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USA Compression Partners, LP (NYSE:USAC)

Q1 2014 Earnings Conference Call

May 7, 2014 11:00 ET

Executives

Greg Holloway - VP, General Counsel, Secretary

Eric Long - President, CEO

Jody Tusa - CFO, VP, Treasurer

Analysts

Vimal Patel - RBC Capital Markets

Ned Baramov - Wells Fargo

Operator

Good day, everyone, and welcome to the USA Compression Partners First Quarter Earnings Conference Call. Today's conference is being recorded and will be available for Web replay.

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

Greg Holloway

Appreciate it, Pricilla. Good morning, everybody and thanks for joining us. This morning as you know we released our financial results for the quarter ended March 31, 2014. You can find our earnings release in the Investor Relations section of our Web site 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, May 7 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.

Eric Long

Thank you, Greg, and good morning everyone. Also with me today is Jody Tusa, our Vice President, Chief Financial Officer and Treasurer and Matt Liuzzi, Senior Vice President of Strategic Development.

I'm pleased to report that we are off to a strong start in 2014 with a solid first quarter of operating and financial performance driven by continued strong market demand for our compression services and made possible by the outstanding job our people do out in the field everyday.

Let me take a minute to say that in this business, the compressors don't run and fix themselves. We truly believe that our people are perhaps the most important factor differentiating USA Compression from our competitors. USA has over 300 hardworking loyal men and women in the field and it is their dedication 24 hours a day, 7 days a week, 365 days a year through good weather and bad, serving the needs of our customers that has differentiated USA Compression over the last 15 years. That dedication manifest itself through our continued pragmatic growth, high utilization of our fleet, the return on our assets and the return on our unitholders capital.

I would like to mention that a few days ago, we welcome back to the United States and the USA Compression a young lady. One of our field service technicians who just finished her third thorough duty in Afghanistan. We and her family are happy that Jessica is back safely. We value greatly the contributions our people making services to our country and are always pleased to support individuals like Jessica. It is the loyalty, integrity, hard work and dedication to their jobs and their customers, which our employees bring to the job everyday that drive the operating and financial performance, quarter-after-quarter for our investors. So on behalf of our entire team, I want to say thank you to all of our employees for the job they do everyday and to Jessica for what you and all of our service men and women do on behalf of our country.

Moving on to our quarterly results, the macro fundamentals in both oil and gas sector broadly as well as to the compression segment more specifically continue to demonstrate signs of strength and we expect a busy remainder of 2014, as our customers continue to invest in infrastructure supporting the development of major unconventional oil and gas basins.

I often compare compression to the human heart. It is the equipment necessary to move gas into and through pipelines and to move gas to the marketplace. And right now in the industry there is more gas being extracted and transported than we have seen in a very long time necessitating record amounts of compression.

The high level of activity you have seen by the gathering and processing MLPs and E&P companies is directly impacting USA Compressions business in a positive way. We benefit from the same fundamental business drivers that impact the broader gathering and processing segment.

As I mentioned, the first quarter was driven by strong market demand for our compression services. Our customers, which include both E&P companies and Midstream entities are investing tens of billions of dollars in developing the infrastructure required to extract oil and gas for both existing as well as newly discovered basins and field and we continue to partner with our customers to take advantage of the changing industry dynamics.

We are active in the same basins you have been hearing about on industry conference calls for the last several years. In previous calls, I discussed new orders of 220,000 horsepower for delivery throughout 2014. Based on the latest indications from our customers, we have now already placed orders for about 280,000 horsepower for delivery this year and we ultimately expect to take delivery of about 300,000 horsepower in 2014. This represents an increase of more than 25% of what was previously a record capital spend for USA Compression and about 3x what we spent last year in 2013. Because of timing of deliveries and installation varies throughout the year particularly weighted towards the backend of 2014. We would expect to see the full impact of revenues and cash flows from this increased 2014 capital program manifest next year in 2015.

The absolute level off as well as the increase in our capital program goes to show just what the state of the marketplace is out there. The demand we are seeing for services has never been stronger and there are simply not enough equipment to go around. Our customers continue to choose USA Compression because of our strong commitment to safety and success in implementing our safety program a strong companywide culture of service excellence and dedicated environmental stewardship.

Our customers demand unwavering excellence and it is our people in the field who deliver quality service to our customers day in and day out. We remain focused on growing our business while never losing side of the needs of requirements of our customers.

For the first quarter of 2014, this morning we reported higher levels of revenue adjusted EBITDA and adjusted DCF as compared to the same period last year. As compared to Q1 2013, our revenue increased 54%, adjusted EBITDA increased 44% and adjusted distributable cash flow increased 45%.

On April 24th, we announced a $0.01 increase in our cash distribution per LP unit to $0.49 for the first quarter of 2014. This represents an increase of 2% over Q4 of 2013 and nearly 13% over Q1 of 2013.

Turning to first quarter operational highlights, we added approximately 73,000 horsepower of new midstream and gas lift compression units to our fleet in the first quarter of 2014. And we ended the quarter with about 1.3 million total fleet horsepower. This growth continues to make USA Compression one of the largest independent providers of compression services in the United States based on total fleet horsepower.

We ended the first quarter with horsepower utilization of 94% which illustrates continuing strong demand for our compression services. Our strong preventative and scheduled maintenance programs continue to pay off allowing our assets to achieve very high run times improving the return on capital employed over the long life cycle of our fleet of asset.

Our geographic diversity continues to delivery benefit. We are seeing especially strong activity levels in the Marcellus, Eagle Ford, Utica and Permian Basin shales and the Mississippi Lime and Granite Wash areas. And remember even in areas where drilling activity isn't as robust such as the Haynesville or Fayetteville shales compression services are still needed to move the gas that is produced.

Returning to our capital program spend, to-date we have ordered approximately 280,000 horsepower of new compression units for delivery in 2014. Taking into account, the full expected order and delivery of about 300,000 horsepower in 2014, our CapEx spend for new compression units will equate to approximately $265 million over the course of the year.

The CapEx add is expected to consist of about 250,000 horsepower of midstream compression units and about 50,000 horsepower of gas lift units.

Already, we have customer contracts are over 65% of the 180,000 horsepower that we initially ordered for all of 2014 and strong customer indications for another 16% of those deliveries. The 100,000 horsepower increase in new compression unit orders is expected to be delivered primarily in the second half of 2014.

As we get closer to taking delivery at various times throughout the year, we expect to have substantially all the new units contracted for service. Our revenue generating horsepower increased from 1,070,457 horsepower at the end of the fourth quarter of 2013 to 1,107,218 horsepower at the end of the first quarter of 2014 due to the additional units we placed in the service in the Marcellus, Fayetteville, Woodford, Utica, Permian Basin and Eagle Ford shale plays as well as the Mississippi Lime and Granite Wash areas.

We are seeing initial contract terms of 2 to 5 years for a midstream unit. We have been successful and are continuing to pursue more comprehensive service offerings to meet the expanding needs of our customer partners. We continue to be excited about the growth we see in both the midstream as well as the gas lift compression services arena.

For midstream compression services, we expect continued growth for 2014 to occur primarily in the liquids rich portions of shale and unconventional plays, areas where we see the largest production growth driven by the most favorable economics.

The tightness in the market has allowed us to be selective in where we choose to operate. We are able to high-grade our investment opportunities and pursue the projects with the most attractive financial returns. The strength in the crude oil market has continued to underpin our gas lift compression activity primarily in our core areas in Western Oklahoma and the Texas Panhandle. After a moderate start in 2014 because of weather in this core areas, we are seeing gas lift demand pick-up meaningfully as producers return to normal activity level.

You will recall that our gas lift units are used in infrastructure application rather than the traditional marginal dry gas hole applications of some of our peers. As a result, we continue to see strong utilization of these assets by our customers to include some of the biggest producers in our core areas. We have also incorporated the knowledge gained through our gas lift activity to apply to other gas lift opportunities whether that means larger gas lift units or applications in other areas of the country. We continue to be pleased with the gas lift acquisition and the positive impact it has had on the partnership.

Consistent with what we have said and done, since our IPO, we will continue to focus on organic growth opportunities by working to increase our business with existing and new customers and growing our presence in the most prolific and attractive basin. We will pursue attractive acquisition opportunities to the extent they became available.

Yes, in our transaction last year demonstrated our approach to M&A identifying accretive deals that come with the strategic advantage and finance in a manner chose not to overly burden our balance sheet. As we evaluate opportunities, we will continue to be disciplined in our approach.

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

Jody Tusa

Thanks Eric and good morning everyone.

As Eric mentioned USA Compression reported higher revenue for the first quarter of 2014. Revenue in the first quarter of 2014 increased 54% compared to the first quarter of 2013 primarily driven by an increase in USACs contract operations revenues as a result of adding revenue generating horsepower.

Contract operations revenue in the first quarter of 2014 increased 55% to $49.3 million as compared to $31.9 million for the first quarter of 2013. The Q1 2014 over Q1 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.

Average revenue generating horsepower increased 37% to 1,094,677 in the first quarter of 2014 compared to 801,574 for the same period of the prior year primarily due to growth in our midstream compression assets along with the acquisition of the gas lift compression assets. Average revenue for revenue generating horsepower per month increased 13% to $15.30 for the first quarter of 2014 as compared to $13.59 for the first quarter of 2013, due to higher revenue for horsepower per month from the gas lift compression assets.

Adjusted EBITDA increased 44% to $25.2 million in the first quarter of 2014 as compared to $17.4 million for the first quarter of 2013. Adjusted distributable cash flow for the first quarter of 2014 was $16.8 million as compared to $11.6 million for the same period last year for an increase of 45%. Gross operating margin for the first quarter of 2014 increased 46% to $32.5 million as compared to $22.2 million for the same period last year.

The gross operating margin percentage decreased from 68% in the first quarter of 2013 to 64.7% in the first quarter of 2014. This 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 well as the timing of certain operating expenses which were mainly motor oil purchases in our midstream assets in the first quarter of 2014. We expect our gross operating margin to improve throughout the balance of 2014 as we add new large horsepower compression units to our fleet and this timing is normalized.

Maintenance CapEx was $5.3 million in the first quarter of 2014 versus $3.1 million in the first quarter of 2013. Our first quarter maintenance CapEx was at expect levels and we continue to expect to spend approximately $19 million in maintenance CapEx for 2014. Cash interest expense was $3 million compared with $2.6 million in the first quarter of last year. Expansion CapEx which was primarily used to purchase new compression units was $81.5 million for the first quarter of 2014 compared to $20.3 million in the first quarter of 2013.

On April 24, 2014, we announced a cash distribution of $0.49 per unit on our common and subordinated units, which represents a 2.1% increase over the fourth quarter of 2013 and 12.6% increase year-over-year. This is the fourth consecutive increase to our distribution since our IPO in January 2013. The first quarter distribution correspondence to an annualized distribution rate of $1.96 per unit. The distribution we paid on May 15, to unitholders of record as of the close of business on May 5th.

USA Compression Holdings LLC, the owner of 50.8% of the partnership's outstanding limited partnership units and Argonaut Private Equity, an affiliate of George B. Kaiser, together with other related investors who own approximately 19.4% of our outstanding limited partnership units have elected to reinvest all of the cash distributions they received on their units pursuant to our distribution reinvestment plan.

Adjusted distributable cash flow coverage for the first quarter of 2014 is 0.88x and adjusted cash coverage for the actual distributions to be paid as a result of USA Compression Holdings LLC and Argonaut Private Equity and other investors participating in our distribution reinvestment plan is 2.95x. Due to the high level of our growth capital expenditures in 2014, we are very pleased to report that Riverstone through its ownership in USA Compression Holdings LLC and Argonaut Private Equity owners of 69% together of the outstanding LP units have committed to receive distributions in the form of additional common units through the partnerships distribution reinvestment plan on any units owned as of each distribution day through the first quarter of 2015 in order to partially fund our continued deployment of growth capital.

I would now like to briefly comment on our credit facility and liquidity. As mentioned in our last earnings conference call on December 31, 2013, we entered into our 5th amended and restated credit agreement. This agreement provides for an increase in the facility capacity from 600 million to 850 million and the extension of the maturity to 2018. In addition, the revolving credit facility contains an according feature whereby it can be expanded to 950 million under certain conditions.

Outstanding borrowings under our revolving credit facility as of March 31, 2014 were $503.6 million, resulting in a forma leverage ratio of 5x on a trailing 3-month annualized basis. We continue to evaluate alternatives to improve our leverage including opportunities to access the capital markets to our previously adopted long-term targets. We are confirming our full year 2014 guidance range, we continue to expect full year EBITDA to be in the range of $109 million to $115 million and the distributable cash flow to be in the range of $75 million to $81 million. We also expect to trend towards the higher end of these ranges.

As Eric mentioned we have increased our growth capital expenditures by 25% for 2014 over our original expectations. However, due to deliveries of this equipment in the latter half of 2014, we would expect to see the full impact of this increased capital program in 2015.

Finally, we expect to file our Form 10-Q with the Securities and Exchange Commission this afternoon. With that operator, we will open the call to questions.

Question-and-Answer Session

Operator

(Operator Instructions) We will take our first question from T.J. Schultz with RBC Capital Markets. Your line is open.

Vimal Patel - RBC Capital Markets

Good morning, guys. This is Vimal filling in for TJ. I have a few questions for you.

Eric Long

Good morning, Vimal.

Vimal Patel - RBC Capital Markets

Good morning. The first question was the 300,000 of horsepower you are adding this year, is that level somewhat above – you would normally add to just given, that you are seeing to get some good opportunities this year, or I guess more effectively how should we think about horsepower additions going into 2015 and 2016?

Eric Long

Very good questions. This is Eric. We will look at that a couple of different ways. We've been pleasantly surprised this year with a level of demand from our customer partners, as you know we are in the early innings of the build out of the shale infrastructure. We see that this as some sustainability into the future. The one thing that we have been extremely pleased about is the financial discipline that we have been able to bring to the table.

This is not an opportunity where we are buying market share. We have actually been able to selectively high grade some of our opportunities. So I think if you go back to my commentary, demand for our goods and services is extremely high And we have been pleasantly surprised with what we have seen.

Jody Tusa

I will add to Eric's commentary that we are – obviously, we are not in a position to provide any type of guidance in the 2015 or 2016. But the demand that we are seeing this year, we would expect to continue strong demand as we get into 2015. We are looking at sizing up our purchase orders for new compression equipment for 2015 over the next two to four weeks. And so we are considering different alternatives in terms of the initial placement of new compression equipment for next year. But I can tell you that we are looking at a continuing strength in the demand for our services as we size up the order for next year.

Vimal Patel - RBC Capital Markets

That's helpful. Secondly, as far as the commitment from Riverstone and Argonaut deferred cash through 1Q 2015, can you provide some color on how those discussions went and specifically why that date was posted?

Jody Tusa

Well, we are consistent with what we have communicated in the past, the Riverstone and Argonaut parties like the growth prospects that they see in the business they certainly have enjoyed the appreciation of the unit price from the units that were adrift throughout 2013 and so far in 2014.

The level of confidence and prospects of growth is strong on their part. So as you know they can look after this period through the first quarter of 2015 to either extent the continuation of the drip or begin to take cash on those distributions those decisions have not been made and would be evaluated throughout the course of this year. But, they like the again, funding the partially the growth capital that we are deploying and that we are deploying at record levels. So they see as the management does, that it gives us an opportunity to delever a bit against all the growth CapEx that we are spending.

So we are very, very pleased to receive their support and report in connection with this release that they extended the continuation of taking units for their distributions.

Vimal Patel - RBC Capital Markets

Okay. The last one that we had was as far as station service application in the Mid-Con, you kind of highlighted that those are going to be – in terms of returns they are going to be a lot better than some of the other service that you provide. Can you extend on that opportunity and what portion of your 2014 CapEx is allocated to those types of applications.

Eric Long

When you look at the magnitude of our 2014 new unit CapEx $250 million, $265 million range. The station services will be a small component of that. We are talking something that's less than 10% or so. It could potentially be more and we have been awarded our second project we are looking at some additional opportunities.

But again, I don't think its one you look at. And look at a seismic shift away from what our current mix of business has been. I think its again an opportunity that has some growth opportunities for us. But its not something that will have that seismic shift where it would drive to be half our revenues or something like that.

Vimal Patel - RBC Capital Markets

All right. Great. Thanks. Congrats on the quarter. That's all I had. Thank you.

Eric Long

Thank you very much.

Jody Tusa

Thank you.

Operator

(Operator instructions) We will go next to Ned Baramov with Wells Fargo. Your line is open.

Ned Baramov - Wells Fargo

Good morning guys.

Eric Long

Ned how are you today?

Ned Baramov - Wells Fargo

Good, good yourself.

Eric Long

Never had a bad as a boss.

Ned Baramov - Wells Fargo

Very good. So I had a quick question on gross margins. So if you could maybe talk about your expectations for the margin improvement through the end of the year? Or maybe just to ask this a different way, where do you see gross margins exiting 2014?

Jody Tusa

I would expect as we go through the year and we are adding primarily these really large horsepower units that we would continue to see some level of improvement in gross margins over the exit rate from 2013. And so we do get as, as we mentioned earlier a little bit of margin dilution from the gas lift assets. But the mix of new compression equipment that we are adding again is primarily oriented towards the large horsepower units where we get better operating leverage.

And so along with the timing that we would expect to watch out from the incremental operating expenses in the first quarter. We would expect to see our margins trend more along the lines of the exit right out of 2013 and by the time we get to the end of 2014 perhaps some slight improvement over the exit rate out of 2013.

Ned Baramov - Wells Fargo

That's great. And I had another question on demand in dry gas regions, like the Haynesville. So given the improvement in the number of rigs that are going back to these regions based on improved gas prices, are you seeing any pickup in demand in dry gas regions?

Eric Long

Ned, good question. What we are seeing would be – let's go back maybe a year and a half to two years ago. We saw some retrenchment in the dry gas areas. We saw consolidation movement for larger central facilities. Some of our customers have a mix of company owned equipment and then an equipment where USA Compression provides a compression services. Because of the longer lead times involved, we are sourcing some of this big equipment when the slow down or the precipitous decline in gas commodity price back in spring two years ago, hit. We saw some slowdown on activity.

To your point, you are starting to see a tick-up in the rig count. And I think we are starting to see folks that have been able to lock-in some hedges for the back half of 2014 into 2015 and 2016 at prices where the returns are acceptable to these folks. I saw one of the – some commentary on a producer the other day. One of our customers where they are backing off on their dry gas activities in the Marcellus and the expectation is that they will kind of be redeploying some of that capital or allocating some of that capital back into the Fayetteville shale.

So I think its fair to say that with the record low storage levels that we are seeing some concerns about ability to replenish and refill storage this summer. That in certain select dry gas areas. There will be a pick up in activity our quote activity has started to increase in those areas. I think the rig count has started to increase in some of those areas. So I think its logical to assume that activity will probably follow.

Ned Baramov - Wells Fargo

That's great color. And then lastly from me, could you provide an update on the S&R operations, and whether these assets continue to track ahead of your initial expectations? Thanks.

Jody Tusa

Sure. And made the way we look at the business now is – if we look at business as a whole if you will so we -- where we fully integrated the business its running along side with all of our midstream assets as well. So the acquisition has been a very good for us. Very pleased that we move through the integration of very timely manner. The demand for the second half of this year for gas lift units they were adding are still aligned with expectations that we have for 2014, which did exceed our acquisition forecast if you will.

So we are very pleased that the utilization rates and service rates continue to remain very high and for the full year 2014, again, we were anticipating buying about 50,000 horsepower move gas lift units. And that did run ahead of the initial expectations that we have for this year.

Ned Baramov - Wells Fargo

Great. That's all I had. Thank you very much.

Jody Tusa

Okay.

Eric Long

Thank you.

Operator

(Operator Instructions) We have no further questions at this time. I would like to turn the call back to Eric Long for closing remarks.

Eric Long

Great. Thank you very much. While we had a good quarter, the prospects for the balance of 2014 remains strong and we appreciate the continued support of our investor group and we look forward to continuing to be good stewards of your capital. Thank you.

Operator

And this does conclude today's conference. You may disconnect at any time.

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