USA Compression Partners, LP (USAC) Q3 2021 Earnings Call Transcript

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USA Compression Partners, LP (USAC 0.72%)
Q3 2021 Earnings Call
Nov 2, 2021, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good morning. Welcome to USA Compression Partners, LP's Third Quarter 2021 Earnings Conference Call. [Operator Instructions]

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

Christopher W. Porter -- Vice President, General Counsel And Secretary

Good morning, everyone, and thank you for joining us. This morning, we released our financial results for the quarter ended September 30, 2021. 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 November 12, 2021. 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 of the management's views as of today, November 2, 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.

Eric D. Long -- President And Chief Executive Officer

Thank you, Chris. Good morning, everyone, and thanks for joining our call. Also with me is Matt Liuzzi, our CFO. This morning, we released our financial and operational results for the third quarter of 2021, reflecting another quarter of continued stability in our infrastructure-driven business model, with results that were, again, consistent with the prior quarter and in line with what we expected. Before Matt gets into the specifics of the quarter, I want to highlight some key facts and observations that help form the decision-making process of your management team. I think that you may actually find them enlightening. Simply put, considering the lack of regulatory clarity and uncertainty emanating from both the executive branch and Congress regarding major policy decisions, which may profoundly impact the energy industry tax structures in our domestic economy, USA Compression will continue to do what we have done in periods of uncertainty. We hunker down, we power through. We maintain a consistent course of action, providing exemplary levels of natural gas compression services to our long-term and strategic infrastructure-oriented customers. We intend to do the same for the balance of 2021 and throughout 2022.

Right now, there is a lot of discussion around the topics of ESG and energy transition. Both are important and are front and center here at USA Compression. For our investors, we believe that it is important to differentiate between the policy noise with all of the feel-good, wish-to-be-true prognostications of the future versus the realities of economics and technology. World leaders with varying degrees of commitment appear to be committed to achieving net 0 by the back half of this century. With the emerging energy crises in China and Europe, as well as the positions taken by China, India and Russia regarding their continued use of coal well into the middle of the century, this commitment appears to be wavering somewhat. What is coming to light is that, one, the energy transition will be one of the most capital-intensive and most complex undertakings in human history; two, multiple -- tens, if not hundreds of trillions of dollars will be spent pursuing these undertakings; and three, policy decisions which currently appear focused on constraining capital required for transitory hydrocarbon sources, meaning natural gas, are disconnected from the realities of today's growing energy needs and the ultimate achievement of net 0.

The bottom line, demand for energy of all types is up, supplies of conventional energy sources are down, and we know of no technology that exists at scale to backstop the intermittent nature of solar and wind supplies. Natural gas prices are surging around the world, part of an emerging global energy crisis spilling into the coal market, causing power prices to spike. While the Henry Hub front month natural gas price is in the upper $5 per MMBtu range, average spot prices for LNG in September were $25.45, a 40% increase on the prior month and more than four times the price from the year before. Prices have continued to rise in October of 2021 and traded at $34 per MMBtu. The utilization of U.S. LNG facilities continues to be high, and countries around the globe are building inventories in anticipation of tight supply this coming winter.

Dutch natural gas for December delivery touched $187 per MMBtu, with December LNG at Japan, Korea, currently $32.01 per MMBtu. The effects of these high natural gas prices include government intervention regarding electric power in Europe, to reduce cost to consumers, shuttering of manufacturing supplies in China and subsequent mandates to secure coal supplies "at all cost." So what is happening in the U.K.? Renewables, mostly wind, displace coal in power generation over the past decade, increasing reliance on natural gas or baseload electric power. Utility-scale battery storage is essentially nonexistent. Nuclear power is about 20% of generation capacity. 70% of the U.K.'s gas storage capacity was shuttered in 2017, with regulators expecting newly constructed renewables and natural gas imports to meet demand. With the combined reduction in gas storage and domestic gas production from the North Sea declining more than 65% since the year 2000, the U.K. became reliant on LNG imports.

Both Japan and Europe are also bidding on limited LNG supplies, resulting in U.K. power prices jumping four to 10 times historical norms. With the U.K. being colder than normal and experiencing lower-than-average wind speeds, renewables have been unable to meet electricity demand. Bottom line, demand for electricity is up at a time when the wind doesn't blow, the sun doesn't shine, available domestic gas supplies and storage are down, coal has been cut and no meaningful utility-level battery storage exists. So shifting gears to the oil side and the domestic drilling and supply side, here are some comments from sources ranging from the Economist to noted industry analyst to energy-focused private equity firms and others. The demonization of oil and gas is unprecedented in the history of the industry. This is leading to capital starvation, the exit of major oils with only 40% of cash flow being redeployed into supply replacement. OPEC+ has done an effective job of managing pricing. Further, signals suggest that OPEC+ will be out of excess capacity by mid-2022. This is unprecedented. Global upstream capital expenditures averaged $320 billion to $350 billion in 2020 and 2021.

This is 1/2 the levels of 2011 to 2014 and 25% short of what is needed to hold oil production steady at 100 million barrels a day, of which 2/3 is for transportation and 1/3 for industrial use. Over the past 18 months, the world has been undersupplied by two million barrels a day. Oil and storage is down over 950 million barrels since the peak in May of 2020 and now runs 200 million barrels below normal. DUC or drilled and uncompleted drawdown. It took three years to build an inventory of 3,300 DUCs and they have been wiped out in the last 12 months. The U.S. E&P sector is now completing 270 more wells than we are drilling on a monthly basis, which is unsustainable. In 2022, additional drilling capital will be needed to sustain production levels. By the end of 2030, the global electric vehicle fleet is expected to be lower than consensus penetration of 30% to 40%. Worldwide, we will need an additional seven million barrels per day to balance the market demand. And where is it going to come from? And finally, we have the regulatory uncertainty relating to the domestic oil and gas industry overall, implications regarding potential methane regulation and taxation, considerations from the myriad and ever-changing proposals emanating from various factions of the current Washington administration as well as the specter of a CO2 tax.

So what does all this mean for USA Compression as we head into 2022? It appears to us that as the world economies continue to open and regain strength, demand for energy in all forms and especially natural gas will continue to increase. It is also apparent that the supplies of oil and natural gas have declined due to underinvestment and that in the interim time frame, renewable sources of energy are insufficient to meet the overall needs for energy. We believe that over the next several years, domestically, we will see increasing, albeit measured drilling and completion activity for both oil and natural gas and that demand for our compression services will continue to increase in 2022 and beyond. We've mentioned before that USA Compression is developing the use of an exclusive proprietary technology developed by Energy Transfer, Dual Drive, as a potential cost-effective offering to allow our customers to switch from natural gas quickly and reliably to electricity as a fuel source. Dual Drive is effectively a hybrid compressor similar to a Toyota Prius, which has the potential to be an important breakthrough for our customers seeking to reduce their carbon dioxide and methane emissions.

Dual Drive will provide the reliability and redundancy of natural gas during what we believe will be a multi-decade transition period to expand the electric grid. We expect growing instability of the electric grid over the intermediate term, exacerbated by the specter of policy mandated reliance on renewables without access to cost-effective utility-scale storage. During 2022, we intend to continue the development of Dual Drive units across several horsepower ranges. One final note before I turn the call over to Matt to walk through our results of the third quarter. With this quarter's payment, we've now achieved 35 quarters of distributions, returning over $1.2 billion to unitholders since our IPO back in 2013. The stability of the business and strong cash flow generation has allowed us to power through the downturns and be positioned to take advantage of the upticks as we are starting to see out in the marketplace. We envision continued stability as we focus on working with our infrastructure-oriented customers in 2022.

Matt?

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Thanks, Eric, and good morning, everybody. Today, USA Compression reported third quarter results, including quarterly revenue of $159 million, adjusted EBITDA of $100 million and DCF to limited partners of $52 million, all of which were consistent with last quarter. Of total revenues of $159 million, approximately $156 million reflected our core contract operations revenues, while parts and service revenue contributed roughly $3 million. Last quarter, Eric mentioned that we have been seeing firming demand signals from our customers with increased quote and contracting activity which had allowed us to push through some rate increases. Pricing continued to increase in the third quarter to $16.62 per horsepower per month, up from $16.55 in the previous quarter.

This reflects the impact of contractual price escalators and the tight supply/demand, especially for the largest horsepower classes. Our adjusted gross margin as a percentage of revenue was 69% in the third quarter consistent with USA Compression's historical levels. We achieved adjusted EBITDA for the third quarter of approximately $100 million, flat to the second quarter. Adjusted EBITDA margin of 62.8% was again consistent with our historical averages. DCF to limited partners of $52 million, also consistent with last quarter. Our total fleet horsepower at the end of the quarter, approximately 3.7 million horsepower was flat with the second quarter. While average utilization throughout the third quarter was essentially flat with the second quarter at 82.3%, you'll note that the period-end utilization has ticked up to 83%, reflecting a positive trend of horsepower deployment as the quarter came to a close.

We continue to exercise caution on capital spending throughout the third quarter with total expansion capital of $14 million. consisting primarily of reconfigurations of idle units and maintenance capital of $5 million, consistent with our expectations. We do not have any units on order for delivery in the remainder of 2022. We continue to evaluate the market demand for 2022, while we expect some moderate amount of new unit orders, we expect the majority of our capital will be focused on redeployment of existing idle units, with nominal capital required to deploy that horsepower. Net income for the quarter was $4 million and operating income was $37 million. Net cash provided by operating activities was $45 million in the quarter.

And lastly, cash interest expense net was $30 million. Based on the third quarter's results, the Board decided to keep the distribution consistent at $0.525 per unit, which resulted in a distributable cash flow coverage ratio of 1.02 times consistent with year-to-date levels. Our bank covenant leverage ratio was 4.96 times flat from the previous quarter. Consistent with prior quarters, our Board of Directors determines the quarterly distribution on a quarterly basis, and the Board can opt to maintain, reduce or suspend the distribution as it deems most appropriate. As for our previously communicated guidance for 2021, which was included in this morning's earnings release, we have narrowed the ranges while keeping the adjusted EBITDA midpoint where it was and slightly increasing the distributable cash flow midpoint. We expect to file our Form 10-Q with the SEC as early as this afternoon.

So to summarize, this quarter was the third quarter in a row of very stable earnings and we see improving fundamentals developing over the next few quarters. We've continued to manage what is in our control, achieving attractive operating margins, and we have managed our capital spending appropriately. We like our position as a leader in large horsepower, multiunit centralized compressor stations and expect that our services will be in demand as things pick up as we move into 2022.

With that, we'll open the call to questions.

Questions and Answers:

Operator

[Operator Instructions] Our first question comes from Brian Reynolds with UBS.

Brian Reynolds -- UBS -- Analyst

Hi. Good morning everyone. Maybe to start off on '21 EBITDA guidance. It seems like the recovery this time around in compression is a little bit slower than in previous cycles. And I was curious if you could provide some color on what is different this time, just given that Mac gas production has remained resilient. Just curious if you could also provide some initial color around like how much of it is around customer optimization and rationalization of compression units? And how we should view '22 compression demand going forward?

Eric D. Long -- President And Chief Executive Officer

This is Eric. I think consistent with our commentary -- we're seeing a lot of discipline from the E&Ps. The major oils have slashed their capex budgets whereas historically, when you saw oil prices in the mid-80s and natural gas prices in the mid-5s, they're hitting the gas and matched the accelerator. We do see some of the private -- larger private players accelerating some of their developmental activity. And I think the other thing you've got are some hedges that are rolling off from 2021 into 2022. If you recall, the Pioneer guys, the other day announced over a $900 million hedge loss for the quarter. So on the one hand, high commodity prices would suggest that there's this massive free cash flow, a lot of that cash flow is going to the counterparties of the E&Ps have entered into these hedges.

So -- what we're hearing from our client customers are: one, there will be continued discipline in the industry moderated by the investor focus on improving balance sheets from the E&P guys. So I think they're listening to the financial investor community. Second, the roll-off of hedges, which then will kind of start to push on some additional activity, the drilling and development of the DUCs, which are going to be nonexistent. So if you want to maintain production is going to require kind of an increase in drilling and developmental capital. And we're hearing from our producers that activity in 2022 will maintain production either flat to slightly up. As we all know, when production is stable, pressures go down, you need an exponential increase in compression horsepower. So I think all of this is weaving together historically, compression is a four- to six-quarter lagging indicator. We're now five or six quarters into that, and demand signals coming into 2022 are significantly stronger than what we heard for 2021.

Brian Reynolds -- UBS -- Analyst

Great. Appreciate all the color. As a quick follow-up, just given recent tax proposals around the MLP tax structure. Just curious if you had any comments around how you USAC ultimately views its current status today and maybe down in the future.

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Yes. Brian, it's Matt. I think that MLP that -- I forget what it's called, but basically treating them as corporations, that provision tends to get put in every single budget if you look back many, many years. And so I think there is a lot of -- there seems to be a lot of support for a broader definition of what MLPs can be in terms of including some of the renewables and kind of transition-type companies in the MLP structure. And so I think if that happens, that's obviously a positive for kind of the overall tax structure of being able to remain an MLP. But in terms of what we do, what we want to do, what we will do. We can't really say anything about that.

Brian Reynolds -- UBS -- Analyst

Great. Fair enough. I appreciate the caller. Have a great day.

Operator

Our next question comes from Vinay Chitteti with JPMorgan.

Vinay Chitteti -- JPMorgan -- Analyst

Hi, good morning guys. I just wanted to talk about the demand signals you mentioned earlier and tightness in the large horsepower market. I mean if you think about the pricing, it kind of is already at the historical highs, especially what we saw last quarter -- or last cycle. Can you give any updated thoughts on what operating leverage does USAC hold to current market conditions? And if you do see any upside to the pricing from where we are today?

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Yes, Vinay. It's Matt. Why don't I start. I think in terms of -- yes, on the larger horsepower side, we mentioned that things are tight. And when we're talking about that, we're really focused 2,500 horsepower and above kind of the really, really big stuff. Part of what we're going to be evaluating for next year is we've got idle equipment. As we show in every Q that we file, a lot of that stuff did come home last year. Well, one of our primary focuses is going to be able to put that out next year. And so we'll be able to use a lot of equipment that we've already bought and paid for that's sitting at the business right now. We'll use that to fund customer demands, et cetera.

And so I think that's the plan in terms of horsepower utilization and there is -- obviously, that is upside because that is equipment, that is -- that we own right now and getting that stuff out, to your point about operational leverage, that 70% gross margin equipment if and when we can get it out. So that will obviously be a big part next year. I think to Eric's commentary earlier, there's still some uncertainty that's floating around the industry and floating around with customers. And so I think everyone is hopeful that we get some resolution on some of those items here as we get toward the end of the year. But I think even regards -- the industry is figuring out solutions to problems. And one of the problems that I think everyone sees is there is a huge demand for gas and how are you going to get that gas out of the ground into customers. And so I think even with some uncertainty, you're going to see customers reacting and taking economical actions, and we think that's going to translate into more demand pressure going into next year.

Vinay Chitteti -- JPMorgan -- Analyst

Got it. Can you just give us a glimpse of how the cycle production outlook is in the different basins. I mean who is driving kind of the activity? I mean, you do talk about a lot of activity increase in the next year, but it's the majors E&P customers have been pretty muted in their call commentaries. So just want to understand where do you expect that activity to pick up coming from? Is it -- are you exposed more to the privates, do you expect to see some upside there? Or do you actually expect some majors to increase the activity?

Eric D. Long -- President And Chief Executive Officer

Yes, I think we're going to see continued activity by some of the large privates. The commentary we're hearing from several of the majors is that we can expect tick up in drilling and completion activity. We see a pick up in the Delaware, we see continued pickup in the Eagle Ford Shale. We see continued pickup in activity over in the Haynesville Shale. I would say kind of moderating to flat to slight tick up in the Mid-Continent areas, the SCOOP/STACK merge, a little bit of tick up in the Rockies. And then Appalachia, we're seeing a fairly significant tick up in what we think will be 2022 activity. So it's -- I'd say we're not offshore in any material way. We're not up in the Bakken. Can't really address those. So I think generically, we're seeing tick up across all basins with probably greatest amount of activity would be Permian Delaware, Eagle Ford, Haynesville and Appalachia.

Vinay Chitteti -- JPMorgan -- Analyst

Got it, got it. Thank you thats welcome.

Operator

[Operator Instructions] Our next question comes from Selman Akyol with Stifel.

Selman Akyol -- Stifel -- Analyst

Thank you. Good morning. You guys alluded to in your comments, contractual price escalators. I was wondering if you could just maybe discuss how much of -- if we think in terms of your EBITDA, is covered by that?

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Selman, it's Matt. I don't have it right at hand, but maybe just to give you some color on how those work. Basically, all of our contracts have in them, contractually, the ability to raise the rates basically on an annual basis according to a CPI index amount. And so what we've done, obviously, CPI is pick your month. I mean we have contracts that are coming up for sort of an annual renewal, if you will, or an annual CPI renewal every month. And so every month, we're out sending out notices and raising those rates. So that's a -- depending on which month it happens to be, over the last nine, ten months, it's been anywhere from 1% to 5% or more depending on the month.

So we just -- those add in, we just kind of layer those in. But again, on the fleet, you've got 70% of the fleet that's under long contracts. I think what's important is those rate escalators allow us -- that's what's helped us maintain the margins, right? And so as you're seeing, if diesel oil, lube oil costs like that are going up, we're able to basically maintain those margins through using those CPI escalators, which is kind of the whole point. So it's not -- I wouldn't say -- I would be guessing, but it's not a significant part of the EBITDA, but it obviously helps in those margins.

Selman Akyol -- Stifel -- Analyst

Understood. And I appreciate that. And then just going through the quarter, it looked like you had really very good control over SG&A this quarter. And I was wondering, was there anything in particular that hit those numbers?

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

No. No, nothing. I mean, it will -- I mean, there's really nothing in particular this quarter versus others. We've obviously just continued to watch, like I said, everything we kind of control. And we've not added even as things have started to kind of tick up a little bit, we maintain those costs as best we can.

Eric D. Long -- President And Chief Executive Officer

Yes, Selman. This is Eric. And I think one thing we pride at ourselves at USA is that we've built scalable systems over time. And I would think that if you look at our corporate G&A, you look at the number of people that we have, the number of folks that we employ. We're significantly leaner than some of our other peers, private and public alike. So our approach to business has been, let's don't slash and burn in a downturn and set aside various programs, let's cut a 401(k) match or let's not take -- take salary cuts or things that are these onetime things that then when the business recovers, then all of a sudden, you layer on additional expenses again.

So we've built the company to be sustainable through peaks and valleys. Where we run a very mean and lean organization with scalable systems. And I think it's proven itself when you look at our financial results, as you pointed out, we didn't see a lot of bloating, and we didn't see a lot of cutting on the downturn. So it's -- again, it's much more stable and probably a much more efficiently run organization than some folks.

Selman Akyol -- Stifel -- Analyst

Got it. I appreciate that. And then just sort of last one from me. And I know next year, you're going to be using primarily idle equipment. But if we just sort of think about all the bottlenecks we're hearing on the industrial side, if you had to go out and get stuff, is there anything out there that's particularly tight for you that you just can't see whether it be large engines? Or is there anything out there that's just in big short supply that would cause you guys a huge bottleneck if you needed to maybe move more aggressively in terms of scaling up?

Eric D. Long -- President And Chief Executive Officer

Yes, good question. We've got a time with our major manufacturer, Caterpillar and then the folks at Ariel who manufacture the compressor side and some component manufacturers with coolers and electronic control devices, et cetera. Is this kind of worldwide global supply chain bottlenecks continue to pick up we have worked proactively to address some of these things. So we're making sure that we've doubled down on available inventory, spare components. So you think turbochargers or oil filters or spark plugs or compressor valves, whatever the major components are that we need to run and support our day-to-day operations.

We've been very aggressive in making sure that we have access to components. What we're hearing from our major manufacturers is that because of supply constraints and bottlenecks and limitations that they are indeed having some limitations on their ability to ramp up manufacturing of engines across all horsepower ranges. So we're seeing lengthening of lead times with -- have appeared to us to be fairly small order placement. So if you were to -- if the question was, hey, it looks like the cycle is a little bit different this time. Things have been somewhat muted. If you go back kind of post 2008 into 2010, you go back after the crude oil collapse of 2014 and saw kind of '16 and '17, there was a dramatic ramp-up on activity and manufacturers have the capacity to ramp-up.

This time, because of those supply chain bottlenecks, they don't have the ability to ramp-up significantly in -- this is horsepower and needs for USA or some of our peers as well. So we think this will give us a competitive advantage coming into 2022 because we've got a -- we have purposely not dump equipment on the marketplace, taking a dive on pricing, knowing what we saw coming, which was demand is going to be up, supplies are going to be down. You're going to have to suck supplies harder to be able to move the same volumes of gas, the exponential increase in compression horsepower. So we've got equipment. Some of our peers don't have equipment, and with the supply bottlenecks, we think that bodes very well for our ability to penetrate the market to maintain and improve upon pricing and be positioned extremely well for 2022 and on into 2023 as well.

Selman Akyol -- Stifel -- Analyst

Alright. Thank you very much.

Operator

Our next question comes from Ned Baramov with Wells Fargo.

Ned Baramov -- Wells Fargo -- Analyst

Good morning. Thanks for taking the question. Could you provide more details on the amount of capital you think you would need for a reconfiguration of idle equipment in 2022? And then also building on the previous question, what are the lead times on new orders these days?

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Yes, Ned, the second question is probably the easier one. I think we're probably in the four- to six-month range, and so you're talking about if you were to put in an order now, you're talking about kind of early spring, April, May, that kind of time frame. So that's in terms of kind of the big horsepower stuff. Again, like Eric said, we're looking at redeploying a lot of that idle horsepower. Right now, I don't have a capital number for you. What we will do as we kind of plan out, we always give the annual guidance in February. So we'll have more color for you and more kind of granular details for you at that point.

Ned Baramov -- Wells Fargo -- Analyst

Thanks. Thats all I had.

Operator

That concludes today's answer -- question-and-answer session. At this time, I'll turn the call back over to Mr. Eric Long for closing remarks.

Eric D. Long -- President And Chief Executive Officer

Thank you very much. The third quarter reflected another quarter of stable cash flow generation by our core compression services businesses. We were pleased to see both utilization and pricing tick up as we move throughout the quarter and believe that bodes well for the remainder of 2021 and on into 2022. Natural gas prices have moved to recent record highs, and the outlook for production is positive, both of which we expect to drive the demand for compression and for our business. The fundamentals of our business remain the same, driven by the demand for natural gas, which we see increasing in the U.S. and throughout the world.

We believe that the underlying stability of our large horsepower infrastructure-focused contract compression services business model has served our unitholders well over the last 18 months and for the nearly 25 years with business. We have a great asset base from which to be involved in the longer-term transition to cleaner energy in which natural gas will clearly play an important part. Thanks for joining us, and please be safe. We look forward to speaking with everyone on our next call.

Operator

[Operator Closing Remarks]

Duration: 36 minutes

Call participants:

Christopher W. Porter -- Vice President, General Counsel And Secretary

Eric D. Long -- President And Chief Executive Officer

Matthew C. Liuzzi -- Vice President, Chief Financial Officer And Treasurer

Brian Reynolds -- UBS -- Analyst

Vinay Chitteti -- JPMorgan -- Analyst

Selman Akyol -- Stifel -- Analyst

Ned Baramov -- Wells Fargo -- Analyst

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