Greg Holloway - VP, General Counsel & Secretary Eric Long - CEO Matt Liuzzi - CFO.

Andrew Burd - J. P. Morgan John Woodiel - Raymond James Hilary Cauley - Ladenburg Thalmann.

Good day, everyone, and welcome to the USA Compression Partners second quarter earnings conference call. [Operator Instructions] Today's conference is being recorded. I'll now be standing by should you need any assistance. At this time, I'd like to turn the conference over to Mr. Greg Holloway, Vice President, General Counsel and Secretary.

Please go ahead, sir..

Thank you, Roxanna. Good morning, everybody, and thanks for joining us. As you know, this morning we released our financial results for the quarter ended June 30, 2016. You can find our earnings release as well as recording of this conference in the investor relations section of our website at usacompression.com.

The recording will be available through August 15, 2016. 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 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 to management's views of today, August 4, and may no longer be accurate at the time of a replay. I'll now turn the call over to Eric Long, President and Chief Executive Officer of USA Compression..

Southwestern Energy, who had zero rigs running companywide for the first half of 2016, recently reinitiated drilling with its first rig in the Northeast Marcellus and announced its intent to add three more rigs in the Marcellus by the end of Q3, increasing its total capital spend in the area to roughly 350 million in the second half versus only 44 million in the first half.

We continue to believe that both the gas supply and gas demand pictures appear to be robust in future years as well. On the oily side, as we have mentioned, we see continued activity in West Texas, particularly in the Delaware Basin.

Given the stacked horizon potential in these areas, E&P operators are still able to earn attractive returns on incremental drilling and new production. We expect the same big four demand factors we touch on every quarter will continue to drive natural gas demand growth for the foreseeable future.

We have seen positive developments related to the industrial demand, driven by new petrochemical facilities, such as Shell's new major ethylene and polyethylene project near Pittsburgh; as well as pipeline exports to Mexico, which the EIA reports averaged 3.5 Bcf per day year to date, which corresponds to an increase of about 90% over the five-year average.

This expected increase in natural gas demand will drive increased infrastructure investment throughout the U.S. of which compression will continue to be an important part.

As we mentioned last quarter, the INGAA now estimates a need of 23 billion to 30 billion of capital for compression for gas gathering lines through 2035, which corresponds to well over $1 billion of projected compression investment annually.

We also see positive trends related to storage, with injections down materially year-over-year and recent results coming in below research consensus. This is due in no small part to the hot summer we are having as well as switching from coal to natural gas due to EPA-mandated environmental requirements.

Natural gas is and will continue to become more and more important over the coming years, and compression remains a critical and essential part of the overall natural gas infrastructure investment. I'll wrap up by recapping our strategy through this energy cycle downturn.

We have aggressively hit the brakes on our expansion capital spending, down approximately 80% year-over-year, and have lived within our existing capital structure. Having kept leverage below 5 times, we have continued to focus on maintaining high fleet utilization by providing superior levels of service to our customers.

And finally, we have wrung out operational, SG&A, and maintenance cost savings throughout the organization, resulting in the highest gross margins and EBITDA margins of our public peers.

Quarter-after-quarter through this down cycle, we continue to prove out the stability of our business model, which focuses on critical infrastructure and must-run compression equipment while also remaining flexible to efficiently respond to changing market conditions.

We remain bullish on the outlook for compression over the long-term, given the attractive macro fundamentals for growing natural gas demand and continued infrastructure buildout.

We believe our business model, which focuses on large, infrastructure oriented equipment and our strategy through this downturn will put us in a position to capitalize on incremental demand as the market rebounds. I will now turn it over to Matt to walk through some of the financial highlights of the quarter and our updated guidance ranges.

Matt?.

Thanks, Eric, and good morning, everyone. As Eric mentioned, USA Compression reported another solid quarter of results against a tough market backdrop. For the second quarter of 2016, USA Compression reported revenue of $63.5 million, adjusted EBITDA of $37.1 million, and DCF of $30.5 million.

In July we announced a cash distribution to our unitholders of $0.525 per LP unit, which results in a DCF coverage ratio for the quarter of 1.03 times. Taking into account the impact of the DRIP program, our cash coverage ratio for the quarter was 1.33 times.

With the support of our largest unitholders, we continue to strike a balance between DRIP and cash paid distributions. This quarter, Riverstone elected to reduce its DRIP participation by taking 50% of its distributions in cash, joining Argonaut Private Equity, who again has elected to go all cash pay.

By methodically working our way towards less reliance on the DRIP program, we believe we can maintain critical financial flexibility in this market while advancing towards the ultimate goal of eliminating our need for the DRIP.

Our total fleet horsepower as of the end of Q2 was similar to where we ended Q1, adding only a few large horsepower units to the fleet. Our revenue-generating horsepower at period-end was down slightly relative to Q1 at 1.4 million horsepower.

We continued to rein in our expansion capital spending, investing only $4 million in the quarter; and total expected expansion capital spend this year remains between $40 million and $50 million. We continue to expect to take delivery of only 15,000 new horsepower in 2016, with the remaining 7,000 horsepower to come in the third quarter.

And we currently have no further commitments to add additional new compression equipment beyond 2016. As Eric mentioned, our strategy in this market is to work off the backlog of existing in-demand large horsepower units in our fleet as incremental compression demand arises before spending new capital on compression equipment.

The remaining expansion capital for 2016 will be spent on certain compressor package components, equipment reconfigurations, IT infrastructure, trucks, and other items necessary to support the business.

Our average horsepower utilization for the second quarter was 86.1%, down roughly 2.5% in sequential quarters from 88.7%, and down from 90.5% in the second quarter of 2015. Utilization was down, mostly due to a decrease in both our active and on-contract pending fleet, as customers continue to optimize their compression needs.

Pricing, as measured by average revenue per revenue generating horsepower per month, was down slightly to $15.52 from $15.72 in Q1 of 2015 and down from $15.83 year-over-year, mostly due to declines in pricing in our smaller horsepower equipment.

Turning to the financial performance for the second quarter, total revenue decreased 4% compared to the second quarter of 2015, primarily driven by a decrease in our contract operations revenues. Gross operating margin as a percentage of revenue was 70.6% in the second quarter, consistent with gross margins last year.

Adjusted EBITDA decreased approximately 4% to $37.1 million in the second quarter as compared to $38.6 million for the second quarter of 2015. DCF in the quarter was $30.5 million as compared to $31 million for the same period last year, a decrease of 1.6%.

Net income in the quarter was $3.3 million as compared to a $15.9 million loss for the second-quarter 2015. Net cash provided by operating activities of 36.5 million in the quarter increased slightly relative to 34 million in the same period last year.

Operating income increased to 8.5 million as compared to an operating loss of 11.4 million for the second quarter of 2015. Maintenance capital totaled $1.6 million in the quarter. As Eric briefly discussed, we have worked this year to optimize our maintenance capital spending, which has resulted in significant savings so far this year.

We now expect approximately 10.5 million of maintenance capital in 2016. Cash interest expense net was 4.6 million for the quarter. Outstanding borrowings under our revolving credit facility as of June 30, 2016, were $735 million, resulting in a leverage ratio of 4.97 times at quarter end relative to our covenant level this quarter of 5.95 times.

Additionally, as we indicated on our previous calls, as the year progressed and we gained more clarity around trends in our business drivers, we would be in a position to provide updated guidance. At this point in the year, we are updating our full year 2016 guidance to reflect the following ranges.

Full year adjusted EBITDA of $140 million to $150 million, and DCF of $110 million to $120 million. As you will note, these updates reflect the tightening of both ranges as well as a slight increase in the DCF guidance, mostly driven by our previously mentioned maintenance capital optimization efforts.

Finally, we expect to file our Form 10-Q with the Securities and Exchange Commission as early as this afternoon. With that, we'll open the call up to questions..

[Operator Instructions] And we will take our first question from Andrew Burd with JPMorgan. Please go ahead..

Eric, I think you highlighted a few large product installations that you see in kind the future, and I think you also indicated that some of those you have under contract.

Can you go into a little more detail there? Maybe quantify the horsepower amount and the timeline? And would those require incremental investment by USAC, or whether you have units in the lot that can be redeployed?.

the Permian, Delaware, and then the Marcellus, with some of our existing core customers. Some of the equipment we have in inventory, some of the equipment we are able to source from inventory that has been repatriated as units have come back, and we have seen that nominal decline in our utilization over the last 18 to 24 months.

I think it is also fair to say that for the back half of this year, we really don't contemplate needing to go out and purchase any additional equipment over and above what we have already previously committed to..

Great. And then I think you had also discussed -- obviously Southwestern is a large customer of yours. That's been disclosed a lot in the past.

Remind us if you serve them in their Marcellus footprint and what type of involvement you might have as they accelerate production, as you outlined?.

Yes, we have dealings directly with Southwestern and various of their subsidiaries. And also, you may recall, Andy, that Southwestern up in the Marcellus monetized some of their gathering assets. And we worked with the successors in ownership to those assets as well.

So to the extent Southwestern does pick up activity, with our dominant footprint that we have in Appalachia and some of the long-standing both contractual relationships and just commercial relationships with their service providers, we will be the beneficiary of some of their increased activity..

how quickly do you think, once you've kind of identified a bottom and see some tightness, especially with larger units, how quickly do you think you can get pass price increases along to customers?.

That's one of those difficult questions to answer. Some of it has to do with availability of equipment. You know, there's a fairly substantial lead time to source the large component inventory. Lead times right now on some of the bigger equipment are running roughly 20 weeks for the individual components.

And more than likely when demand picks up and we start to enter into commitments to purchase equipment, as do some of our major competitors, those lead times will start to go out. So if you go back and look at past cycles, when you saw a bottom, you would start to see utilization trend upwards a few percentage points over the next few quarters.

And then you'll start to see pricing become a little stickier at that point in time. So I don't think it's something you're going to see immediately. But I do think this is something that as utilization of our collective fleets in the industry goes up, lead times for equipment gets longer, you'll start to see some upward pricing on pressure..

Excellent. Thanks for taking my questions..

And we will take our next question from John Woodiel, from Raymond James. Please go ahead..

First off, great cost execution in the quarter. What I was really hoping was that you could provide a little bit more color around pieces on the cost side.

I assume that most of those are structural in nature, but if you could go into, kind of looking into how much of those are variable, and might be derived from fuel lubricant costs, and might increase a little bit as we move forward?.

Sure, John, it's Matt. And I think, you know, we've talked about it in the past, but I think a little bit. We obviously don't get into the details of what makes up those costs.

But I think when we think about it, even going back to the beginning of last year, when we sort of really kicked off kind of the cost savings initiatives companywide, we kind of guided people towards gross margins kind of in that upper 60% range.

So I think as we have kind of come through now, you know, a full six quarters of the implementation of this program, all those margins have stayed very consistent. So we think there's a good chunk of it that is very structural in nature.

I mean, to your point, some of the fuel costs and whatnot, as commodity prices rise, we will see a little bit of a tick-up in that. But as we've looked at it, we think the margins, kind of in the range where they are now, in the high 60%s, we even ticked above 70% this quarter. We think that's very sustainable going forward..

All right, that's very helpful. And then you all touched on this a little bit earlier, but obviously you're going to try to use up the utilization gap that you have been your current equipment base first.

But when you're thinking about building out your fleet going forward in 2017, are you going to be looking for kind of firm customer commitments and projects in place? Or will that be built mostly on spec, just given the time delay of that?.

A fair way to answer that is when we look at peak to trough. And as we indicated, our utilization from peak to trough is approximately 9 percentage points or so. As we start to see utilization ticking back up 2, 3, 4, 5 percentage points, we'll start to have indications from our customers of what their future demand is going to look like.

And if you think logically what we're seeing in the marketplace, a fair number of some of our longer-term, larger customers have announced that they have added additional rigs, SCOOP/STACK, Delaware, Permian. And we are starting to see some activity like that up in Appalachia as well.

These are folks who were able to lock can hedges last quarter or early this quarter at very attractive pricing, in the low to mid 50s on oil. And we have some guys that actually locked in some $3.50 gas. So with the drilling costs like they are, they are obviously very economic projects.

So we've got folks who now have 18 to 24 months’ worth of developmental visibility. And when our sales team sits down with their technical teams and commercial teams, we get a pretty good indication of what their plans look like. Most of the time, we will not have firm contracts in place.

This is a little bit like you want to go out and buy a new car, and you order a car, and you go to the car lot, and somebody's got one on the lot that meets 85% or 90% of your requirements. You tend to buy that car off the lot. So I think our business works a lot the same way.

There are points in time where we do actually get some contracts in advance of ordering equipment. Generally, we'll make a commitment and we'll stagger things on a quarterly basis. So we're not making years’ worth of financial commitments, but a few quarters at a time.

And typically what we see by the time that equipment is ready to be built, we tend to have contracts in place, so that when we are paying for the equipment, many, many times it actually leaves the fabricator goes directly out to a job with a primary term contract of 2 to 5 years..

Right. So it seems like, for the most part, your business model hasn't really changed too much when thinking about CapEx. I appreciate the color, guys. Thank you..

Thank you..

And we will take our next question from Rich Verdi with Ladenburg Thalmann..

This is actually Hilary Cauley on for Rich. And most of my questions have been asked, so just a few quick ones. For Q2, I was wondering if you could tell us what the order of the strength for the months were there.

Was April the weakest, with May and June getting stronger sequentially? Or variability there?.

Excellent question, and I think a fair way to answer that is as the year has progressed, we have started to see tick-up in commodity pricing. The order book started to improve and has continued to improve from the beginning of the quarter toward the end of the quarter, and now even on forward into the third quarter.

So we're starting to see strengthening demand rather than variability in demand or a tick down in demand. We're actually seeing improvement month over month for the last three or four months..

Okay, great.

So you're expecting July to be even stronger than Q2 ended off?.

I think we're off to a good start..

Okay, great.

And then just kind of a high level question for you, if you guys see any kind of large left-field items out there that could be impacting you guys over the next 18 months or so?.

No, Hilary; it's Matt. I don't think there's anything out there that we see. Again, I think our commentary pointed to the fact of customer, the general tone of customer conversations, and Eric just mentioned some of the order type stuff. So I think where we sit now, we hope to just kind of keep chugging along and get through this.

I think a little bit of stability in commodity prices will help all of us out..

Okay, great. Thanks for taking my questions..

Thank you..

And it appears we have no questions at this time. I would like to turn the call back over to Eric for closing remarks..

Thank you, operator. The entire USA Compression team thanks everyone on the call today for your continued support of and interest in our Company. We continue to believe that we have a differentiated and superior business model to those of our various peers, public and private alike.

We continue to demonstrate our ability to maintain our margins and our distributions due to the stability that our demand driven focus on the larger horsepower infrastructure oriented compression business offers in comparison to other sectors of the energy business.

As we have the past almost 2 decades, we will work to continue delivering exemplary levels of compression services to our customers. And we remain laser focused on our balance sheet, our leverage, optimizing cash flow, and maintaining appropriate levels of coverage. I look forward to our third quarter up the call sometime in early November.

Thanks again..

This does conclude today's conference. You may disconnect at any time and have a wonderful day..