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Edited Transcript of USAC earnings conference call or presentation 6-Nov-18 4:00pm GMT

Q3 2018 USA Compression Partners LP Earnings Call

Austin Dec 4, 2018 (Thomson StreetEvents) -- Edited Transcript of USA Compression Partners LP earnings conference call or presentation Tuesday, November 6, 2018 at 4:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher W. Porter

USA Compression Partners, LLC - General Counsel, VP and Secretary

* Eric D. Long

USA Compression Partners, LLC - CEO and President

* Matthew C. Liuzzi

USA Compression Partners, LLC - CFO, VP and Treasurer

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Conference Call Participants

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* Barrett Auten Blaschke

MUFG Securities Americas Inc., Research Division - Senior Analyst

* Charles W Barber

JP Morgan Chase & Co, Research Division - Analyst

* Michael Christopher Gyure

Janney Montgomery Scott LLC - Former Analyst

* Shneur Z. Gershuni

UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst

* Torrey Joseph Schultz

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, and welcome to the USA Compression Partners, LP's Third Quarter 2018 Earnings Conference Call. (Operator Instructions) This conference is being recorded today, November 6, 2018.

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

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Christopher W. Porter, USA Compression Partners, LLC - General Counsel, VP and Secretary [2]

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Good morning, everyone, and thank you for joining us. This morning, we released our financial results for the quarter ended September 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 November 16, 2018.

During this call, our management will discuss certain non-GAAP measures. You will find definition and reconciliation 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 view, as of today, November 6, 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.

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Eric D. Long, USA Compression Partners, LLC - CEO and President [3]

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

This morning, we released our financial and operational results for the third quarter of 2018.

The overall market for compression services remains very strong, driven by solid natural gas fundamentals and the continuing midstream infrastructure build out, which is not just combined to 1 region, but rather is taking place across the country in areas which we operate. We continue to take advantage of the strong market to push through rate increases, while prudently investing capital in the business. Our utilization metrics demonstrate the current strength of the market, and we expect continued strength throughout 2019, based on the current visibility for compression services demand.

This is the second full quarter we've owned the CDM assets. We are extremely pleased with the substantial progress we made on integrating the CDM business, while continuing to manage our day-to-day base business and drive top line revenue growth in a strong market environment.

We have already identified our -- in our various stages of implementing on a bunch of opportunities. Low-hanging-fruit, so to speak, involving synergies that are lining up to be even better than we expected.

As we've discussed previously, the integration of these 2 businesses is a significant undertaking. While we experienced some expected integration noise that impacted the third quarter results, this was temporary in nature and we don't expect it going forward. One example that Matt will touch on in more depth later, was the impact of the accounting treatment for the CDM acquisition. Since it was treated as a reverse merger, USA Compression's reported first quarter financials, now reflect the historical first quarter for CDM resources, instead of USAC, which reduced adjusted EBITDA by almost $10 million.

Even with this impact, you'll note our 2018 adjusted EBITDA guidance is essentially unchanged. So as you can see, we continue to be bullish on the ongoing prospects for the business and our leading position in the marketplace.

We continue to believe that the large horsepower strategy is well-positioned to benefit from the broader macro trends in the energy sector. Our focus on that part of the market along with the full integration of the newly acquired CDM assets and people will prove to be a strong combination that we believe will continue to differentiate USA Compression from our peers.

We believe, our size, scale, geographic footprint, quality and young age of our fleet assets and enviable customer mix is a winning combination for the future.

So a little more on the integration. We continue to make great progress on the integration of the 2 very similar, yet different businesses into 1 cohesive machine. Since closing, we've been operating the business as a single entity in the marketplace, but behind the scene, we've been doing all the grinding, blocking and tackling associated with an acquisition of this sort.

As of early November, we have now migrated substantially, all customer, contract and asset data in the USA Compression systems, providing us the ability to manage the fleet as a single entity. The finance and accounting functions have all been integrated in the USA Compression scalable operational and financial platforms, with granularity down to the discrete asset level. This is a big deal. When you consider the many thousands of individual assets of the combined fleet and what could have been a daunting task, this extensive conversion process went according to plan on time and on budget.

One of the most beneficial aspects of this is that substantially, all of our 900 plus employees across the country are now accessing and working from the same systems.

This improves efficiency, communication and reporting, reduces redundant inventory and working capital, and helps us to monitor, evaluate and manage the business as a combined entity.

At this point of the year, we are on track to achieve the initial targeted synergies we indicated to you. As planned, and as we finalized the back office transition, we will see the impact of additional synergies kick in at the beginning of 2019.

As I mentioned earlier, we have some negative cost items directly related to the integration that impacted our margins in the quarter.

For example, we had a higher than normal number of legacy CDM field service technicians up to the part post-closing.

In the interim, we used outside parties to perform routine maintenance on some of our units. These third parties were considerably more expensive than using internal personnel. With the strong energy market we've been experiencing, it took a while to fill those spots with the USAC caliber technicians. We have now remediated that situation. And frankly, we were able to improve the area employee talent pool.

We also continued to monitor and make changes of various regions cost structures, particularly with regards to labor and duplicative inventory as well as begin to instill the USAC commercial approach to revenue generation. We are applying the same historical USA Compression discipline across the combined company, and quite frankly, this takes some time to implement. We are already seeing results, and are confident that we will successfully make the necessary adjustments and manage the business consistent with the way USA Compression has done in the past.

Now to the quarterly results. In the third quarter, the strong business environment for our compression services continued. We had average utilization during the quarter of 92.8% compared to Q2 average utilization of 91.5%. We have been able to redeploy a lot of the legacy CDM assets out to our customers, and that has helped drive the utilization metric higher. As we stand here today, we are effectively sold out of the larger horsepower assets. We have new units being delivered through the end of the year and well into 2019, but those contracts are by and large already committed to customers under long-term contracts.

Our utilization speaks to the dynamics of the marketplace. The market for large horsepower equipment has remained very tight, as we've experienced throughout the entire year.

Demand continues to be especially strong for the very largest horsepower categories in which USA Compression specializes. As we will discuss, this is where our focus and capital spending has been and will continue to be, our large horsepower infrastructure based equipment.

On the operation side, our total fleet horsepower at period end was over 3.6 million horsepower, an increase of over 53,000 horsepower over Q2. Active horsepower at the period end increased 61,000 to over 3.2 million horsepower, an increase of about 2% over Q2 2018. One interesting tidbit regarding the combined CDM USAC idle fleet. Since the trough of the cycle, we have redeployed approximately 350,000 horsepower from the combined idle fleets at nominal additional CapEx cost. We view this as a low-cost alternative to pricy acquisitions, and the end result is that the expansion of our active fleet from idle over the past several years is comparable to the entire fleet size of all, but a few of the largest in the industry at a far lower cost, creating value for our unitholders.

Like in previous quarters, most of our truly idle horsepower consists now of the predominantly smaller horsepower. While those (inaudible) in this segment of the market is; one, less predictable than large horsepower infrastructure applications; two, prone the swings in demand; and three, has more utilization sensitivity tied to commodity prices, we are seeing increasing demand for smaller horsepower, gas lift oriented units.

The stability and overall strength in crude oil has benefited this part of our business.

Pricing continued to tick upwards during the third quarter, reflecting the market dynamics for new delivery units as well as our efforts at selectively raising service rates on equipment out on the field.

Average monthly revenue was $16.17 per horsepower for Q3, which was an increase of about 2.5% over the second quarter. Keep in mind that this metric reflects the blended rate we are receiving across the entire USA Compression fleet. The upward movement is due in part to our efforts to raise prices on units currently on a month-to-month contract basis.

We believe, we still have room to enhance prices in certain areas and for certain equipment types, and that will continue to happen over time.

Midstream infrastructure activity levels and the tight supply demand dynamics for both new and used large horsepower equipment are positive for both, utilization and pricing in the contract compression sector.

I'd like to address the topic of capital allocation for USA Compression, as there is much discussion by investors relating to living within your means in the energy sector.

Now that USA Compression has doubled our fleet, a fleet that is both one of the youngest in the industry and largest average horsepower, part of our job is to maximize the financial returns on this premium pool of assets. We continue to work through the active CDM legacy fleet, and believe there is additional horsepower that we can redeploy to provide for more efficient operations and improved monthly service fees. While this will take some time to implement, this type of opportunity, low-hanging-fruit, as we like to call it, can provide revenue, adjusted EBITDA and DCF improvements at nominal costs to us.

This will be a major part of our focus during 2019.

In addition, we plan to continue to selectively add growth CapEx. Our limited expansion capital is focused on only the very largest of horsepower, with select key long-term customers under longer-term contracts that generate attractive returns to USA Compression.

In Q3, our growth capital was approximately $73 million, consisting primarily of large horsepower units. During the quarter, we took delivery of approximately 60,000 total horsepower. For the remainder of 2018, we have scheduled about 38 horsepower for delivery, consisting of substantially all large horsepower units, which have already been fully committed to customers under long-term contracts, generating attractive financial returns for USA Compression.

As of September 30, we had commitments for the delivery of 120,000 horsepower, of the largest horsepower class during 2019. Given the lead times for new equipment, we went ahead and placed orders with our packagers, so that we would have units available for select key customers well into the back half of 2019.

Lead times for the large horsepower equipment, while they have improved slightly, are still right around a year. This has kept the supply-demand dynamics largely unchanged, as it has been the case for the entire year. We don't see this changing meaningfully for the foreseeable future, and so we took actions to make sure we're prepared for next year.

The third quarter financial performance reflected continued strong top line revenue performance, as USA Compression reported increased active horsepower, improved pricing and revenue growth. Adjusted EBITDA of $90.1 million was impacted by an increase of approximately $2.6 million in third-party labor compared to the second quarter, which as we mentioned, was transitory in nature, and we do not expect to be significant in the future.

In addition, at the end of the quarter, we made some changes to the cost structure in certain operating areas that impacted the quarter by about $0.5 million. Likewise, overall gross operating margin of 62% and adjusted EBITDA margin of 53% were also impacted by the same onetime type items. As I mentioned, fully integrating the assets and people, and USA Compression culture takes time. And we are well on our way to completing it successfully.

Ultimately, we believe, we will drive the legacy CDM business to margins more in line with USA's past performance.

The quarterly results led to bank covenant leverage of 4.9x, up slightly from the second quarter and a distributable cash flow coverage ratio of 1.01x.

Now turning to the market and some of the demand drivers. We continue to work to optimize our assets and pricing across our geographically diverse operating footprint, taking into account region-specific activity levels, market dynamics and future outlooks. Not all regions are experiencing the same market trends. Each has its own set of drivers and long-term benefits. The Permian and Delaware basins, and the SCOOP/STACK merge plays have recently seen the highest activity levels, driven by increased levels of associated gas production, while the Marcellus and Utica shales in the Northeast are continuing their steady levels of growth, especially as more takeaway capacity comes online.

South Texas in the Eagle Ford shale, which has historically experienced cyclical periods of activity, has become more active again due in part to the availability of takeaway capacity, proximity to markets and better basis differentials than other bottleneck regions. In the Rockies, we see pockets of activity where operators are expanding their activity. With the Colorado election today that has investors focused on Initiative 97, the 2,500 foot setback requirement and Initiative 112, which has compensation for property devaluation, we've been asked about the possible impact on USA's business in the state of Colorado.

First, it is important to remember that very few of our assets are located there, less than 5%. And regardless of what happens today, those assets will still be required by our customers, as existing production will be grandfathered. And unlike a buried pipeline, our compression assets are skid mounted, enable to be picked up and relocated, with that cost pay for by USA's customers. So unlike EMPs, our midstream players in Colorado, we are not concerned about the election outcome, as it regards our business.

The final area of operations for us, Louisiana, is also gaining more interest by producers, also due to favorable location and pipeline and export access. So while each region is different, you'll note that they all have some attractive qualities, the market dynamics, which we believe, will help drive not only our stability but our growth over time.

The big 4 demand drivers, LNG exports, petrochemical feedstock demand, clean-burning domestic power generation and exports to Mexico, continue to move in a positive direction for our business, and all indications are, they should continue. As we like to point out, more gas moving around the country requires more gas infrastructure and increased demand for compression. Large horsepowers continue to be in high demand. And as our customers begin finalizing their plans for 2019, we are seeing strong indications of demand for those units which we have on order. With growth on the top line, we will continue to ring out cost from the organization with the goal to, once again, return to higher margins.

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

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [4]

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Thanks, Eric, and good morning, everyone. Today, USA Compression reported third quarter results, just a quick reminder, as individuals review our financial statement, because of the accounting treatment for the CDM acquisition as a reverse merger, USA Compression's financials now reflect the historical first quarter of CDM resources. As an example, the 9 months financial and operational data included in our earnings release and 10-Q, reflects the first quarter of CDM and the second and third quarters of the combined business.

The updated guidance we are providing today reflects the inclusion of CDM's first quarter results, which were approximately $10 million lower on an adjusted EBITDA basis than the USA Compression standalone results for that same quarter.

Turning to the results. The third quarter achieved revenue of $169 million, adjusted EBITDA of $90.1 million and DCF to limited partners of $47.5 million.

In October, we announced a cash distribution to our unitholders of $0.525 per common unit consistent with the previous quarter, which resulted in coverage of 1.01x.

Our total fleet horsepower, as of the end of Q3, was over 3.6 million horsepower. Our revenue generating horsepower at period end was approximately 3.2 million horsepower. On a net basis, we added over 61,000 of active horsepower to the fleet during the quarter.

Our average horsepower utilization for the third quarter was 92.8%. Pricing, as measured by average revenue, per revenue generating horsepower per month was $15.17 for the quarter. We continue to benefit from attractive pricing on new unit deliveries as well as selective price increases on the existing fleet.

Total revenue for the third quarter was $169 million, of which approximately $163 million reflected our core contract operations revenues, an increase of about $3.1 million over Q2. Parts and service revenue was down around $1 million from Q2.

Gross operating margin, as a percentage of revenue was 62% in the third quarter. Net loss for the quarter was $563,000. Net cash provided by operating activities was $38.8 million in the quarter and operating income was $23.9 million for the quarter. Maintenance capital totaled $6.4 million in the quarter and cash interest expense net was $23.9 million.

We currently expect 2018 adjusted EBITDA of between $310 million and $320 million, and DCF between $170 million and $180 million. In addition, we expect a net loss of between $8 million and $18 million.

Last, we expect to file our Form 10-Q with the SEC as early as this afternoon. And with that, we'll open the call to questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Shneur Gershuni, UBS.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [2]

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I just wanted to start off on the kind of, the pricing cycle that we're in right now. We've seen a tremendous increase in rigs over the last couple of years. Obviously, more wells have been drilled, starting to decline and so forth. In -- kind of my thought process would be that, this should sort of the sweet spot of the pricing cycle for USA Compression. What kind of trends are you seeing? I mean, I do recognize that you did talk about the ability to see a higher prices. But shouldn't we see, sort of, exponential type of increases at this point of the cycle?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [3]

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Shneur, this is Eric. Exponential, kind of, takes 3x and 4x price increases, and that's not the nature of our business. What we do see is pricing increasing in excess of typical rates of inflation. What we look at is, over a longer-term cycle peak to trough, assets and trough of cycle returns for newly deployed capital would tend to be in the low to mid-single digits, which is why guys like us don't build any new assets in a downturn. And when you look at peak of cycle, which we're not quite at peak of cycle yet, we see things that are in the upper teens to low 20s on levered returns.

So I think what we're looking to do is to take assets that we have as part of our fleet, particularly the legacy CDM assets, that were deployed 2, 3, 4, 5 years ago at rates that are significantly below the current spot rates, and redeploy them and drive our average price book across the overall fleet, up significantly where it is today. When we look at the spot pricing on the new units that we'll deploy, 120-some odd thousand horsepower for next year, these are extremely attractive new unit economics, effectively 5-year or less cash-on-cash type of payouts, low 20s IRR on an unlevered type of basis. So hopefully, that gives you a little bit of feel and color and flavor of, kind of, how we're looking at the market.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [4]

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No, it definitely gives me a flavor. Just wondering if we can unpack it a little bit more. I would assume that, kind of, this dealing is kind of a rent versus own type of process from your customers perspective and that's why there -- it should be somewhat of a limiting factor. How much capacity is it out there for someone to go and buy assets at this point right now? Or new build assets? Is that a limiting factor at all also? I was just wondering if you can sort of talk about that dynamic.

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Eric D. Long, USA Compression Partners, LLC - CEO and President [5]

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Yes, multiple limiting factors. First, access to building new units. It's -- if XYZ energy company or XYZ midstream company wants to acquire something today, it's a year lead time to source that equipment today. There is significant bottlenecks in the manufacturing supply chain. There's not a lot of these types of assets that exist, and I think in addition to having asset bottlenecks, you've got people limitations and you've got capital limitations. You've got E&P companies that are under the scrutiny of living within their capital means, living within free cash flow. And I think compression -- the wave towards continuing to outsource is actually trending to accelerate. So I think you're actually in a very unique time right now that you've got limitations on access to capital, you've got limitations on access to people and you have limitations on access to new equipment. So all of those 3 things together can provide for a perfect storm, which we think, plays well to our strength of large horsepower infrastructure equipment and will allow us to reprice our book upward over time.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [6]

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Okay. Fair enough. Just moving on 2 more questions. Just with respect to costs or cost of sales, I should say, is that a function of the accounting convention you were talking about in your prepared remarks? Or is there is some underlying trend that we need to be thinking about?

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [7]

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Yes. Shneur, it's Matt. When you're looking at third quarter specifically, I think in terms of the margins, what it really reflected this quarter was really two things, and I think Eric touched on both, but; one, we had some temporary issues where we had to higher some third-party services. We had lost a handful of our people, or people that we had acquired as part of the CDM acquisition and needed to basically outsource a bunch of maintenance services that normally we would do internally. And so that drove up -- that was a couple of millions more than we would have normally spent for instance, back in the second quarter or even last year. So that was a temporary phenomenon if you will.

I think if you were to add -- kind of normalize that line item, you're probably picking up a couple percentage points overall on margin. And then the other item that Eric also touched on, was the operating cost structure. And really, we just -- as we've kind of gotten into this and gotten our arms around every single region and that we're operating in, some regions just had a little bit too much cost in it, if you will. So we've remedied that during the quarter, and so I think going forward that was about the $0.5 million impact that Eric mentioned. So going forward, that $0.5 million should no longer be in there as well. So we think it's really those 2 items, and then the other item, which is a, when you think about where USA was historically versus the combined business now, again, it's this retail service line, kind of, on the revenue side. And again, that is a business where we take care of, or we'll perform maintenance work on customer owned items, and that is a lower margin business. We do that really as a courtesy to customers.

The CDM legacy business had a bit more of that activity in it than we as USA standalone did. So as we're combining that and kind of working through that, you're seeing a little bit of impact from that. But if you were to strip out just solely the retail, you're probably adding another 2 -- 2 to 3 percentage points on margin as well.

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Shneur Z. Gershuni, UBS Investment Bank, Research Division - Executive Director in the Energy Group and Analyst [8]

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Great. And one final question. You, sort of, talked about lower leverage, higher coverage as kind of goals. Do you have specific goals and time lines as to when you would like to achieve certain -- both of those types of metrics?

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [9]

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Sure. Not specifically. As we've talked about it internally and with our board, getting our hands around this and doing the integration work is, kind of, priority #1. As we look forward, hitting on some of the stuff Eric talked about -- pricing increases, restrained capital spending, things like that. We expect the leverage to come down and the coverage to go up over time. But, we still have some work to do to kind of get this thing integrated, so I think it might be a little premature to set exact time lines and targets out at this point. But certainly, the -- I think the trend lines would be in to areas where in the low to mid 4x leverage over time and coverage at a level where I know this quarter's dipped down to, kind of, that [101] but again, if you were to add back, I think some of those kind of onetime type expenses, I think you'd see it probably 0.05 or so higher. So I think when we look at that, we're in the right -- we're headed in the right direction for sure. And it will -- we'll have to evaluate that quarter-by-quarter.

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Operator [10]

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(Operator Instructions) The next question comes from Jeremy Tonet, JPMorgan.

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Charles W Barber, JP Morgan Chase & Co, Research Division - Analyst [11]

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This is Charlie in for Jeremy. Following up a little bit there on the leveraging coverage side, just wondering if you can talk a little bit more about your 2019 financing strategy, taking into consideration your current span and, kind of, coverage sits today. But also wanted to add in, I mean, you talked about it last quarter, but you've got the increased pricing pressures from suppliers, and I understand you're going to pass that on through higher monthly service rates. I'm curious if there is a timing lag between passing it on and how that may impact, I think you kind of alluded to the second half of 2019 is when you would really see those increased pricing pressures flow through. Just curious on those dynamics and how that might impact 2019?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [12]

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Let's break it into a couple of components. On the growth CapEx side, the 120,000 horsepower to be delivered over the course of 2019, we were able to lock in commitments from our suppliers prior to any rate increases. So when you start to hear about tariffs and increased costs of steel and some of those types of things, you were able to mitigate that for the balance of 2018 and on in to the back half of 2019. We've seen lube oil and antifreeze prices, basically, kind of, be flat to come down slightly. The combined CDM USA fleet has doubled in size, which has given us some pricing power. We're actually working with multiples of our larger suppliers in looking at bringing some additional cost containment to the table on parts and in pieces that go into our business.

So I think what we've seen is our largest driver on our cost of operations have been labor costs. You could envision when you're out on the Permian and the Delaware basins, particularly the Delaware basin, you've got counties that, prior to these booms starting up, had larger than the state of Rhode Island with 20 or 25 people living there. So it's not like you've got a giant labor pool to draw from. You've got to rotate people in and out and some of those costs are obviously, are somewhat higher and we've got some inflationary pressure on that.

So I think Matt and I feel pretty good about -- what we're seeing for the back half of 2018, on O&M cost control. And frankly, on into 2019, with the caveat being what does some of the labor cost look like.

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [13]

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And Charlie, it's Matt. Back to your first point on the leverage and coverage for next year. As we look out, we don't need any equity in order to execute on the plan we have right now. We obviously, gave some color about the horsepower on order for 2019. But again, I think it's a relatively reasonable amount of CapEx, especially when you look at the more recent past, in terms of how much we spent. We've certainly reined it in a little bit, I think, for just the units and the customers that we're really want to deal with. And we expect to be able to finance that under the current revolver, but also with free cash flow as that coverage ratio increases over time.

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Charles W Barber, JP Morgan Chase & Co, Research Division - Analyst [14]

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Great. That's good color. Other questions are largely answered. I guess, one other would be, you spoke about Permian, SCOOP/STACK, obviously, can be pretty good growth areas there from a macro standpoint. Curious on your thoughts and you alluded to it a little bit, but their price realizations have improved quite a bit in Northeast, obviously, with a lot of the takeaway projects coming online, just curious on optimism there in the Northeast down the road?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [15]

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Yes, we have said this on calls in the past as well, but right now, the Permian and Delaware and the SCOOP/STACK merge in the mid-continent for 2018 and early part of 2019 are larger growth areas. We've had a footprint in Appalachia from the formation of the company, took over 20 years ago. And that's an area that we have seen lots of growth over the years. And to your point, due to basis differential and lack of takeaway capacity the last couple of years, we've seen methodical growth, but it's been tempered somewhat from the rates of growth that we saw in past years. We envision that in the back half of '19 and on into 2020, 2021, that you'll start to see, kind of, a tick up again in activity in that area, which bodes well for our broad footprint that we can balance our CapEx spend and new units deployed or repatriation of equipment based on the best economics that we see across multiple basins.

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Operator [16]

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Your next question comes from Barrett Blaschke MUFG Securities.

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Barrett Auten Blaschke, MUFG Securities Americas Inc., Research Division - Senior Analyst [17]

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Just really a lot of mine have been answered but it's kind of down to housekeeping items. The SG&A number dropped off pretty sharply from the second quarter, is this, kind of, the new run rate we should expect at this level?

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [18]

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Yes, Barrett, it's Matt. In the second quarter, we had some expenses directly related to the transaction in there. And so, I think you're much better, kind of, looking at the current rate.

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Barrett Auten Blaschke, MUFG Securities Americas Inc., Research Division - Senior Analyst [19]

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So this is more the normalized rate we're looking at now?

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Matthew C. Liuzzi, USA Compression Partners, LLC - CFO, VP and Treasurer [20]

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Yes, yes. That's right.

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Barrett Auten Blaschke, MUFG Securities Americas Inc., Research Division - Senior Analyst [21]

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Okay. And again, you brought up the free cash flow piece as sort of how it trickles down to compression. Can you give us any more color around that as it -- are you hearing that people are wanting to do more outsourcing just consistently now from producers? Or is there still kind of a balance between own versus lease with you guys?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [22]

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Well, I think it's customer specific. What we find interesting is that some of the folks that have the largest and strongest balance sheets have made the strategic decision to outsource. So I've said in the past, people don't own their drilling rigs, they don't own their fracking crews, they don't own their logging trucks, they don't own their data centers and a lot of them made have made the decision not to outsource. And what we're seeing particularly in the Permian and the Delaware, and I think our -- some of our competitors and peers are seeing the same things that folks who have very sizable acreage positions, who've been in the area for 10, 20, 30, 40, 50 years with very large footprints haven't been the first movers in the area. And as they start to now increase their activity and developmental plans, we see kind of a shift from the early adopters, the private equity based smaller private independents to some of the larger multinational integrated oil companies who are starting to gear up for their activities in different areas in different basins. So interestingly, we see more of a push from some of those folks to outsource and obviously, the undercapitalized or those living on a diet right now continue to look to outsourcing. So we see the trend accelerating in a point in time where again, there is not enough equipment to meet all the demand that's going to be imposed on the system.

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Operator [23]

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You're next question comes from TJ Schultz, RBC Capital Markets.

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Torrey Joseph Schultz, RBC Capital Markets, LLC, Research Division - Analyst [24]

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I think, this is first to Eric, you mentioned better demand for smaller horsepower gas lift. Do you have these types of units sitting idle? ? Or do you need to or plan to order those to meet demand? And then, where is that demand coming from primarily?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [25]

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Yes. Great question, TJ. We've got stuff sitting around idle, a fairly large tranche of that came -- came along with the CDM acquisition as well as some of the assets that we have had in the past in the USA legacy fleet. So now we don't intend to purchase any more of that stuff. And we see really it's in 2 geographic areas, we see it in the Permian/Delaware and as well as in the central banks and uplift the mid-continent area of the SCOOP/STACK merge, and it's -- that's another one that kind of depends on who the player is and where they are in the economic life. You've got some companies who initially will free flow then move to the electric sub-pumps, will move to gas lift, will move to rock pump. So they, kind of, cycle things over the life of their hyperbolic decline curve that they have in the area. So the two biggest areas would be Permian Delaware and then followed by the SCOOP/STACK merge up in the mid-continent.

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Torrey Joseph Schultz, RBC Capital Markets, LLC, Research Division - Analyst [26]

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Okay, great. And I think just following up on something you guys have been discussing here on the rent versus own. Maybe if you could talk a little bit about contract terms for new compression? And the reason I ask all this commentary on kind of accelerated outsourced demand, and in the past you've talked about the stickiness of these larger horsepower units, just as they get placed into the field. So if a producer puts one of your units out there, is it still what I would consider unlikely that even if that contract terms end, there isn't really a likelihood that the producer's kind of been sitting in wait while they have ordered their own compression. Is that, kind of, still the case as these contracts roll over?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [27]

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Yes, the contracts roll over, TJ, you have to look again area by area. There's been new developmental activity going on. You might see a production profile, which is flat or even actually increasing. So it's an area where people should look, I've developed my area, I have what I have and I have gone 2 years worth of hyperbolic decline and they start to go into a little more steady state, shallower decline rates that you see. Keep in mind, you've got pressures of decline and then, you have the increase in GORs in some of these casing head gas wells. So you've got a lot of dynamics that move on.

I think what we historically see is, we go out with our larger units typically, kind of, a 3 to 7-year initial primary term contract. At the end of the primary term, that's now where it gets interesting. If you have a few units here and a few units there, with the smaller undercapitalized producer who doesn't have a lot of growth and developmental plans, we've been known to pro offer a new contract, here is a new rate, here is a new term and tenure, what do you mean, you're going to raise my rate 50%, wow that's kind of expensive. Well, send it home, we'll redeploy it to somebody who's willing to pay that with a piece of equipment that's in high demand. So I think these units are very sticky. And in the environment that we're living in. You think about real estate, is it a buyer's market? Or is it a seller's market? We're the equivalent of a seller's market right now, where there is a lot of demand and not a heck of a lot of supply with 3.6 million horsepower active fleet and a total fleet of 3.8 million 3.9 million horsepower. So it gives us the opportunity in this perfect storm to selectively push through the rate increases, and high grade our book, improve our customer mix, improve our operating efficiencies. So it's a combination of increasing rates, improving margins with productivity and high grading our customer mix, all at the same time.

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Operator [28]

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Our final question comes from Mike Gyure, Janney.

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Michael Christopher Gyure, Janney Montgomery Scott LLC - Former Analyst [29]

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I think most of my questions have been answered. Maybe you talk about, I guess, what you're seeing maybe as an early outlook for 2020. It looks like 2019 pretty much your horsepower scheduled for delivery is pretty much sold out. I guess, what's your view on sort of the early look for 2020? Do you think that potentially is an extension of 2019? Or is it too early to tell?

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Eric D. Long, USA Compression Partners, LLC - CEO and President [30]

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I think it's look a lot like 2019. We're definitely in the rinse and repeat mode.

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Operator [31]

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At this time, I'd like to turn the call back over to Mr. Eric Long. Go ahead sir.

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Eric D. Long, USA Compression Partners, LLC - CEO and President [32]

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Thank you, operator, and thank you all for joining us on the call today. The third quarter represented a strong quarter for compression demand, utilization and pricing. The work to integrate CDM continues, and we are focused on driving productivity, improving monthly service fees and getting margins back to where we expect them to be. The benefits we expected from the combination will come over time, and a lot of work has been done to get to this point. We believe, our strategy is a right one for the market place, and should result in a leading large horsepower, infrastructure oriented compression services provider, with stability in cash flows and multiple areas for continued growth. In these volatile times, USA Compression continues to be a long-term story of stability and growth. We look forward to updating you on the next quarterly call. Thank you for your continued interest in and support of USA Compression.

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Operator [33]

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