USA Compression Partners LP (USAC) 2018 Q2 法說會逐字稿

Good morning and welcome to the USA Compression Partners LP Second Quarter 2018 Earnings Conference Call. (Operator Instructions) This conference is being recorded today, August 7, 2018.

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

Good morning, everyone, and thank you for joining us. This morning, we released our financial results for the quarter ended June 30, 2018. You can find our earnings release as well as a recording of this call in the Investor Relations section of our website at usacompression.com. The recording will be available through August 17, 2018.

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

As a reminder, our conference call will include forward-looking statements. These statements include projections and expectations of our performance and represent our current beliefs. Actual results may differ materially. Please review the statements of risk included in this morning's release and in our SEC filings. Please note that information provided on this call speaks only to management's views as of today, August 7, and may no longer be accurate at the time of a replay.

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

Thank you, Chris. Good morning, everyone, and thanks for joining us on our call today. Also with me is Matt Liuzzi, our CFO.

This morning, we released our financial and operational results for the second quarter of 2018. Notably, these are the first quarterly results reflecting the combined USA Compression, CDM Resource Management business. We closed the acquisition on April 2, 2018. Throughout the organization, we have been working to integrate the 2 businesses and combined with the attractive market dynamics for large horsepower compression, we are extremely pleased with the progress we've made and are excited for the prospects for the future combined USA Compression.

Before I discuss the market and our results, I'd like to provide some more color on the acquisition and the ongoing integration. As you're aware, this acquisition brought together 2 very similar compression fleets. CDM was comprised primarily of large horsepower compression targeted towards infrastructure-type applications, just like USA Compression. Over the last 20 years, we both followed similar business strategies, each centered on new vintage equipment, high-quality customers and excellence in customer service. This transaction has broadened USA Compression's geographic presence as well as customer relationships, all while staying consistent to the large horsepower business strategy.

Very early on, we integrated our field operations. We have updated our geographical organization into 7 operating groups covering 5 operating regions. Leadership at the field level is now comprised of a mix of legacy USA Compression and legacy CDM individuals. We are truly taking the best talent of both worlds. We are currently working through the back office integration effort, which primarily consists of migrating over the CDM fleet and customer data, as well as fully integrating the finance and accounting functions on to USA Compression's scalable, operational and financial platforms. Once this is complete later this year, everything will be run off the systems that we at USA Compression have built and expanded over time. You can appreciate that with over 2,000 individual compression units in the CDM fleet alone, getting this done right the first time is critical. Once complete, it will give us the ability to manage the entire fleet more efficiently and profitably, going forward.

Results from the early stages of this integration effort continue to go well. We are finding a lot of low hanging fruit, which is having a positive impact, not only on the efficiency of the business, but also on the overall leverage profile of the business, ranging from reduction in working capital requirements due to productivity improvements, improved cycle times and reduced inventory levels across operating regions, the adoption of unit level expense tracking on CDM legacy assets and the implementation of USA's integrated fleet management and contract tracking systems, are collectively driving both expense reduction and revenue growth at levels above what we previously expected.

As we get further through the back office integration, we expect to reap further benefits. We are approaching this the way we always have at USA Compression, which is to run as lean and efficient an organization as possible. While it could be challenging to change the way you've been doing things for 20 years, everyone throughout the combined organization understands the value that can be created and is on board.

So in summary, one quarter following the closing of the CDM acquisition, I am pleased to report that we are executing ahead of plan and are seeing results better than we expected.

So now the quarterly results. In the second quarter, we experienced a continuation of the strong business environment for our compression services, illustrated by average utilization during the quarter of 91.5%. While this is a slight tick down from USA's stand-alone Q1 metric, keep in mind that this number reflects the inclusion of the CDM assets into the USA fleet. As we discussed at the time of the deal, the CDM fleet have somewhat lower utilization than USA, and so as a result, this was not unexpected. Frankly, we're happy to have some, but not many, idle units for deployment out to customers, given the demand signals that we continue to receive.

As mentioned, the market is very tight and continues to tighten across all horsepower classes. The overall macro environment is very supportive of continued demand, and during the quarter, we deployed horsepower across all size ranges for customer applications. Demand is especially strong in the largest horsepower categories, in which USA Compression specializes. This bodes well for our performance in the back half of 2018 and, we believe, positions us well for the future.

On the operations side, our total fleet horsepower at period end was about 3.6 million horsepower and active horsepower at period end was almost 3.2 million horsepower. As I mentioned, this resulted in fleet utilization at period end of approximately 91.5%. A utilization level in the mid-90% area is essentially sold out, so while we have some units that we can deploy, this still generally represents a level of utilization last seen before the oil price decline that started in late 2014. Most of our truly idle horsepower consists of smaller horsepower. The large units are by and large completely sold out. We are seeing increasing demand for either some smaller horsepower units, particularly in gas lift applications, which require higher operating pressures, which much of the legacy small horsepower in the industry lacks.

Pricing continued to tick upwards during the second quarter, reflecting the attractive market. While we deployed new large horsepower units out to customers, which units command very attractive pricing, we also continue to monitor the market and make price increases across our operating regions for existing units already operating on month-to-month contracts. Looking to the future, we think sector activity levels and the tight supply demand dynamics for both new and used large horsepower equipment will continue to support enhanced pricing going forward.

Given the strong market dynamics and demand for equipment, we continue to prudently invest capital in order to grow alongside our customers. In Q2, we invested growth capital of approximately $67 million, consisting primarily of large horsepower units that are in greatest demand by our customers. We continued our focus of the largest horsepower class, the 2,500-horsepower CAT 3608 model and the 5,000-horsepower CAT 3616. And during the quarter, we took delivery of approximately 34,000 total horsepower.

For the rest of 2018, we have scheduled about 95,000 horsepower for delivery, consisting of substantially all large horsepower units, which have already been fully committed to customers. As we look into 2019, we have commitments for the delivery of an additional 67,000 horsepower of the largest horsepower class throughout the first half of 2019. This is up slightly from the 50,000 horsepower we had previously mentioned.

In addition to lead times, which continued to lengthen and now approach 60 weeks for larger iron due to supply chain bottlenecks from several of our major manufacturers, we are beginning to see upward pressure on our new unit CapEx cost. Several suppliers have announced price increases for 2019 in the vicinity of 5%. Additionally, our fabricators have indicated that recent increases in the cost of flat plate and rolled steel, due in no small part to the announced 25% tariff on imported steel and 10% on imported aluminum, will begin to filter throughout the system and will most likely result in increased pricing for orders placed in the back half of 2019 and beyond.

So while initial capital costs are likely to increase, which sometimes gets missed, is the positive impact that can have on our overall business. Because of the increased capital cost, this will necessarily result in increases in the monthly service rates that we charge our customers for compression services, for both new equipment as well as existing fleet iron that either comes off a contract or is redeployed to new applications. Thus, the value of our existing fleet, one of the youngest in the industry, will continue to increase as the replacement cost continue to climb and we continue to replace -- or to reprice our monthly compression services fees across our existing fleet.

The second quarter financial performance represented a great start to the new USA Compression as the strong market dynamics led to increase active horsepower and improved pricing, adjusting -- resulting in adjusted EBITDA of $95.4 million. Achieving an overall gross operating margin of 65.5% and an adjusted EBITDA margin of 57.2% represented great strides for the combined company. As we have mentioned, the CDM fleet historically operated at an EBITDA margin of about 10% below USAC levels, and so these results demonstrate the progress we've already made in the integration of the business.

We expect a continued effort around fleet integration and the combined focus on large horsepower, infrastructure-based applications will allow USA Compression to ultimately derive margins consistent with our past practice. The strong quarter -- the strong quarterly results led to leverage of 4.4x, down from 4.8x in the first quarter for USA and a distributable cash flow coverage ratio of 1.09x, up from the 1.03x that USA reported for Q1.

So let me shift a little bit to the marketplace. The productivity paradigm shift we've been witnessing in domestic E&P operators has continued through the second quarter. Everyone is well aware of the efficiency gains the industry has made over the last few years. The continued focus on pad site drilling, multistage fracking and the resulting volume gains in, not only initial production rates, but also EURs, continues to drive demand for large horsepower compression. Clearly, USA Compression now has a more geographically diverse operating footprint. This has allowed us to focus resources on faster growing areas, like the Permian and Delaware basins, the Marcellus and Utica shales in the Northeast, and the SCOOP/STACK merge plays in the Mid-Continent, but also reach stable cash flows from areas of historical activity, including South Texas up through the Gulf Coast, as well as Louisiana and Rockies regions.

So the big picture continues to be strong. Compression services play a critical role in the natural gas value chain, and the drivers of natural gas demand continue to be attractive. The big 4 demand drivers, as we call them, continue to move in a positive direction. Those big 4: LNG exports, petrochemical feedstock demand, clean burning domestic power generation and exports to Mexico, are poised to absorb the increased natural gas production in this country and the increase that is primarily coming from the shale and unconventional plays where our assets are located.

As we've been saying for a long time, more gas moving around the country requires more gas infrastructure and increased demand for compression. Within the compression sector, we believe large horsepower will continue to be in the highest demand as it is this class of horsepower that is required for the mission critical infrastructure that our customers are building. Their operations demand a high level of service and reliability, and we believe that we've proven that the USA large horsepower model is a great fit for our customers' requirements.

Over the last 20 years, both USA Compression and CDM built strong businesses, taking care of customers who are part of this infrastructure build-out. As we have now combined these 2 companies, we expect to be even better positioned to benefit from the continued infrastructure development and demand growth we see ahead in this country.

I'll now turn the call over to Matt to walk through some of the financial highlights of the quarter. Matt?

Thanks, Eric, and good morning, everyone. Today, USA Compression reported second quarter results, which reflect our first quarter of combined results including CDM. As Eric mentioned, from an operational, commercial and financial standpoint, the combination has performed well as we had expected. I'll walk through the financial results in a bit, but first I want to explain how the transaction structure affects the financial reporting for the entity going forward.

To refresh everyone on the transaction structure, we had 3 simultaneous transactions, all of which closed earlier this year on April 2. First, Energy Transfer Equity acquired the GP interest, IDRs and approximately 12.5 million LP units from USA Compression Holdings, which served as Riverstone's investment vehicle in USA Compression. Second, USA Compression acquired CDM Resource Management for a mix of cash and equity. And third, we extinguished the economic GP interest in IDRs in exchange for LP unit at ETE.

Since closing, we've continued to operate as a publicly traded third-party compression services provider just with the new owner of the noneconomic GP interest with a significantly larger asset base. I would like to call your attention, however, to a change in our financial reporting entity that you may have noticed in our earnings release this morning and which may impact comparability of financial results between periods.

The transaction between USA Compression and CDM is being treated for accounting purposes as a reverse merger. Because CDM's ultimate parent, Energy Transfer Equity, acquired control of USA Compression through the GP purchase, CDM is deemed to be the accounting acquirer. As such effective as of April 2, 2018, the predecessor for financial reporting purposes is CDM.

So what this means practically is that any historical data or information that is filed in the future but relates to periods prior to the second quarter of 2018 will reflect historical CDM financial and operational results. As such, the 6 months financial and operational data included in our 10-Q will reflect the first quarter of CDM and then the second quarter of the combined business.

To be clear, USA Compression's historical filings are not being restated. The accounting treatment, in no way, affects the business going forward, it is merely the presentation that the accounting guidelines require. Because historical periods will reflect only the CDM portion of the business and not the results of the USA Compression business you have seen before, any quarter-over-quarter or year-over-year comparisons may not be as meaningful for readers of the financial information. The end result of all this is that this results in somewhat apples-to-oranges comparative period reporting and it may not be particularly easy to compare current and past period. Again, this was driven by the accounting guidelines and has no impact on our business or performance going forward.

So turning to the results. The second quarter achieved revenue of $167 million, adjusted EBITDA of $95.4 million and DCF to limited partners of $51.4 million. In July, we announced the cash distribution to the unitholders of $0.525 per LP unit, consistent with the previous quarter.

Our total fleet horsepower as of the end of Q2 was almost 3.6 million horsepower, reflecting primarily the CDM acquisition, but also the delivery of new units was about $67 million in growth capital spent during the quarter. Our revenue generating horsepower at period end was approximately 3.2 million horsepower.

Our average horsepower utilization for the second quarter was 91.5%. Pricing, as measured by average revenue per revenue generating horsepower per month was $15.77. We continued to benefit from attractive pricing on new unit deliveries as well as selective price increases on the existing fleet.

Total revenue for the first quarter was $167 million, of which approximately $155 million reflected our core contract operations revenues. Gross operating margin as a percentage of revenue was 65.5% in Q2.

Walking through a few of the other specific line items, net income for the quarter was $3.2 million. Net cash provided by operating activities was $75.5 million in the quarter. Operating income was $28.6 million in the second quarter. Maintenance capital totaled $7.9 million for the quarter, and cash interest expense net was $23.6 million.

When we announced the transactions back in January, we noted that we expected the deal structure and consideration to result in deleveraging of the balance sheet and growing distribution coverage over time. The second quarter got a good start on both as leverage decreased at 4.4x, including our senior notes and outstanding borrowings under the revolver of $950 million. Total distributable cash flow coverage of 1.09x was also improved than the previous quarter's level of 1.03x.

You'll recall that in May when we provided guidance, we did so on an actual 2018 basis. That is, we took a full year of USA Compression and added 3 quarters' worth of expected CDM results based on the April 2 closing. Because of the accounting treatment I discussed earlier, when we get to the end of 2018, our full year results will now reflect a full year of CDM and 3 quarters of USA Compression results. Subsequent to May's guidance, we determined that treating the acquisition as a reverse merger with the appropriate accounting treatment. As a result of switching out the USA Compression's first quarter for the CDM first quarter, our adjusted EBITDA for the 6 months ended June 30, was approximately $10 million lower than we would have reported using USA Compression's first quarter financials.

However, because of an improvement in the forecast for the back half of the year, we are keeping guidance unchanged at this point in time. As such, we continue to expect 2018 adjusted EBITDA of between $310 million and $330 million and DCF of between $170 million and $190 million. In addition, we expect net income of between $10 million and $30 million. Last, we expect to file the Form 10-Q with the SEC as early as this afternoon.

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

(Operator Instructions) Our first question comes from Jeremy Tonet with JPMorgan.

This is Charlie on for Jeremy. Congratulations on the progress made on the integration front today. I was just curious, given it seems like you're ahead of schedule and maybe seeing synergies a bit above expectations, could you give -- provide a little more color maybe on quantifying where you are now versus what you had -- you said in the past? And then also when are we really going to start to see these savings flow through during the back half of the year?

Sure. Charlie, it's Matt. I guess, going back when we announced the deal and when we closed it, we were talking about $20 million kind of on a run rate synergy amount. I would just say that, number one, our guidance incorporates kind of where we are on those synergies and where we expect to kind of get through kind of the end of the year. But a lot of that was -- again this is all cost-related synergies. And I would say, we were well on our way kind of very early on as we continue to get through the integration, the back office, the accounting, the IT, those sorts of issues. I think we'll see the rest of that amount kind of get here through the back half of this year, so we'd expect by the time the integration is complete, which we think is later on this year on a run rate basis, we'll be kind of at that -- certainly, at least at that amount that we announced earlier.

Okay, great. And then also on utilization, 91.5%, and you said that you'd kind of ramp up, up to where you've historically been? What -- how should we think about that ramp during kind of the back half of this year?

Sure. Charlie, yes, I think we've made the comment that CDM historically had been running at slightly lower utilization kind of fleet wide than USA had been. We spent most of 2017 redeploying a lot of idle equipment on the USA fleet and that basically led to kind of that utilization you've seen in recent quarters for USA in that kind of mid-90s area. CDM, as we had mentioned, CDM was sort of behind us by 6 to 9 to 12 months on that front of redeploying. So that's kind of what's driving that 91.5%. It's really just the combination of the fleets. But again, when we get up in the mid-90s utilization, that's effectively sold out. Given the demand we see, it's not going to take long. The market dynamics that Eric talked about are all very positive. And so what we're doing now to work on that utilization is, again, all of the USA side of things were basically all sold out, all of the new stuff being delivered, this year, is already all contracted. We put in some orders for next year, but then what we're looking at as we kind of work through, it is really the CDM idle fleet that we took on April 2 in really getting that -- spending some capital, getting that make-ready, reconfigured as needed to get that out into the field. So I think what you'll see is us continue to do that throughout the course of the year and that will drive that utilization and really that CDM side of the utilization. It will drive that number and the combined number north.

Okay. That sounds good. Then, I guess, the last one for me, just can you give us the latest on the Northeast outlook and maybe what you're hearing from customers, anything changing as of late?

Yes. Charlie, this is Eric, and we've seen some pipeline delays for some of the long line takeaways. There continues to be scrutiny at the environmental level, at the regulatory level. The several of the larger pipeline construction projects have been delayed. So I think as we've indicated on some earlier calls, we've seen continued activity up in the Marcellus and the Utica, albeit at a pace that has been slower than what we saw a couple of years ago. So I think, consistent with the last few quarters, we continue to see the Permian and the Delaware basins to be red-hot, the SCOOP/STACK merge to be red-hot, the Marcellus and Utica with some of our longer-term larger customers who actually have firm transportation commitments on some existing lines and are able to move gas supplies out of those basins, continue to propagate, but it's a little bit slower than it's been in the past. So I think our view of the world is that's an area that is dominant -- one of the dominant gas producers close to the market areas in the Northeast. And -- although new activity may have slowed down a little bit, existing activity remains strong. And we look at that as an area that once some of these new long-line projects actually are affected and brought on screen, that activity will start to tick up again, and clearly, we'll be right in the middle of the growth in those areas. So it's -- take a little bit of a breather in the area, probably a good thing. It allows us all to catch up and get ready for the next innings of the ballgame when activity starts to pick up again.

Your next question comes from Marshall Adkins, Raymond James.

This is Marshall in for Marshall. I'm going to ask you some modeling questions. Obviously, we're all trying to recalibrate our models on the new format. Let's start with the parts and service and related party stuff. Give us some more color on exactly what all of that is. And can you give us some sense of a run rate on that going forward, because that's just kind of a black box as far as we're concerned?

Yes. Marshall, it's Matt. On the -- I'll divide it up into the 2 that you noted. So parts and service, you'll recall USA historically we have done some of that. It was a relatively minor amount of the business. CDM had a little bit bigger part of that business. Again, in the whole scheme of things, it's pretty small. But that's kind of what's driving that business. We don't -- we typically don't do a whole lot of budgeting around that amount because it is -- it's very -- it can be very one-off. It's work for customer-owned units that are sitting next to units that they are -- that we own and so we go and change the oil on one unit, and they say, "Hey, why don't you change the oil on my unit, too." And we bill them for it. So it's very -- it can be kind of lumpy. So we don't typically try to forecast a whole lot of that parts and service amounts just because it's not a long-term monthly contracted-type service like the core stuff is, but -- so that's going to be a little bit lumpier and difficult for, I think, anyone to really forecast well. The related party stuff...

Was this second quarter kind of representative of kind of where you think, well, I'll just kind of keep it. Obviously, understanding, it's going to be bouncing around, but is that just a good starting point?

I mean, it's probably as good as any starting point. Just understanding that it's hard to project out what might -- we don't even know what August might look like for that kind of a service. It's kind of a very ad-hoc thing. But I think we were kind of running at $1 million or $2 million of revenue a quarter on the USA stand-alone, so with a little bit more, it'll be -- it's never going to be a huge part of the business, but it's -- that second quarter is probably a fair place to start.

Perfect. Yes, just a lot bigger than what I used to seeing that's why I'm asking. And then on the related party?

Yes, so I think the second quarter number is kind of a good run rate deal. That's obviously given the Energy Transfer relationship, there is a little bit of business that CDM had historically done with Energy Transfer entities and that's what is reflected in that number. So we would expect that to continue on as it is.

Right. Normally, I don't ask -- like to ask a lot of modeling stuff on these, but it is kind of a different quarter. So run rate on SG&A, depreciation interest, I assume we just kind of keep them roughly where they are and carry that forward from where it is now?

Yes, I think -- and we'll file the Q this afternoon. And so I think that will give you a little more detail on some of the nonrecurring numbers that are in those numbers. So I would suggest take a look at the Q, give me a call after you do that. But that will -- there is some kind of onetime nonrecurring stuff that will be in that number that, that Q will illustrate for you.

All right. Last one for me, obviously, you have a lot of expansion capital plans that are visible back half for this year and early '19. With rising prices, you've been able to take the debt-to-EBITDA down. Is the idea to continue growing EBITDA into the higher levels of debt you're going to have to put on to fund that? And is there a point in time, where you back off of the growth CapEx and say, "Hey, we are where we want to be, let's get the balance sheet down even more?"

This is Eric. One of the things that's interesting when we look at the leverage of the type of assets that we're adding, the largest to the large horsepower have extremely attractive economics. I think you've hit the nail on the head, now that we're pushing a 4-million horsepower company, we're not growing at a clip of 400,000 or 500,000 horsepower a year. We look at the kind of 125,000, 150,000, 175,000 horsepower range. When we look at continuing kind of moderate, but extremely attractive growth, continued rate increases on our existing fleet, we envision that we will continue to delever the balance sheet. People have asked the question, "Gosh, if you've got massive increases in tariffs and your customers aren't willing to eat the increased costs that have come across, what do you do?" We're not going to grow for the sake of growth. We're in the business to maintain stable distributions. We always said that USA Compression is a long-term story of stability and growth. When the financial markets and our operational markets tell us to grow, i.e. the returns on capital deployed are attractive, we'll deploy capital. And if the market said, "Hey, it's not attractive to grow" then you slow the growth or stop the growth and further delever your balance sheet. So I think our view of the world is we want to capitalize on moderate levels of highly profitable growth and coupled with that, we'll be able to delever the balance sheet and continue to build coverage. Matt, any other color from your perspective?

No. I think that's exactly -- we're going to spend money where it makes sense to and then as we -- and again, the other thing, Marshall, that we're doing is these new units come on at good rates and that has the kind of a knock-on effect on the rest of the fleet, where we can go out and, like we mentioned, kind of take on selective price increases. So I think as you get that, that's going to be growing the EBITDA as well as the new unit deliveries, and I think the combination of that builds coverage and decreases leverage naturally.

The next question comes from Mike Gyure from Janney.

Yes, I was wondering if you guys could maybe talk about the integration of CDM from like a working capital perspective, maybe the receivables, payables, that kind of thing, if you guys see any opportunity that's different than, I guess, what you expected when you -- sort of a quarter along here through the acquisition?

Yes. Mike, it's Matt. As we've -- the business itself -- the 2 businesses we're operating, somewhat very similarly in terms of billing a month in advance. It's still a monthly service rate kind of business. And we were billing a month in advance as we've taken on the CDM stuff we were starting to migrate customers kind of to that month in advance billing cycle. So I think as we work through it, obviously, there is a lot of customers and a lot of contracts to work through, but the whole idea is that we're taking everything as they were doing and bringing it on to our platform, our procedures, et cetera. And so we've obviously always been in a pretty good working capital situation at USAC. So we think -- once we get everything integrated that we're going to continue doing things like we were at USAC. So -- but overall from a customer, from a payment, this stuff, the assets that CDM had were big horsepower, mission-critical stuff, just like the USAC fleet. So you don't -- there wasn't a whole lot of difference in customer payments, bad debt that kind of stuff. So very similar from that standpoint. I think it's sort of just tweaking things around the edges more than anything.

There are no further questions in the queue.

Okay. Well, thank you, operator. And thank you all for joining us on the call today. The second quarter has been a busy one for USA Compression, both from a market demand standpoint with continued high utilization and improved pricing received for our compression services, as well as strategically with the completion of the CDM acquisition and the work to integrate the CDM business as we position USA Compression for the future. We're pleased with the early benefits we're seeing from the combination, and we think our broadened geographic reach and customer exposure will contribute to an even more stable compression services provider with multiple areas for continued growth. With the sector upturn in full swing, we are seeing customer activity levels remain very high. Our field operations, bolstered with the assets and people from CDM, are running at full speed to safely meet the ever growing needs of our financially strong upstream and midstream infrastructure-driven customers. In addition to serving great customers with the critical part of their overall operations, our business model, not only generates stable cash flows throughout the cycle, but can also take advantage of the cyclical upswing in the energy sector just as we're seeing now. USA Compression continues to be a long-term story of stability and growth. We look forward to updating you on our next quarterly call. Thank you for your continued interest in and support of USA Compression.

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.