USA Compression Partners LP (USAC) 2014 Q3 法說會逐字稿

Good day, everyone, and welcome to the USA Compression Partners' Third Quarter Earnings Call. Today's conference is being recorded. Following today's prepared remarks, we will have a question-and-answer session. (Operator Instructions)

And at this time, I'd like to turn the conference over to Mr. Greg Holloway, Vice President, General Counsel and Secretary. Please go ahead, sir.

Thank you, Jamie. Good morning, everybody and thanks for joining us. This morning, as you know, we released our financial results for the quarter ended September 30, 2014. You can, as always, 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 the management's views as of today, October 30 and may no longer be accurate at the time of a replay.

I'll 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 today is Jody Tusa, our CFO. This morning we reported record levels of revenue, adjusted EBITDA and adjusted distributable cash flow. The third quarter demonstrated the strength of USA Compression's business model, one characterized by stability and growth as we benefited from strong customer demand for our compression services throughout the quarter and continued to invest capital to meet our customers' growing needs.

Our business is quite straightforward. We provide natural gas compression services on a fixed fee basis under term contracts. We are part of the midstream infrastructure value chain and our business is driven primarily by the overall production of and demand for natural gas. The vast majority of our business is focused on traditional natural gas midstream applications where our assets served a critical role in transporting natural gas from regional gathering systems to long haul pipelines. Compression is required over the entire life of the regional gathering systems and processing plants, often lasting decades with compression involved in every step of the supply chain.

The demand for our compression services really kicks into gear after 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. We provide a significant portion of our services on a multi-year take-or-pay basis for a set monthly fee. As such, our business has no direct exposure to commodity prices.

Reflecting the continued growth in our business, for the third quarter, we announced a distribution of $0.505 per limited partner unit, an increase of approximately 10% over the same period last year. We have increased the distribution every quarter since our IPO. The increase in our distribution reflects the continual growth in long-term stability of our underlying business. As noted in this morning's earnings release, we expect to be at the high end of our guidance range for the full year. The business is performing well and we'll provide some more details on the operating and financial performance a little later.

From a big picture perspective, the third quarter continued to be attractive investment theme under which we've been operating for many, many years. The continued build-out of the natural gas gathering, processing and transportation infrastructure and areas of significant production, including the Utica and Marcellus Shales, the Permian Basin and Delaware Basins both in West Texas. This build out is being driven by the economics of these producing areas, but also by more global factors that I'll get into in a minute.

In order to meet the needs of our customers, we continue to invest heavily in new compression equipment during the quarter, increasing our fleet by approximately 100,000 horsepower. I have mentioned before that this year will be a record year in terms of capital spending for USA Compression. We will invest approximately 350 million in new compression units by the end of 2014. Importantly, we have managed a significant level of capital spending while keeping our utilization at near-record levels; 94% at the end of the third quarter, which we view as essentially fully utilized.

One of our strengths historically has been our ability to keep our assets out on the field working. As mission-critical equipment, our compression units are continually working and throughout our history we have demonstrated our ability to maintain a high utilization across multiple commodity price cycles. Keeping our assets working takes dedication on the part of all of our employees, but especially our service technicians working out on the field each and every day.

Turning to the macro drivers of our large horsepower midstream compression business, we continue to really like the overall natural gas sector picture. The supply demand equation is not terribly out of balance right now. Approximately only 2 Bcf to 3 Bcf a day of excess supply and keep in mind that that is on total domestic production of somewhere in the 73 to 75 Bcf a day range.

When you look out over the near term, we've got steadily increasing natural gas production coming primarily from the shale plays, but at modest rates of growth. Contrast that with the demand side of the equation, we are looking at some very significant events with the potential to add meaningfully and meaningful additional demand into the system.

First, LNG. This country has over 5 Bcf a day of export projects that have been approved by FERC. There is another 15 Bcf per day of LNG export projects filed will the FERC and will not all of these will actually make it through to construction and approval. The magnitude of the export capacity and the intermediate term start up of some of the facilities is expected to positively impact the domestic gas market. This will help underpin the continued production of natural gas from economically advantaged producing regions, the shale plays, and that gas needs compression.

Another large export market being pursued is Mexico. As we speak, Mexico continues building approximately 4 Bcf a day of transport capacity to move natural gas from Texas into Mexico which should start up in the near future. This gas will be used to fuel electric power generation, which is currently fueled by relatively higher value crude oil. Again, this demand will further support domestic gas production in the US. Those two factors alone have the potential to soak up at least 10 Bcf a day of US gas production compared to domestic gas production of roughly 73 Bcf to 75 Bcf a day. You can see the potential impact on the market for domestic gas and in turn our business.

As these and other industrial type projects come onboard, a relatively small current excess of domestic natural gas production over demand can go away pretty quickly. It is clear that natural gas is increasingly becoming a global commodity and our business benefits from the incremental production that will be required as these and other global macro steps and events take shape. As I've said, our business is demand driven and the future of natural gas demand looks strong.

On the gas lift side of our business, which accounts for only about 15% of our total fleet horsepower, we continue to have strong demand for our compression services. This is in part due to the nature of our customers' activities. You recall our gas lift units serve crude oil wells primarily in Western Oklahoma, the Texas Panhandle and more recently in the Permian and Delaware Basins. These are primarily horizontal wells that exist at very attractive initial economics. They have rapid initial payouts and then remain profitable with low lifting cost once a stable, long-life producing sale occurs. We believe the breakeven lifting cost for crude producers in these areas remain attractive.

The cost of our services represents a very small fraction of the value of the crude oil recovered. We view these crude oil lift assets is infrastructure natured, unlike gas oriented wellhead equipments that is much more commodity price sensitive. We expect our assets will continue to see demand even at current or lower crude oil prices. Similar to our large horsepower operations on the natural gas side, we believe we are in the right geographic areas to benefit from the most attractive producer economics.

Executing on our business plan resulted in strong financial results for the quarter. Our fee-based business model is straightforward. As a result, our margins are predictable and consistent, year-in and year-out, which gives us good cash flow visibility. As a company with significant growth prospects, we have to balance that growth with our leverage and coverage metrics.

In early 2014, we made the strategic decision to go after a number of specific market opportunities, most notably the Permian and Delaware Basins, as well as maintaining a continued strong presence in the Utica and Marcellus Shales. We took advantage of the market opportunity and raised our CapEx budget. In the midst of this level of capital investment, we remain mindful of the need to balance distribution growth and coverage.

For the third quarter, I am pleased to say total LP coverage was 0.99x. Some of our major unitholders have continued to participate in 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 2.4x. We continue to see coverage at 1.0x by the end of the year.

Our aim has always been to provide our unitholders with attractive distribution growth, while at the same time pursuing market opportunities that we believe will benefit the partnership over the longer term. Jody will address leverage in his comments, but we still believe 3.5x to 4.0x is the right level for our business over the long term. We continue to be focused on getting the coverage and leverage metrics to the right levels.

As the spot 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 pricing certainty gives them forward cash flow visibility, allowing them to continue to invest in required infrastructure, as well as sign up for 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 will require even more compression horsepower to move the same volume of gas when compared to conventional plays due to the relatively lower producing pressures of the shales. We have therefore positioned our fleet and have focused our new business opportunities in regions where gas production is increasing the fastest, areas like the Northeast and West Texas. As a fee-based service provider, commodity price levels don't directly affect us.

Touching on growth, we continue to invest in expanding our modern compression fleet adding approximately 100,000 horsepower in the third quarter. Bringing the fleet to a total of approximately 1.5 million horsepower and our utilization to around 94% during the quarter. Our customers continue to need the equipment as soon as possible. We work to deploy our new units as quickly as possible to generate immediate cash flow and provide returns to our investors. So far this year, we have spent around $260 million in expansion CapEx.

As I mentioned, we expect to finish the year off with record levels of spending and new compression unit purchases approaching 352,000 horsepower 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. We know with certainty the contractual revenues are customers' obligated to pay under a multi-year contract, just like a pipeline or storage terminal asset that happens all across our asset portfolio every day.

We are deploying those units in active areas and earning attractive rates of return on that capital. We continue to spend maintenance capital for the upkeep of the fleet. Without that investment you can't maintain the high utilization levels and run times we have continually demonstrated to our core base of customers. This has always been a priority for USA Compression.

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. These units will go to serve producers and midstream operators as they continue to build out the country's infrastructure in the Northeast, West Texas, the Mid-Continent and elsewhere.

I'm pleased to say that we continue to execute on our business plan and take advantage of favorable market conditions to invest in the long-term success of USA Compression. As I've discussed, we benefit from the same fundamental business drivers that our gathering and processing customers do and the market continues to exhibit strength even in the face of the recent weakness in commodity prices. Gas is increasingly becoming global and that bodes well for both USA Compression as well as our customers.

We continue to balance cash distribution growth and balance sheet strengthening with record amounts of capital we are spending. We remain confident that these investments will pay off for USA Compression in the future, expanding our business and serving our customers.

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

Thank you, Eric, and good morning, everyone. USA Compression reported record levels of revenue, adjusted EBITDA and adjusted distributable cash flow for the third quarter of 2014. Turning to the third quarter operational highlights, as Eric mentioned, we added approximately 100,000 horsepower of new midstream and gas lift compression units to our fleet in the third quarter of 2014 and ended the quarter with approximately 1.5 million of total fleet horsepower.

Based on the current plans, reflecting customer demand, we have already placed orders for approximately 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 unit growth capital expenditures of approximately $350 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, of which we have already received approximately 240,000 horsepower of the total new compression units ordered for delivery in 2014.

Additionally, we have ordered so far over 200,000 horsepower for delivery in 2015 which primarily will be delivered over the first three quarters of next year. Our revenue-generating horsepower increased from 1,200,547 at the end of the second quarter 2014 to 1,259,387 at the end of the third quarter 2014 due to the additional units we placed in 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 third quarter of 2014, revenue increased 49% compared to the third quarter of last year, primarily driven by an increase in our contract operations revenues as a result of adding revenue-generating horsepower. Contract operations revenues in the third quarter of 2014 increased 46% to 55.3 million as compared to 37.9 million in the third quarter of 2013. The third quarter 2014 increase in our contract operations revenue over the third quarter of last year was driven almost exclusively by growth in our revenue-generating horsepower, including fleet growth through the acquisition of gas lift compression assets from S&R Compression in August 2013 and further organic growth.

Average revenue-generating horsepower increased 33% to 1,224,938 in the third quarter of 2014 compared to approximately 900,000 for the same period of the prior year, primarily again due to growth in our midstream compression business along with the acquisition of the gas lift compression assets. Average revenue per revenue-generating horsepower per month increased 11% to $15.67 for the third quarter of 2014 compared to $14.13 for the third quarter of 2013, due to higher revenue per horsepower per month from the gas lift compression assets.

Adjusted EBITDA increased 46% to $29.3 million in the third quarter of 2014 as compared to $20.2 million for the third quarter of 2013. Adjusted distributable cash flow in the third quarter of 2014 was $23 million as compared to $13.7 million for the same period last year, an increase of 68%.

Gross operating margin for the third quarter 2014 increased 42% to $37.6 million as compared to $26.4 million for the same period last year. Gross operating margin percentage decreased from 68.9% in the third quarter of last year to 65.9% in the third quarter of 2014 and this decrease in our operating margin percentage is due primarily to the addition of the lower horsepower gas lift units, which as we mentioned in the past carry lower gross operating margin percentages as compared to our midstream compression units.

Maintenance CapEx was $3.3 million in the third quarter of 2014, which is consistent with expected levels for the quarter. Expansion CapEx which was primarily used to purchase new compression units was $83.4 million for the third quarter of 2014. Cash interest expense was $3.1 million compared with $2.6 million in the third quarter of last year. Interest expense on the face of our financials for the third quarter of 2014 included $400,000 of interest income related to capital leases.

On October 23, 2014, as Eric mentioned, we announced a cash distribution of $0.505 per unit on our common and subordinated units, which represents an approximate increase of 10% over the same quarter last year. This is the sixth consecutive increase to our distribution since we completed our IPO in January 2013. The third quarter distribution corresponds to an annualized distribution rate of $2.02 per unit. The distribution will be paid on November 14 to unitholders of record as of the close of business on November 4.

As announced last quarter, USA Compression Holdings, LLC, the owner of 41.7% of the Partnership's outstanding limited partnership units, and Argonaut Private Equity, an affiliate of George B. Kaiser, together with other related investors, the owners of approximately 16.2% of our outstanding limited partnership 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.

Adjusted distributable cash flow coverage for the third quarter of 2014 is 0.99 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 DRIP is 2.37 times.

I would now like to briefly comment on our credit facility and liquidity. Outstanding borrowings under our revolving credit facility as of September 30, 2014 were 510 million, resulting in a leverage ratio of 4.4 times on a trailing three month annualized basis. Based on our current borrowing base, we had availability of approximately $290 million under our credit facility. We are confirming our full year 2014 guidance at the high end of our guidance range. We continue to expect full year adjusted EBITDA to be in the range of $109 million to $115 million and distributable cash flow to be in the range of $75 million to $81 million. Finally, we expect to file our Form 10-Q with the Securities and Exchange Commission on or before November 10.

And with that, operator, we'll open the call to questions.

Thank you, sir. (Operator Instructions) Jim Rollyson, Raymond James.

Good morning, guys.

Good morning, Jim.

Hey, Jim.

Hey, Eric, are you sure your business is 100% tied directly to oil prices? [Unit price] seems to think that way. Question on orders and opportunity and what you are seeing heading into next year. Obviously you started this year with a little over 200,000 horsepower order expectation and because of opportunities that grew to over 350,000. And you have already booked, it sounds like, for 200,000 next year through the first three quarters which puts you probably on pace between 250,000 to 275,000. Just do you think next year's order rate will be most likely backing off from the extreme pace you've had this year, just based on what you see?

Good observations there, Jim. And as you know, as we pointed out, we did come in the last year at the 220,000 level and wound up north of 350,000. The type of the projects that were involved with tend to have a lot of forward visibility. Folks have announced $0.5 billion, $1 billion type gathering systems that they're in the midst of constructing or connecting incremental laterals to. So a lot of the projects that we're seeing for Q1 and Q2 were already, not just on drawing boards and glimmers or somebody's imagination, but are actually moving forward.

So what's not clear to us is what the back half of 2013 is going to look like, and we have the same question just like everybody on this call and then the industry have is, what were the impact of commodity price due to some of the incremental demand. Again, a lot of the projects that we're involved with have long-term visibility, their processing plants where you've got to need to construct to clean the liquids out of the gas stream, you've got ongoing infrastructure development. The Permian and Delaware basins right now, even with some slowdown activity, will have lots of infrastructure that's going to be built and developed.

We start to look at plans that are being announced. We saw some folks the other day with Anadarko and KKR announcing a big project over in the Eagle Mine area of kind of North -- Southcentral Texas, around the Bryan/College Station area, where they've got plans to drill 350 or 400 wells.

So there's going to be continued activity and continued pockets of activity and continued growth opportunities. So long-winded way to say, we don't contemplate massive acceleration in 2015, but we continue to see slow, steady, methodical demand at frankly pretty nice growth rates for us.

Yeah, Jim, I'd like to add to Eric's commentary that as we get into to announcing our fourth quarter earnings, we'll have the order book for next year shaped up a bit more firmly. But to the points that you were making, we do expect another strong year in 2015.

Okay, that's helpful. And on the distribution growth rate, congrats on six quarters of growth. Your growth stepped down a little bit. Kind of the last two prior quarters you were running up about $0.01 a quarter and then dropped to $0.005 a quarter. Just curious, A, what drove the slightly lower sequential growth rate and maybe how you are thinking about that going forward?

Sure, we again continue to have ample cash coverage with the operation of the DRIP at nearly 2.5 times, but we've been visiting with investors, both investors that have significant positions in our units and those who have an interest in moving in and taking a position. And we think as we've communicated since we completed the IPO that we need to make progress against being all-in covered. And as we continue to communicate to investors, we would want to move into the all-in coverage at something that looks more like 1.1 to 1.15 times.

But we just felt it was important over the back half of this year to make progress to being fully covered at 1 times and that weighed in part in terms of how we set the distribution for Q3. With the growth of the business and the growth CapEx that we're investing, we continue to expect strong distribution growth again as we move into 2015.

Okay, that's helpful. Last one. Eric, just maybe a reminder, historically what's been your experience on -- you mentioned your initial contracts for new compression equipments two to five years. What's been your historical experience on the renewal rate of that once it gets past the initial term?

Jim, another really good question. It varies from horsepower to horsepower range. One, if you are a small wellhead gas well guy and you see a precipitous decline in commodity price, that equipment tends to come home fairly quickly, which is why we tend to not focus on that sector. On the infrastructure side, the bigger horsepower, after the primary term, unless you see a change in conditions, volume dramatically declines, these assets stay deployed and deployed for an extended period of time. We have multiple instances in the company where we are now on our coming in -- we are in our third fifth-year renewal cycle, literally assets that we deploy 15 years ago are still installed and generating revenue in place.

So the majority of our assets, far in excess of 50%, tend to stay sticky and deployed beyond the primary term. The industry kind of uses a rule of thumb. A five-year contracts typically stays installed seven and a half to eight years. Three-year contracts typically stay installed four and a half to five years. Two-year contracts, three to three and a half-year type arrangement, kind of 150% of your original primary term. And we've seen that for the last 15 years through multiple commodity cycles up and down alike. And I think the world that we're living in today with these large tad facilities where we've got an installation of 6 or 8 or 10 compressor packages, to the extent you see some decline in volume, not all of the stuff may get sent home. It might be one unit here and one unit there and we very quickly turn around and redeploy those units someplace else.

Perfect. Appreciate the answer. Thanks guys.

Thank you.

Thank you, Jim.

Jeremy Tonet, JPMorgan.

Hey, guys, good morning. It's actually Andy for Jeremy. Thanks for the color on the order book potential for the end of next year 2015. Is the lead time still 9 months to 12 months for the newer, larger midstream units and if that's the case, wouldn't orders need to placed sooner or already been placed to sustain growth into the back half of next year or have we seen progress with fabrication bottleneck so that that might not be as much of a concern?

What's interesting is, that's being met two-fold. The equipment manufacturers, predominantly Caterpillar and Ariel have sufficient capacity to ramp up the production queue if they need to. They can put on multiple shifts and in the case of Caterpillar, they've seen some slow down in the mining industries which they've then redirected some of the engine manufacturing capacity away from mining back into the nat gas business.

There have been some select bottlenecks with the fabricators. In particular, one of our large fabricators that's in the Tulsa area has a pretty big backlog that they're working through with some of the midstream guys for very long-term projects. Their back half of the year is starting to debottleneck a little bit, so we're looking at roughly nine month lead times right now. The really big step would be the 36-16 type of products we're still looking at almost 12-month lead time.

But the stuff that we're looking at, call it, nine month leads, so we've got a little bit of time. We've got another 90 days or so before we need to start looking at the back half of 2015. And I think by that point in time, we'll have a little bit better visibility and color on what (Technical Difficulty)

(Technical Difficulty) and obviously not a ton of compression players with a big presence there, what's the opportunity for you guys and when might that opportunity [rear and pad]? Do you have an advantage given the newer equipment or the expertise or maybe a little more color on that opportunity would be great?

Clearly, the State of North Dakota has allowed flaring to go on for an extended period of time. And some of the things we're seeing here recently is the State is starting to focus more on trying to mitigate the 600 million cubic feet of gases being flared each and every day up there. So that's starting to move forward with looking at capturing natural gas which will require the build out of gathering systems that will require processing plants to extract the high BTU liquids that are in place in that.

So folks are in the midst of figuring out just what that's going to look like right now. We are aware of three or four players up there looking at specific projects. We're having some visitations with a couple of those folks about how compression and USA Compression could fit in the mix with that. It's still a little early. Until pipe is in the ground, you don't need the compressor to move gas when there's no pipe in, but it's coming here. Particularly over the next 12 to 24 months that will be a growth area for the gathering and processing industry and obviously by definition an opportunity for USA.

Great. And then final one from me. And I apologize, if I missed it. Any additional discussion surrounding the DRIP. I think the most recent guidance was first quarter '15 participation, but any indication of thereafter given that all-in coverage likely will get better with lower distribution payout?

Andy, the topic is under discussion. So it's a bit premature for us to indicate whether there's an extension. We will be actively discussing that through the balance of this year. And the DRIP, as you know, was extended for approximately one year from the last time the sponsor and the organized folks agreed to continue the DRIP. So we'll see how that progresses and it is helpful in terms of funding our higher level of growth CapEx need. So we think that we'll come to a conclusion for that for the business, but a little bit premature to give any specifics.

Great. That's all from me. Thanks a lot guys.

Thank you.

Thanks, Andy.

Richard Verdi, Ladenburg.

Good morning, guys, and congrats on a great quarter.

Thanks, Richard.

Thank you, Richard.

So my first question pertains to my model. Obviously the company had a great quarter with record revenue. Revenue was spot on to my model and I had 29,327 for adjusted EBITDA. It is exactly what you guys reported, which is great [as it's chosen] my thesis being on track. However, there was a little bit of noise in my model versus what was reported and particularly around the gross margin. In last year, it was slightly higher than it is this year. So moving forward, what should we be thinking about gross margin? Should it be staying around these levels for modeling purposes?

Richard, I think for modeling purposes, for the balance of this year, that's a good working assumption. We had mentioned on some of these calls in the past is, we have this really large horsepower compression into the system. It carries gross margins that are above the aggregate for our fleet. And so we look towards trying to drive through some gross margin expansion as we look into our forecasting in the business over there the next couple of years. And so all that depends of course on how a lot of factors move, but the fundamentals continue to be strong again, especially around the really large equipment. So I think that you could probably look to some improvement as we get into next year.

Excellent. Okay, great. Thanks for the color. And Eric, in your prepared remarks you had mentioned that the company doesn't really see much of an impact from the move in the price of oil, et cetera, but you do have the crude oil well application. I mean, how much of an impact is the variance in the price of oil having on that business and is there a price of oil that would concern you around that business?

Richard, I'm going to break it into two pieces. One has to do with economic finding cost, does it make sense to go out and drill new wells and spend $6 million for a horizontal well and a couple million dollars for a frac job and incremental pipe connections and those type of things. And that's a very different set of numbers than incremental lifting cost. So what you'll find is it may be very economic to produce oil at $40 or $50 a barrel for wells that have been drilled. So the existing base of gas lift equipment that we have will stay installed and will continue to produce.

These are wells that initially have production of 1,000 or 1,500 barrels a day or 800 barrels a day. They've exhibited hyperbolic decline and now you are down kind of in that flat shallow decline component at 30, 50, 80, 100 barrels of oil a day. So the economics of that, when you look at it, the O&M cost to have the gas lift compression, to pay the pump or the operator, pay your severance and ad valorem, those types of things are economic at significantly lower pricing than what it might cost to go drill a new well. So I think what you'll see -- if you see or have a continued long-term decline in crude oil prices, so say you go from instead of being $80 a barrel, you're at 70, you are having to forbid $60, you'll start to see a slowdown in new drilling activity related to the oil side, but the existing installed gas lift equipment would tend to stay in place and produce cash flows to cover the debt service that all those E&P companies are really going to need at that point in time. So I think it's a bifurcation of new activity versus what you have currently installed and in place and the installed and in place will stay deployed and in place.

Excellent. Okay, fantastic. And thank you for that, Eric. And just one last question kind of the big picture question. It's a follow-up to the last caller's inquiry. Regions where you're seeing strength, what might it be and also weakness and new opportunities, et cetera?

Hey, Rich. I'm going to categorize things kind of, call it, the haves and the have nots of when you've got some very large, very well capitalized operators with large acreage positions or large dedications of throughput for their pipeline gathering and processing systems. I'll contrast that with folks who maybe a little undercapitalized, don't have hedges in place, don't have the balance sheet to support those things.

The good news for USA Compression is when you look at our customer base, these tend to be very strong, long-term stable customers. Folks that have very strong balance sheets, folks who are able to put hedges in place which we look at 2015 and 2016 kind of de-risk the commodity price side of things. Strong balance sheets where folks continue to have dominant positions regionally. So although you've got basis differential, i.e. some significant spot for or very low spot prices, for example, in the Marcellus. Folks who are dealing with or folks who have firm transportation kind of first-mover early advantage in the play and continue to have a very different economic set than maybe some of the other folks might.

We're seeing some pickup in dry gas activity again interestingly. Some folks who have redeployed capital out of one area into another area, they were able to put some hedges in place back in the summer time looking at the next several years of activities. So if you're looking at $4.50 natural gas prices back to their gathering and all back to the wellhead, fairly attractive economics for some of those folks. So we continue to see the strong areas. So the Marcellus/Utica remain strong for us. We continue to see activity in the Permian and the Delaware Basin growing. We continue to see, call it, kind of methodical, sustainable activities in the Mid-Continent area.

So I think you start to see some of the fringe areas, the core and the meat of somebody -- of the major plays continues. Clearly, the Eagle Ford is ongoing, a lot of strength in that area. When you start to get to some of the fringe areas, call it, Class II or Class III prospects, a little bit lower IPs, steeper decline, the type curve is a little bit lower, those are the areas that probably could potentially be a little bit higher risk for slowdown in activity and generally that's not the areas that we're participating in.

Okay, great. Well, that's it from me and congrats again on the great quarter. Thank you.

Thank you, Richard.

Jerren Holder, Goldman Sachs.

Good morning. Just want to start again with the contract renewals here. Thinking about some of the legacy contracts that may have gone over already its initial contract period which may be longer and now on a shorter-term cycles, maybe monthly, have you seen any sort of change in renewal activity just recently given the downturn in commodity prices of those contracts?

Jerren, we have seen a consistency in our pattern in terms of renewal and as Eric mentioned, we're running at mid-90s percent utilization rates and which is, for us, essentially fully utilized. So renewal activity and the length of time the compression units are staying in the field after primary terms are pretty consistent against what we've seen over the last few years.

Okay. And just switching I guess across to the distributable cash flow calculations that you guys do, the transaction expenses, seems like that number creeped up quite a bit, it's about 4% of TCF this quarter. Can you guys just expand a bit on what those are just given that there aren't any material acquisitions that we've heard of and how does that kind of factor in?

Jerren, as we've communicated pretty regularly that we continue to look at opportunities. And so that's not new to us and that would be something that we continue to look at to see if there's something opportunistic. The transaction expenses for this quarter were at a level that's higher than what we saw last quarter. And it's possible, as we have in the past, that we won't incur those costs from one quarter to the next, but it's just part of our regular ongoing analysis of good M&A opportunities. And so that's why we have set those aside in terms of add-backs to adjusted EBITDA and distributable cash flow.

Okay. And I guess lastly, just switching to the balance sheet here, it looks like your leverage ratios are creeping up a bit here and just given the amount of CapEx that you are spending for the orders that you expect to supply the strong demand you're seeing, are you guys planning on managing your balance sheet as the level seem a bit here, high here with more CapEx to come?

Yeah, and as Eric mentioned, we do want to make progress against the 3.5 to 4 times leverage, but we are clearly putting a lot of growth CapEx if we were to take advantage of the market opportunities. To the extent that the two parties and the large parties in the DRIP will continue to DRIP their units, that will have some delevering improvement. And then, if we look towards the delevering, we may once again like we did this year, look into the equity markets to take the leverage down a bit. So we're staying pretty, pretty flexible, pretty nimble on those opportunities, but we'll be looking into how the markets are performing next year to see whether we take advantage of the equity markets to delever.

Okay. And just lastly just in terms of your credit facility covenants, do you guys get credit for the CapEx that's already contracted on the two to five year contracts, similar to how you would get a, I guess, EBITDA credit for an acquisition if you were to make one?

Well we get a couple of points. We did have a half a turn step up for two quarters on any acquisitions. So that is in the credit facility. The growth CapEx, the way it works inside of the credit facility is once we acquire units and particularly when they go into the customer contracts, they go into our borrowing base. So we get credit for borrowing against those assets, both when they are acquired and then when they go into customer contracts.

The add-back in terms of what you were describing in the growth CapEx, we don't have a provision specifically like that the way we made some changes to our credit agreement to take advantage of the fact that we're adding lot of growth CapEx and building EBITDA was to convert the leverage requirement to a trailing three month annualized covenant test. And that's how we accomplish what you are indicating there in the first part of your question.

Okay, great. Thank you.

(Operator Instructions) Sharon Lui, Wells Fargo.

Hi, good morning.

Good morning, Sharon.

Just following up on the previous questions, what's the potential to, I guess, exercise the option to increase the credit facility versus maybe issuing some long-term debt to get additional capacity?

That's a very good question, Sharon. We are actively looking both at the high-yield markets and how they're developing. And also always continually in discussions with the lenders who are in our credit facility, particularly our agent. And we are considering a number of different alternatives, because we have such an attractive interest rate under our ABL facility. And you may recall, there's $100 million accordion under the credit facility. We actually have borrowing base to support an upsize, particularly as we get into next year. So we are considering all alternatives, but also in discussions with our lenders in the ABL to see what we might do there to further fund our growth, just like we did at the end of 2013.

That's helpful. And then I guess on prior comments on newer resource plays, just wondering if producers initially typically own their compressor units or look to contract with the service provider when they enter into new place?

Yeah, a lot of the time, Sharon, and it's company specific obviously, but if it's a new frontier area where a company doesn't have a base of operations or infrastructure, they might outsource early on. And as the play matures, then they may make the decision as compression considered to be a core competency. If so, they might opt to end up with a larger percentage of company owned equipment.

Some operators look at it and say, we will try to balance where half of the assets would be outsourced to a company like USA and then maybe they own kind of a long-term base load of equipment. Others might look at it and say, we're an E&P company, owning compression doesn't do anything for Sec-10 reserves. But there is an opportunity to monetize compression equipment maybe it makes more sense on a USA Compression's balance sheet than it would on an E&P company who trade at typically a significantly lower multiple than a midstream company like the USA. So it varies, but I would think in general as you -- when you move into a new frontier area kind of early on their opportunities for companies like the USA, I think the Bakken would come to mind as an example that there will be some opportunities as that starts to get the natural gas infrastructure installed.

Okay, that's helpful. And Eric maybe if you can just touch on the decision process to actually allocate some of your resources to these emerging resource plays. How did you decide how much energy to devote to pursuing of first mover advantage in one area versus another? Does it depend on I guess the producer relationships that you have that are in these regions?

As we've touched on before Sharon, we have a long history in working with our top 10 or even 20 customers. Eight of our top 10 customers we worked with for over a decade. So it comes as no surprise that as they move into a more frontier area, expand their base of operations. We have a long working relationship and when it comes to mission-critical type of projects even if it's a new area, we oftentimes get that phone call.

So we typically don't move into a new area just on a, call it a, speculative basis. We're not going to take 10 or 15 or 20 service guys, load them up in their pick-up trucks and drive out to new area and hang up. Now we're in business sign on the front door. So we'll follow along behind the existing customers and as they grow into an area we'll grow alongside of them.

Okay. Excellent. Thank you.

Thank you, Sharon.

Andy Gupta, HITE Hedge.

Hi. This is actually Matt Niblack. Congratulations again on the great quarter. A couple of things. First is that one of the concerns the marketplace seems to have is you are going to get over your SKUS a bit on ordering equipment, particularly given the question marks around the second half of next year which has been pretty thoroughly explored here in the call. But maybe could you speak a bit about the detailed process that you go through to make sure that you don't over order in uncertain commodity environment and talk about how you think about the impact of lower oil and natural gas prices on your volumes as you are going through that process?

Sure. And I think as we pointed out all along, USA Compression is really two stories. One is stability and the other is growth. And we will grow when it makes sense to grow and we'll be stable when it makes sense to be stable. When we look at 2014, I kind of envision we're like the big anaconda who -- body was going to eat a rabbit, we eat a big old pig. So we have to work the pig through the system this year. Short term, that has some [hanks] but longer term there's good stable cash flows and revenues that are associated with it.

When we look at coming into 2015, as I hinted the first half of the year is very visible and extremely strong. We think we've got very good visibility as well with our existing customer base for what the back half of the year is going to look like. Do we think we're going to do 350,000 horsepower growth this year? The potential exist to do that. If it makes sense to do and just like everybody else right now, we're watching to see what happens with some of the commodity markets and does that have an impact on some of the projects, particularly more with the E&P companies, less so with the midstream companies for the back half of the year.

So when we look at the level of horsepower that we've committed the build, Q1, Q2 and on in the Q3 of a couple of hundred thousand horsepower, we're extremely comfortable with our abilities to place that. Now if we were to really get into a nuclear meltdown scenario, and we saw that back in 2008 after Lehman Brothers collapsed, the financial markets dried up. We were able to cancel with no penalty some of the commitments that have been made. We deferred some deliveries of equipment, we pushed some things out.

So when we look at it, our ability as a 1.5 million horsepower compression company to absorb what now looks like, call it 100,000-ish horsepower of unplaced equipment in 2015, now with a couple of hundred thousand horsepower, we're highly confident in our ability to absorb that one way shape or form. So I think the more important question is going to become, what does 2016, what does 2017, what does 2018 look like in light of if there is a protracted downturn in commodity prices.

We're talking several years out from today, not today. The environment we will be living in as USA Compression will be very, very stable at that point in time. If there is a downturn in the cycle we just blow our horns in and have the free cash flow that we have and continue to make the distributions for our unitholders.

Right. Is Williams a customer and is there any impact of the WPZ-ACMP merger on your business?

Yeah, we have several pockets of relationships with Williams. As Williams -- as well as with AMCP. So we're involved with both of them and at this stage of the game, we're hearing nothing to the negative that could impact us. Actually, we're hearing some things that could positively impact us from those guys.

Okay. And also obviously E&P CapEx budgets getting stretched potentially with lower commodity prices. One output of that could be that they may actually want to outsource things like compression to a higher degree. Is that something you observed at all in previous cycles or hear rumblings about it at all?

And in fact some folks have heard me actually speak to the world we live in. Compression is kind of a Goldilocks land. It's not too hard, it's not too cold but just right. When commodity prices zoom through the roof like they did post Katrina and Rita, $16 natural gas, all of a sudden people mash accelerator and all sorts of activities go on. To the extent that you see a collapse in the commodity price, budgets are constrained, people need to do more with less, our business gets really good.

And that's frankly when the monetization, the sale leaseback, so to speak, opportunities actually inner themselves. So I've been doing this for a long time and we go back and look at the cycles where capital was tight, balance sheets were strained, your E&P folks looking to play avoided capital games, companies like USA Compression are very well poised to take advantage and can be opportunistic at those points in the cycle.

Okay. And last question, your cost to capital lease on the equity side is unfortunately high, I think in large part because the market doesn't really understand your business. But that being said, it's a fact. Is there any thought strategically of things that you might do in response to that situation? And I'm thinking even as aggressive as looking for a larger merger you could participate in to get liquidity up and scale up, and may make the story more investable or anything else creative to potentially address that cost of capital issue?

Yeah, your commentary was very much in line with our thinking. Again, we continue to look at those types of opportunities. And we also recognize that the liquidity in terms of the flow and improvement thereof is something that should help improve our yield and we agree with your commentary now and previous commentary about where we believe the yield marker should be relative to where it is today.

But without getting into specifics, we look up and down the capital structure both with the existing business that we have and particularly if there was a larger M&A opportunity than what we did last year. And the flows did improve significantly after our first follow-on equity offering in May of this year. And if we can accomplish a strategic transaction particularly in the M&A area we think we will have some opportunities to further improve the yield and liquidity.

And as part of that with something more like a merger of equals beyond the tables, merging with Compressco for instance or is it fully that you would be looking at opportunities where you could sort of swallow the acquisition?

We don't want to really comment on any specific opportunities. I think suffice it to say we identify that longer-term we want to improve our cost of capital. There are lots of ways to do that and lots of levers that potentially we could grow. So it involves assets that maybe E&P companies own, maybe Midstream company owns, peers and competitors. There is a lot of different ways we could potentially skin the cat.

Okay, great. Well, keep up the good work and we'll keep hoping that the market starts to recognize it here.

Thanks, Matt.

Thanks, Matt.

And at this time there are no further questions in queue, I would like to turn the conference back to you Mr. Long for any additional or closing remarks.

Thank you much. Well, we appreciate everybody's continued interest in USA Compression. We continue to manage the company for both stability and opportunistic growth. I think times like these where there's some uncertainty in the commodity cycles will longer term any concerns by investors that we have will be satiated as we look at how the company will -- we expect the company to perform in quarters ahead. So thanks for your continued support and everybody have a great day.

And again that does conclude today's conference. We do thank you for your participation.