record and performance since the IPO, as well as the 15 years since the founding of the Company, validate the asset class and demonstrate the story of stability and growth we have been telling the investor community.

While we came into 2014 expecting a banner year operationally and financially, it is shaping up to be even stronger than we anticipated. Now, I've been doing this a long time and, frankly, the demand for our compression services is the strongest it has ever been. Our customers continue to spend significant capital building out gathering, processing and transportation infrastructure in areas including the Utica and Marcellus Shales, the Permian Basin, and the SCOOP play in Oklahoma. In order to meet their needs, we continued to invest in new equipment during the quarter, include increasing our fleet by about 73,000 horsepower during the second quarter alone. This continues what will be a record year in terms of capital spending for USA Compression.

While we have evaluated and continue to evaluate M&A opportunities, when you have the organic opportunities that we see in the market, it can be challenging to find third-party opportunities or assets that complement our business model. In this business, you need to make sure what you are buying fits your business model, otherwise it can result in stranded capital and unforeseen complications.

Similar to previous quarters, we have almost no spare equipment lying around. Everything we take delivery of quickly makes its way out to the field. Over the years, we have built a strong track record of delivering compression services to our customers how and when they need it. And in a tight market like we are currently in, our customers consistently call on us to take care of their compression needs in the field. This level of demand allows us to run a utilization in the mid-90s% area as we have done throughout most of our history, and that produces capital efficiency which we believe translates into attractive returns for unitholders.

Executing on our business plan resulted in strong financial results for the quarter as we saw both margins and pricing move in the right direction. You will recall that our business model is very straightforward, providing compression services under fee-based contracts over a specified term. As a result, our margins are very predictable and consistent year in and year out.

Our service model, like many in the traditional pipeline MLPs, does not suffer the wide swings in margins that oilfield service companies do, nor the low margins typically associated with a manufacturing or fabrication type of business. Our compression services business is stable with good cash flow visibility. As we have grown the business and distributed cash to our unitholders, we have also continued to grow into our distribution coverage, which was 0.94X for the quarter, and should continue to improve during the balance of the year.

Now, we have been asked that our coverage level and expectations going forward. Simply answered, we have executed on growth opportunities far in excess of what we expected at the time of our IPO. We have invested heavily in the timing of the cash flow ramp presents a choice between building coverage now or growing future distributions. And quite honestly, we don't think now is the appropriate time to manage coverage to the detriment of distribution growth. The benefits of investment later in the year as cash flow ramps up. And we have some large unitholders who prefer to participate in that growth through our DRIP program, taking back additional units instead of cash payments. This provides our public common unitholders additional cushion, boosting their cash distribution coverage to almost 2.5X.

We are confident of our ability to continue to grow our cash distributions at attractive rates while maintaining adequate coverage. In fact, we see coverage increasing to close to 1X by the end of the year.

Touching on the macro drivers of our business, as you will recall, we are natural gas price agnostic. This was true when we started the Company 15 years ago and it remains true today. Back in 1998, domestic gas production was about 53 Bcf a day. Today, domestic gas production is roughly 78 Bcf a day, a huge increase. A large percentage of that production is now coming from shale plays across the US, requiring compression at every stage from the wellhead, through gathering systems, through processing plants, all across the natural gas supply chain. So our overall level of business activity is driven by natural gas production, not necessarily just new well activity. And unlike oilfield services such as fracing, compression is required over the entire life of the well, the field and the related regional gathering systems of processing plants, often lasting decades with compression involved in every step of the supply chain. Demand for compression is a lagging indicator. The demand for our compression services really kicks into gear after the wells are drilled, pipelines are laid, and processing plants are installed. So as other sectors mature and develop, demand for our compression services increases and, we believe such demand will continue long beyond those activities. And so when you consider that, by most accounts, we are in the early innings of the overall infrastructure buildout in this country, it is safe to assume that we are expecting continued strong years ahead.

As the price of gas strengthened to the $4.50 to $4.75 range earlier this year, a lot of our producer customers took the opportunity to lock in multi-year forward pricing. This price certainty gives them forward cash flow visibility, allowing them to sign up for future compression services for longer periods of time.

At the end of the day, our business is driven by gas production, and gas production continues to grow from shale plays which need even more compression horsepower to move the same volume of gas when compared to conventional plays due to the relatively lower producing pressures of shale plays. We have positioned our fleet and have focused our new business opportunities in regions where gas production is increasing the fastest, areas like the Northeast, where the Marcellus now produces in excess of 15 Bcf a day and the prolific basins in West Texas. In our other regions, we continue to stay busy and expect a steady amount of recurring business.

Overall, we are very pleased with the level of activity we have seen and all indications are for a strong second half of the year. As I said at the opening, demand for our compression services is the strongest that I have ever seen.

We continue to invest in expanding our modern compression fleet, adding approximately 73,000 horsepower in the second quarter alone, bringing our fleet to a total of just over 1.3 million horsepower and our utilization to around 95% during the quarter. Our customers need the equipment as soon as possible. The majority of our new units are immediately deployed to the field, generating immediate cash flow and returns to our investors.

So far this year, we have spent around $180 million in expansion CapEx. As I mentioned, we expect to finish the year with record levels of spending and new compression unit purchases approaching the 350,000 horsepower level for the year. While we won't see the full impact of that spending until 2015 in our financial results, the level of contract activity provides us tremendous visibility with respect to future cash flows. As an example, if we take delivery and spend capital for a new unit delivered in Q4 this year, we may only get a month or two of actual results in our financials. However, we know with certainty the contractual revenues our customer is obligated to pay under that multiyear contract into the future, just like a pipeline or a storage terminal type of asset. That happens all across our asset portfolio every day. We are deploying those units into active areas and earning attractive rates of return on that capital.

We continue to spend maintenance capital for the upkeep of the fleet. If you're going to achieve a 95% utilization level and the high runtimes that USA Compression does, you must stay on top of the maintenance for the compression units. This has always been a priority for USA Compression. Our customers demand it, our customers rely on it, and it is all part of excellent service that our employees provide.

Looking forward, we expect strong continued demand for our compression services and have already placed orders for over 200,000 horsepower for delivery in 2015. On the gas side, our units are designed to operate in a variety of field conditions and as producers and midstream operators continue to build out the country's infrastructure, whether it's in the Northeast, West Texas, the Mid-Continent or elsewhere, we expect strong demand for our services.

The gas lift activity connected to crude oil production also looks to remain strong. With current oil prices, financial returns remain attractive for continued drilling activity and we are seeing a lot of activity in Texas and Oklahoma, where our gas lift business is primarily focused.

As I have discussed, we benefit from the same fundamental business drivers that our gathering and processing customers do. And right now, the market is as strong as I have seen in my career.

We've had a busy 18 months since going public. Since our IPO, USA Compression has increased cash distributions above expectations, we have delevered the balance sheet, we've spent record amounts of capital and in doing so we have accelerated the growth trajectory of our business. All this has combined to provide meaningful financial returns to our unit holders, total returns of about 52%.

Now, with that, I will turn it over to Jody to walk you through the details of our operational and financial performance.

Thanks, Eric, and good morning everyone. USA Compression reported record levels of revenue, adjusted EBITDA and adjusted distributable cash flow for the second quarter of 2014.

Turning to our second-quarter operational highlights, as Eric mentioned, we added approximately 73,000 horsepower of new midstream and gas lift compression units to our fleet in the second quarter of 2014 and ended the quarter with approximately $1.3 million of total fleet horsepower. Based on the current plans reflecting customer demand, we have already placed orders for 352,000 horsepower for delivery of new compression units this year as compared to our initial expectations of 220,000 horsepower. Our order for new compression units will result in compression unit capital growth expenditures of approximately $354 million over the course of 2014. The new horsepower is expected to consist of 278,000 horsepower of midstream compression units and 74,000 horsepower of gas lift units. For the 108,000 horsepower that we initially ordered for 2014, we have customer contracts for 83% of these units and strong customer indications for another 80% of those orders. The remaining 172,000 horsepower on order for 2014 are expected to be delivered in the last half of this year. We have customer contracts for 38% of the new horsepower and strong customer indications for another 24% of those deliveries. As we get closer to taking delivery at various times throughout 2014, we expect to have substantially all of the new units contracted for service. We have at this time received 150,000 horsepower of the 352,000 horsepower of new compression units ordered for delivery in 2014.

Additionally, as Eric mentioned, we have ordered over 200,000 horsepower for delivery in 2015, which will be delivered over the first three quarters of next year. Our revenue-generating horsepower increased from $1.1 million at the end of the first quarter of 2014 to $1.2 million at the end of the second quarter of 2014 due to the additional units we placed into service in the Marcellus, Fayetteville, Woodford, Utica, Permian Basin, and Eagle Ford Shale plays, as well as the Mississippi line and Granite Wash areas. We are seeing initial contract terms of two to five years for our midstream compression units.

Turning to the financial performance for the second quarter, revenue increased 60% compared to the second quarter of 2013, primarily driven by an increase in our contract operations revenues as a result of adding revenue-generating horsepower. Contract operations revenue in the second quarter of 2014 increased 59% to $52.7 million as compared to $33.1 million in the second quarter of 2013. The second-quarter 2014 over second-quarter 2013 increase in our contract operations revenue was driven almost exclusively by the growth in our revenue-generating horsepower, including fleet growth due to the S&R acquisition and further organic growth.

Average revenue-generating horsepower increased 40% to 1,158,804 in the second quarter of 2014 compared to 829,684 for the same period of the prior year, primarily due to growth in our midstream compression business, along with the acquisition of a gas lift compression assets.

Average revenue per revenue-generating horsepower increased 14% to $15.48 for the second quarter of 2014 as compared to $13.55 for the second quarter of 2013 due to higher revenue per horsepower per month from the gas lift compression units.

Adjusted EBITDA increased 48% to $26.9 million for the second quarter of 2014 as compared to $18.1 million for the second quarter of last year. Adjusted distributable cash flow in the second quarter of 2014 was $19.9 million as compared to $11.9 million for the same period last year, an increase of 67%.

Gross operating margin for the second quarter of 2014 increased 52% to $35.3 million as compared to $23.2 million for the same period last year. The gross operating margin percentage decreased from 69.6% in the second quarter of 2013 to 66.2% in the second quarter of 2014. The decrease in gross operating margin percentage is due to the addition of the lower horsepower gas lift units which have lower gross operating margin percentages as compared to our midstream assets. As expected, our gross operating margin percentage increased as compared to the previous quarter due to the timing of certain expenses that we incurred in the first quarter of this year.

Maintenance CapEx was $3.8 million in the second quarter of 2014. Our second-quarter maintenance CapEx was at expected levels for this quarter, and we continue to expect to spend approximately $19 million in maintenance CapEx for the full year 2014.

Expansion CapEx, which was primarily used to purchase new compression units, was $97.9 million for the second quarter of 2014. Cash interest expense was $2.8 million for the second quarter compared to $2.4 million for the second quarter of last year.

On July 24, 2014, we announced a cash distribution of $0.50 per unit on our common and subordinated units, which represents a 2% increase over the fourth quarter of 2013 and 13.6% year-over-year. This is the fifth consecutive increase to our distribution since our IPO in January 2013. The second-quarter distribution corresponds to an annualized distribution rate of $2 per unit. This distribution will be paid on August 14 to unitholders of record as of the close of business on August 4.

As announced last year, USA Compression Holdings LLC, the owner of 41.3% of the partnership's outstanding limited partner units, and Argonaut Private Equity, and affiliate of George B Kaiser, together with other related investors, the owners of approximately 16% of our outstanding limited partner units, have agreed to reinvest all of the cash distributions they receive on their units pursuant to our distribution reinvestment plan through the first quarter of 2015.

Our adjusted distributable cash flow coverage for the second quarter of 2014 is 0.94 times and adjusted cash coverage for the actual distributions to be paid as a result of USA Compression Holdings LLC, Argonaut Private Equity, and other investors participating in our distribution reinvestment plan is 2.42 times.

I would now like to briefly comment on our credit facility and liquidity, outstanding borrowings under our revolving credit facility as of the end of the second quarter were $452 million, resulting in a leverage ratio of 4.2 times on a trailing three-month annualized basis.

On May 19, 2014, the partnership closed a public offering of 6.6 million common units, of which 5.6 million were sold by the partnership, and 1 million common units were sold by certain selling unitholders at a price to the public of $25.59. The partnership used the net proceeds of $137.3 million, net of underwriting discounts, commissions and offering expenses, to reduce the indebtedness outstanding under its revolving credit facility. The partnership did not receive any proceeds from the common units sold by the selling unitholders.

We are confirming our full-year 2014 guidance, and we expect to be at the high end of our guidance range. We continue to expect full-year adjusted EBITDA to be in a range of $109 million to $115 million and distributable cash flow to be in a range of $75 million to $81 million.

Finally, we expect to file our form 10-Q with the Securities and Exchange Commission later this afternoon.

And with that, operator, we will turn the call over to questions.

(Operator Instructions). Sharon Lui, Wells Fargo.

Hey there. Good morning. For the horsepower that's ordered for 2015, does this acceleration of timing -- and when do you anticipate you'll start contracting the horsepower?

That in fact is an acceleration of timing. With all the demand for compression equipment we are seeing leadtimes with our packagers extending. And so we wanted to make sure that we were very well positioned to have the new orders for next year. And of course, as you probably have already gathered, that 200,000 horsepower for next year is only a partial order for what we expect for 2015.

Customer contracts we would expect, as we saw this year, to be signing those up at about the time that we are taking delivery of the equipments. And as for now, that equipment is expected to be delivered fairly evenly through the first three quarters of 2015.

Okay. And I guess you indicated that this is just partially -- potentially a larger order. How much I guess can demand for horsepower be?

Obviously, we are in the early stages of building out the continuing shale infrastructure. We look at it from the context of being opportunity long. So it's one of these scenarios we are balancing our growth rate with our capital structure, with people demands. Interestingly, we have actually been turning some opportunities down right now just due to the long leadtimes associated with the equipment. So to answer your question, basically as much as we want is out there for us to go grab.

I may just add, we will be providing guidance for 2015 as we get -- we customarily get into reporting the fourth quarter this year, so we are clearly not stepping out to provide guidance at this time. But the demand is shaping up quite strongly. Could we see something that would resemble higher horsepower levels than what we added this year? We think the demand could be there, but we are going to evaluate that as we get closer to the end of this year in looking to supplement the orders that we've already placed for next year.

Okay. And then I guess, in terms of the split between midstream and gas lift, will it be similar to your 2014 spending?

We do expect that, so as we've communicated on earlier calls, we see the gas lift is still remaining a relatively small portion of the fleet. And all of the orders that we place for next year, the 200,000 horsepower has been for the larger compression units.

Okay. And in terms of likely deployments, do you anticipate that will be to similar regions of growth for this year?

We do. Based upon the demand signals coming from our core customers, we continue to see activity in the Northeast with the Marcellus and the Utica. We continue to see strong demand coming from the various basins of West Texas, the Permian, the Delaware, etc. The SCOOP play is continuing to have a lot of demand for the gas lift equipment, and then our other operating areas. The Fayetteville continues to have this basic nominal growth that we see. So it's not the Herculean growth we see in some of the other areas, but when you look at the Barnett, when you look at East Texas, when you look at the Fayetteville continued growth, we are starting to make some inroads into the Eagle Ford and South Texas. So, I think that's an area that, in 2015, will probably be an incremental growth opportunity for us.

Great, thank you so much.

T.J. Schultz, RBC Capital Markets.

Good morning. So Compressco obviously recently acquired CSI. The CSI business, is that something you looked at? And if you could just comment in general how that combination alters kind of the competitive landscape, if at all, and just generally how active you want to be in M&A?

Good question, T.J. I think as we've indicated to the marketplace, our primary focus is of course organic growth opportunities. To the extent there is something that fits geographically from the type of assets, vintage of assets, size of assets, it would be accretive, it would be something we would consider.

CSI is a good company. We've known those folks for a long time, but their business model is very different than ours. They are predominantly a fabricator of equipment. They provide retail services and they do have a fleet obviously. It tends to be kind of intermediate to smaller horsepower. It's a little bit older fleet, and it's one of those things that's a little outside of our fairway. I think it's something that is transformative for the Compressco folks. So, a very different business model, Compressco with very small wellhead oriented equipment. CSI is a fabricator with intermediate sized equipment. Rather than being complementary business lines, I think, frankly, they're very different business lines. So they've got a lot of work to do to reform contracts, go from a rental model into a services model. They've got integration issues to deal with, and frankly we don't see either one of those players that much in our marketplace. That's just a very different dynamic and a different market sector than where we have elected to play in.

(Operator Instructions). Matt Niblack, HITE.

Thank you and congratulations on the great quarter. I guess the question I have is, it's a bit of a strategic one here related to your decision to continue to push the distribution growth in light of the fact that it seems like your units are not really getting credit for that growth. And I just wonder, given that you're passing on opportunities, your cost of capital is higher than honestly what it should be by any rational metric, how do you think about that trade-off of generating less in fact negative internal cash to pursue this growth opportunities, testing to go more to the equity markets with this high cost of capital versus restraining that growth a bit so you can start to generate some internal cash, which obviously would be much less expensive than the equity issue with these depressed prices.

Obviously, Matt, that is something we think about every single day. When we were out on the road talking about the IPO, we contemplated growth in the 100,000, to 150,000 horsepower per year range. And here we are growing at a clip of 300,000, 350,000 horsepower.

So one of the things that the financial community signaled to us early on was, guys, you need to get your leverage down, work on your balance sheet. You need to kind of grow into things and we would like to (technical difficulty) where it was and where it is. So we actually have made a conscious decision to try to balance the high level of growth, balance coverage, balance leverage. You hit the nail right on the head. With our cost of capital like it currently is, frankly it does constrain our ability a little bit. So I think Jody will chime in here. We're doing everything humanly possible to continue to grow our business, but yet balance the financial side of the shop. So as we talked about from the get-go, we are a story of stability. We are a story of growth. And I think we have exhibited a high degree of growth already. Sure, we could even escalate more, but there comes a point when we look at it and go with our current capital structure like it is, we are not being rewarded for that.

Yes, I think just to echo Eric's comments, we smiled when we heard your commentary about our cost of capital. So we believe that the distribution growth with the visibility that we have on our cash flows is sustainable, and so we are again targeting growth rates that would not only reward the unitholders in terms of distribution growth, but also in being strategically placed with our customers. So the only other element that we have there, as Eric mentioned, was moderating our leverage and making sure that's within the kind of targets we have been communicating to the market.

And then on a similar note, we've seen some other MLPs, particularly in the E&P space but also in the gathering and processing space that have a high cost of equity capital compared to the professional preferred market. Is that something that you've considered?

Can you clarify that a bit in terms of the professional preferred market?

Issuing perpetual preferred equity.

Oh perpetual preferred.

(multiple speakers)

Yeah, and I've actually chatted with Scott Smith about their drivers, why they did that. And frankly, it was to attract folks who have UBTI issues and not really interested in dealing with K-1s So I think they were looking at that as kind of an alternative way to attract some incremental investor types rather than looking at it as an alternative capital type of play.

And then in terms of our debt capital structure, you know that our cost of funds under our revolver is less than 2% all-in. Now, we have several hundred million dollars of capacity there, so we like the use of that revolver for growth CapEx in the business.

All right. That makes sense. The thought of the perpetual preferred is given the experience of Atlas, it might be the case you could issue the professional preferred equity at a distribution rate that's even lower than what your common equity distributes them and wouldn't have the same growth and therefore would be a real benefit to common equity holders while providing a different way for those with UBTI issues or other concerns to participate. So just a thought. (multiple speakers) during the quarter.

That may be. I'll tell you probably, like a lot of MLPs are doing these days, our first look would to be to an after-market type of program. So that's something that we are monitoring pretty closely as well.

Great, thank you.

It appears there are no further questions at this time. Mr. Holloway, I would like to turn the conference back to you for any additional or closing remarks.

Thanks Chanel. As always, we appreciate everyone being part of these calls, and we'll look forward to the next one, but for now have a great day.

That does conclude today's conference. Thank you for your participation.