c

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

(MARK ONE)

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED March 31, 2017

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM               TO               .

Commission File No. 001-35779

USA Compression Partners, LP

(Exact name of registrant as specified in its charter)

(512) 473-2662

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒  No ☐

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒  No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes ☐  No ☒

As of May 2, 2017, there were 61,178,151 common units outstanding.

TABLE OF CONTENTS

PART I.  FINANCIAL INFORMATION

ITEM 1.Financial Statements

USA COMPRESSION PARTNERS, LP

Unaudited Condensed Consolidated Balance Sheets

(in thousands, except for unit amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

USA COMPRESSION PARTNERS, LP

Unaudited Condensed Consolidated Statements of Operations

(in thousands, except per unit amounts)

See accompanying notes to unaudited condensed consolidated financial statements.

USA COMPRESSION PARTNERS, LP

Unaudited Condensed Consolidated Statement of Changes in Partners’ Capital

Three Months Ended March 31, 2017

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

USA COMPRESSION PARTNERS, LP

Unaudited Condensed Consolidated Statements of Cash Flows

(in thousands)

See accompanying notes to unaudited condensed consolidated financial statements.

USA COMPRESSION PARTNERS, LP

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(1)  Organization and Summary of Significant Accounting Policies

(a)  Organization

Unless otherwise indicated, the terms “our”, “we”, “us”, “the Partnership” and similar language refer to USA Compression Partners, LP, collectively with its operating subsidiaries. We are a Delaware limited partnership. USA Compression GP, LLC, a Delaware limited liability company, serves as our general partner and is referred to herein as the “General Partner”. Our General Partner is owned by USA Compression Holdings, LLC (“USA Compression Holdings”). Through our operating subsidiaries, we provide compression services under term contracts with customers in the natural gas and crude oil industries, using natural gas compression packages that we design, engineer, own, operate and maintain. We provide compression services in a number of shale plays throughout the United States, including the Utica, Marcellus, Permian Basin, Delaware Basin, Eagle Ford, Mississippi Lime, Granite Wash, Woodford, Barnett, Haynesville, Niobrara and Fayetteville shales. 

Certain of our operating subsidiaries are borrowers under a revolving credit facility and the Partnership is a guarantor of that revolving credit facility (see Note 6). The accompanying unaudited condensed consolidated financial statements include the accounts of the Partnership and its operating subsidiaries, all of which are wholly owned by us. 

Net income is allocated to our general and limited partners using the two-class income allocation method. All intercompany balances and transactions have been eliminated in consolidation. Our common units representing limited partner interests in the Partnership trade on the New York Stock Exchange under the ticker symbol “USAC”. 

Our ownership structure was as follows:

(b)  Basis of Presentation

Our accompanying unaudited condensed consolidated financial statements have been prepared on the same basis as the audited consolidated financial statements included in our annual report on Form 10-K for the year ended December 31, 2016 filed on February 13, 2017 (our “2016 Annual Report”). In the opinion of our management, such financial information reflects all adjustments necessary for a fair presentation of the financial position as of March 31, 2017 and December 31, 2016, and the results of operations for the three months ended March 31, 2017 and 2016, changes in partners’ capital for the three months ended March 31, 2017 and the statements of cash flows for the three months ended March 31, 2017 and 2016 in accordance with U.S. generally accepted accounting principles (“GAAP”). Operating results for the three months ended March 31, 2017 are not necessarily indicative of the results that may be expected for the year ending December 31, 2017. Certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”). Therefore, these consolidated financial statements should be read in conjunction with our audited consolidated financial statements for the year ended December 31, 2016 contained in our 2016 Annual Report.

(c)  Use of Estimates

Our unaudited condensed consolidated financial statements have been prepared in conformity with GAAP, which includes the use of estimates and assumptions by management that affect the reported amounts of assets, liabilities, revenues, expenses and disclosure of contingent assets and liabilities that existed at the date of the unaudited condensed consolidated financial statements. Although these estimates were based on management’s available knowledge of current and expected future events, actual results could differ from these estimates.

(d)  Inventory

Inventory consists of serialized and non-serialized parts used primarily in the repair of compression units.  Serialized parts inventory is valued at the lower of cost or market value using the specific identification method, while non-serialized parts inventory is valued using the weighted average cost method. Purchases of these assets are considered operating activities in the Unaudited Condensed Consolidated Statements of Cash Flows.

Components of inventory are as follows (in thousands):

(e)  Identifiable Intangible Assets

Identifiable intangible assets, net consisted of the following (in thousands):

Identifiable intangible assets are recorded at cost and amortized using the straight-line method over their estimated useful lives, which is the period over which the assets are expected to contribute directly or indirectly to our future cash flows. The estimated useful lives range from 4 to 30 years. Accumulated amortization of intangible assets was $20.9 million and $20.0 million as of March 31, 2017 and December 31, 2016, respectively.

We assess identifiable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We did not record any impairment of identifiable intangible assets for the three months ended March 31, 2017 or 2016.

(f)  Property and Equipment

Property and equipment are carried at cost except for (i) certain acquired assets which are recorded at fair value on their respective acquisition dates and (ii) impaired assets which are recorded at fair value on the last impairment evaluation date for which an adjustment was required. Overhauls and major improvements that increase the value or extend the life of compression equipment are capitalized and depreciated over 3 to 5 years. Ordinary maintenance and repairs are charged to cost of operations, exclusive of depreciation and amortization. Depreciation is calculated using the straight-line method over the estimated useful lives of the assets as follows:

When property and equipment is retired or sold, its carrying value and the related accumulated depreciation are removed from our accounts and any associated gains or losses are recorded on our statements of operations in the period of sale or disposition.

See more information on property and equipment in Note 3 to our unaudited condensed consolidated financial statements.

(g)  Impairments of Long-Lived Assets

Long-lived assets with recorded values that are not expected to be recovered through future cash flows are written-down to estimated fair value. We test long-lived assets for impairment when events or circumstances indicate that the assets’ carrying value may not be recoverable or will no longer be utilized in the operating fleet. The most common circumstance requiring compression units to be tested for impairment is when idle units do not meet the performance characteristics of our active revenue generating horsepower. During the three months ended March 31, 2017, we evaluated the future deployment of our idle fleet under current market conditions and determined to retire, sell or re-utilize key components of 2 compression units, with a total of 2,760 horsepower, which were previously used to provide compression services in our business. The cause of the impairment was due to estimated significant repair costs from previous damage to the equipment. These compression units were written down to their respective estimated salvage value. As a result of our decision to retire, sell or re-utilize components of these compression units, we recorded $1.1 million of impairment of long-lived assets in the three months ended March 31, 2017. We did not record any impairment of long-lived assets in the three months ended March 31, 2016. 

(h)  Fair Value Measurements

Accounting standards on fair value measurements establish a framework for measuring fair value and stipulate disclosures about fair value measurements. The standards apply to recurring and nonrecurring financial and non-financial assets and liabilities that require or permit fair value measurements. Among the required disclosures is the fair value hierarchy of inputs we use to value an asset or a liability. The three levels of the fair value hierarchy are described as follows:

Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities that we have the ability to access at the measurement date.

Level 2 inputs are those other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.

Level 3 inputs are unobservable inputs for the asset or liability.

Phantom unit awards granted to employees under the USA Compression Partners, LP 2013 Long-Term Incentive Plan (the “LTIP”) are accounted for as a liability, and such liability is re-measured on a quarterly basis. The liability is based on the publicly quoted price of our common units, which is considered a Level 1 input, and is recorded within the accrued liabilities caption on the Unaudited Condensed Consolidated Balance Sheets. 

Net liabilities measured at fair value on a recurring basis are summarized below (in thousands):

As of March 31, 2017 and December 31, 2016, our financial instruments consisted primarily of cash and cash equivalents, trade accounts receivable, trade accounts payable and long-term debt. The book values of cash and cash equivalents, trade accounts receivable and trade accounts payable are representative of fair value due to their short-term maturities.  The carrying amount of long-term debt approximates fair value due to the floating interest rates associated with the debt. 

(i)  Operating Segment

We operate in a single business segment, the compression services business.

(j)  Pass Through Taxes

Sales taxes incurred on behalf of, and passed through to, customers are accounted for on a net basis.

(2)  Trade Accounts Receivable

Trade accounts receivable are recorded at the invoiced amount and do not bear interest.  The allowance for doubtful accounts, which was $0.6 million and $0.7 million at March 31, 2017 and December 31, 2016, respectively, is our best estimate of the amount of probable credit losses included in our existing accounts receivable. We determine the allowance based upon historical write-off experience and specific customer circumstances.  The determination of the allowance for doubtful accounts requires us to make estimates and judgments regarding our customers’ ability to pay amounts due.  On an ongoing basis, we conduct an evaluation of the financial strength of our customers based on payment history, the overall business climate in which our customers operate and specific identification of customer bad debt and make adjustments to the allowance as necessary. Our evaluation of our customers’ financial strength is based on the aging of their respective receivables balance, customer correspondence, financial information and third-party credit ratings. Our evaluation of the business climate in which our customers operate is based on a review of various publicly-available materials regarding our customers’ industries, including the solvency of various companies in the industry. During the three months ended March 31, 2017 and 2016, we reduced our allowance for doubtful accounts by $0.1 million and $0.8 million, respectively, due mostly to collections on accounts that had previously been reserved.

(3)  Property and Equipment

Property and equipment consisted of the following (in thousands):

We recognized $23.3 million and $21.2 million of depreciation expense on property and equipment for the three months ended March 31, 2017 and 2016, respectively.

As of March 31, 2017 and December 31, 2016, there was $11.3 million and $1.4 million, respectively, of property and equipment purchases in accounts payable and accrued liabilities.

During the three months ended March 31, 2017, a $0.2 million gain on sale of a compression unit was recognized. During the three months ended March 31, 2016, cash insurance recoveries of $0.2 million were received on previously impaired compression equipment. Each of these is reported within the Gain on sale of assets caption in the Unaudited Condensed Consolidated Statements of Operations.

(4)  Installment Receivable

On June 30, 2014, we entered into a FMV Bargain Purchase Option Grant Agreement (the “Capital Lease Transaction”) with a customer, pursuant to which we granted a bargain purchase option to the customer with respect to certain compressor packages leased to the customer.  The bargain purchase option provides the customer with an option to acquire the equipment at a value significantly less than the fair market value at the end of the lease term.

On November 1, 2016, we entered into a second capital lease transaction with a customer with respect to certain assets leased to the customer.

Both capital leases were accounted for as sales type leases and as of March 31, 2017 and December 31, 2016, resulted in a current installment receivable of $8.9 million and $8.9 million, respectively, included in other accounts receivable, and a long-term installment receivable of $13.2 million and $14.1 million, respectively.

Revenue and interest income related to both capital leases is recognized over the respective lease terms, which range from 6 months to 7 years. We recognize maintenance revenue within Contract operations revenue and interest income within Interest expense, net on the Unaudited Condensed Consolidated Statements of Operations. For the three month periods ended March 31, 2017 and 2016, maintenance revenue related to the Capital Lease Transaction was $0.3 million and $0.4 million, respectively. There is no maintenance revenue component to the second capital lease. Interest income related to both capital leases was $0.4 million in each of the three months ended March 31, 2017 and 2016.

(5)  Accrued Liabilities

Accrued liabilities include accrued payroll and benefits and accrued property taxes.  We recognized $2.7 million and $6.9 million of accrued payroll and benefits as of March 31, 2017 and December 31, 2016, respectively. We recognized $4.4 million and $6.6 million of accrued property taxes as of March 31, 2017 and December 31, 2016, respectively.

(6)  Long-Term Debt

Our first lien long-term debt, of which there is no current portion, consisted of the following (in thousands):

In March 2016, we entered into a third amendment to our revolving credit facility, which amended the credit agreement to, among other things, (i) modify the leverage ratio covenant to be (A) 5.50 to 1.0 as of the end of the respective fiscal quarters ending March 31, 2017 and June 30, 2017, (B) 5.25 to 1.0 as of the end of the respective fiscal quarters ending September 30, 2017 and December 31, 2017 and (C) 5.00 to 1.0 thereafter, and (ii) amend certain other provisions of the credit agreement, all as more fully set forth in the third amendment.

In connection with entering into the third amendment, we paid certain amendment fees to the lenders party thereto and paid a certain arrangement fee to the arranger of the third amendment in the amount of $2.0 million, collectively, during the three months ended March 31, 2016. These fees were capitalized to loan costs and will be amortized through January 2020. No such fees were paid during the three months ended March 31, 2017. 

As of March 31, 2017, we were in compliance with all of our covenants under our revolving credit facility.

As of March 31, 2017, we had outstanding borrowings under our revolving credit facility of $714.8 million, $342.1 million of borrowing base availability and, subject to compliance with the applicable financial covenants, available borrowing capacity of $76.8 million. Our interest rate in effect for all borrowings under our revolving credit facility as of March 31, 2017 and December 31, 2016 was 2.91% and 2.94%, respectively, with a weighted average interest rate of 2.98% and 2.47% during the three months ended March 31, 2017 and 2016, respectively. There were no letters of credit issued as of March 31, 2017 or 2016.

In the event that any of the operating subsidiaries guarantees any series of the debt securities as described in our registration statements on Form S-3, such guarantees will be full and unconditional and made on a joint and several basis for the benefit of each holder and the Trustee.  However, such guarantees will be subject to release, subject to certain limitations, as follows (i) upon the sale, exchange or transfer, whether by way of a merger or otherwise, to any Person

that is not our affiliate, of all of our direct or indirect limited partnership or other equity interest in such Subsidiary Guarantor; or (ii) upon our or USA Compression Finance Corp.’s (together, the “Issuers”) delivery of a written notice to the Trustee of the release or discharge of all guarantees by such Subsidiary Guarantor of any Debt of the Issuers other than obligations arising under the indenture governing such debt and any debt securities issued under such indenture, except a discharge or release by or as a result of payment under such guarantees.  Capitalized terms used but not defined in this paragraph are defined in the Form of Indenture filed as exhibit 4.1 to such registration statement.

Our operating subsidiaries and USA Compression Finance Corp. are our only existing subsidiaries. We have no assets or operations independent of our subsidiaries, and there are no significant restrictions upon our ability to obtain funds from our subsidiaries by dividend or loan. None of the assets of our subsidiaries represent restricted net assets pursuant to Rule 4-08(e)(3) of Regulation S-X under the Securities Act of 1933, as amended.

Our revolving credit facility matures in January 2020 and we expect to maintain this facility for the term.

(7)  Partners’ Capital

Common Units and General Partner Interest

As of March 31, 2017, we had 61,178,151 common units outstanding.  USA Compression Holdings held 24,135,031 common units as of March 31, 2017 and controlled our General Partner, which held an approximate 1.3% general partner interest (the “General Partner’s Interest”) and the incentive distribution rights (“IDRs”). See the Unaudited Condensed Consolidated Statement of Changes in Partners’ Capital.

Cash Distributions

We have declared quarterly distributions per unit to limited partner unitholders of record, including holders of common, subordinated units and phantom units and distributions paid to the General Partner, including the General Partner’s Interest and IDRs, as follows (in millions, except distribution per unit):

Announced Quarterly Distribution

On April 20, 2017, we announced a cash distribution of $0.525 per unit on our common units.  The distribution will be paid on May 12, 2017 to unitholders of record as of the close of business on May 2, 2017. USA Compression Holdings, the owner of approximately 39.5% of our outstanding limited partner interests, has elected to reinvest 50% of this distribution with respect to its units pursuant to our distribution reinvestment plan (the “DRIP”).

Dividend Reinvestment Program

During the three months ended March 31, 2017 and 2016, distributions of $4.1 million and $11.5 million, respectively, were reinvested under the DRIP resulting in the issuance of 0.2 million and 1.4 million common units, respectively.  Such distributions are treated as non-cash transactions in the accompanying Unaudited Condensed Consolidated Statements of Cash Flows.

Earnings Per Common and Subordinated Unit

The computations of earnings per common unit and subordinated unit are based on the weighted average number of common units and subordinated units, respectively, outstanding during the applicable period. The subordinated units and our General Partner’s Interest (including its IDRs) meet the definition of participating securities as defined by the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification Topic 260 Earnings Per Share; therefore, we apply the two-class method in our computation of earnings per unit. Basic earnings per common and

subordinated unit are determined by dividing net income allocated to the common and subordinated units, respectively, after deducting the amount allocated to our General Partner (including distributions to our General Partner on our General Partner’s Interest and its IDRs), by the weighted average number of outstanding common and subordinated units, respectively, during the period.  Net income is allocated to the common units, subordinated units and our General Partner’s Interest (including its IDRs) based on their respective shares of the distributed and undistributed earnings for the period. To the extent cash distributions exceed net income for the period, the excess distributions are allocated to all participating units outstanding based on their respective ownership percentages. Diluted earnings per unit are computed using the treasury stock method, which considers the potential issuance of limited partner units associated with our LTIP. Unvested phantom units are not included in basic earnings per unit,  as they are not considered to be participating securities, but are included in the calculation of diluted earnings per unit. Incremental unvested phantom units outstanding represent the only difference between our basic and diluted weighted average common units outstanding during the three months ended March 31, 2017 and 2016.

Incentive Distribution Rights

Our General Partner holds all of our IDRs. The IDRs represent the right to receive an increasing percentage of our quarterly distributions of available cash from operating surplus after the minimum quarterly distribution and the target distribution levels have been achieved. 

The following table illustrates the percentage allocations of Available Cash from Operating Surplus between our unitholders and our General Partner based on the specified target distribution levels. The amounts set forth under “Marginal Percentage Interest in Distributions” are the percentage interests of our General Partner and our unitholders in any Available Cash from Operating Surplus we distribute up to and including the corresponding amount in the column “Total Quarterly Distribution Per Unit.” The percentage interests shown for our unitholders and our General Partner for the minimum quarterly distribution are also applicable to quarterly distribution amounts that are less than the minimum quarterly distribution. The percentage interests set forth below for our General Partner include its General Partner’s Interest, and assume our General Partner has contributed any additional capital necessary to maintain its General Partner’s Interest and our General Partner has not transferred our IDRs.

(8)  Transactions with Related Parties

John Chandler, who has served as a director of our General Partner since October 2013, has served as a director of one of our customers since October 2014. During the three months ended March 31, 2017 and 2016, we recognized $1.9 million and $2.2 million, respectively, in revenue from compression services provided to this customer in the Unaudited Condensed Consolidated Statements of Operations. We recognized $0.9 million and $1.1 million in accounts receivable from this customer on the Unaudited Condensed Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, respectively.

We provide compression services to entities affiliated with Riverstone/Carlyle Global Energy and Power Fund IV, L.P. (“Riverstone”), which owns a majority of the membership interests in USA Compression Holdings. As of March 31, 2017, USA Compression Holdings owned and controlled our General Partner and owned 39.5% of the limited partner interests. During the three months ended March 31, 2017, we recognized $0.2 million in revenue from compression services from such affiliated entities in the Unaudited Condensed Consolidated Statements of Operations. We recognized no revenue from such controlled entities during the three months ended March 31, 2016.  We may provide compression services to additional entities affiliated with Riverstone in the future, and any significant transactions will be disclosed.

(9)  Commitments and Contingencies

(a)  Major Customers

We did not have revenue from any single customer representing greater than 10% of total revenue for the three months ended March 31, 2017 or 2016.    

(b)  Litigation

From time to time, we and our subsidiaries may be involved in various claims and litigation arising in the ordinary course of business. In management’s opinion, the resolution of such matters is not expected to have a material adverse effect on our consolidated financial position, results of operations or cash flows.

(c)  Equipment Purchase Commitments

Our future capital commitments are comprised of binding commitments under purchase orders for new compression units and serialized parts ordered but not received. The commitments as of March 31, 2017 were $99.3 million, which are expected to be settled throughout 2017 and 2018.

(d)  Sales Tax Contingency

Our compliance with state and local sales tax regulations is subject to audit by various taxing authorities.  Certain taxing authorities have claimed that specific operational processes, which we and others in our industry regularly conduct, result in transactions that are subject to state sales taxes. We, and other entities in our industry, have disputed these claims based on existing tax statutes which provide for manufacturing exemptions on the transactions in question. The state taxing authority has indicated that additional documentation to support the manufacturing exemption will be required before it will consider releasing its claim; however, it had not, until recently, indicated what documentation would be acceptable to them. In response to these recent events, we are in the process of gathering the documentation available to us to support the position we have taken with regard to the disputed transactions. We have recognized a liability of $0.1 million related to this issue; however, we believe it is reasonably possible that we could incur additional losses for this matter depending on whether the taxing authority accepts our documentation as sufficient to support our position that the disputed transactions are not taxable and the impact of any potential resulting litigation. Management estimates that the range of losses we could incur related to this matter is from $0.1 million to approximately $3.0 million. The upper end of this range assumes that we will be unable to apply the manufacturing exemption to any of the transactions in question, which management believes is remote.

(10)  Recent Accounting Pronouncement

In July 2015, the FASB agreed to defer by one year the mandatory effective date of its revenue recognition standard to annual and interim periods in fiscal years beginning after December 15, 2017, but has also provided entities the option to adopt it as of the original effective date. We expect to elect the modified retrospective transition method for adoption to annual and interim periods in fiscal years beginning after December 15, 2017. We expect to identify similar performance obligations under the new accounting standard as compared with deliverables and separate units of account previously identified. As a result, we expect the timing of our revenue recognition will not be materially impacted under this new accounting standard. Further, we expect that the revenue amounts we historically reported will not materially change as we apply the modified retrospective provisions of this new standard. We do not expect significant changes to our current accounting policies and are in the process of developing pro-forma quantitative and qualitative disclosures to reflect the nature, timing and uncertainty of cash flows, changes in contract balances, and significant judgments related to our performance obligations. 

In February 2016, the FASB issued a new leasing standard that increases transparency and comparability among organizations by, among other things, requiring lessees to recognize lease assets and lease liabilities on the balance sheet and requiring both lessees and lessors to disclose expanded qualitative and quantitative information about leasing arrangements. Income recognition for lessors will remain substantially similar to current GAAP but with some changes to conform and align guidance with the new lessee guidance and other areas within GAAP, such as Accounting Standards Codification Topic 606, Revenue from Contracts with Customers. The new leasing standard requires modified retrospective adoption, with elective reliefs, and becomes effective for public business entities for annual and interim periods in fiscal years beginning after December 15, 2018. We expect to adopt this new standard on January 1,

2019.  We are still in the process of evaluating the financial impact of adopting this standard on our consolidated financial statements.

In March 2016, the FASB issued an Accounting Standards Update (“ASU”) that clarifies the implementation guidance on principal versus agent considerations. The amendments are intended to improve the operability and understandability of the implementation guidance on principal versus agent considerations within the revenue recognition update. The effective date and transition requirements for the amendments in this update are the same as the effective date and transition requirements of the revenue recognition update. We are currently evaluating the impact, if any, of this ASU along with the revenue recognition ASU, on our consolidated financial statements.

In June 2016, the FASB issued new guidance for the accounting for credit losses on certain financial instruments. This guidance will become effective for interim and annual periods beginning after December 15, 2019, with early adoption permitted by one year. This ASU requires immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets. We plan to adopt this new standard on January 1, 2020. We expect that our adoption of this standard will not have a material impact on our consolidated financial statements.

ITEM 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations

DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

This report contains “forward-looking statements.” All statements other than statements of historical fact contained in this report are forward-looking statements, including, without limitation, statements regarding our plans, strategies, prospects and expectations concerning our business, results of operations and financial condition.  You can identify many of these statements by looking for words such as “believe,” “expect,” “intend,” “project,” “anticipate,” “estimate,” “continue” or similar words or the negative thereof.

Known material factors that could cause our actual results to differ from those in these forward-looking statements are described in Part II, Item 1A (“Risk Factors”) and elsewhere in this report. Important factors that could cause our actual results to differ materially from the expectations reflected in these forward-looking statements include, among other things:

All forward-looking statements included in this report are based on information available to us on the date of this report and speak only as of the date of this report.  Except as required by law, we undertake no obligation to publicly update or revise any forward-looking statement, whether as a result of new information, future events or otherwise.  All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the foregoing cautionary statements.

Overview

We provide compression services in a number of shale plays throughout the U.S., including the Utica, Marcellus, Permian Basin, Delaware Basin, Eagle Ford, Mississippi Lime, Granite Wash, Woodford, Barnett, Haynesville, Niobrara and Fayetteville shales. The demand for our services is driven by the domestic production of natural gas and crude oil; as such, we have focused our activities in areas of attractive natural gas and crude oil production growth, which are generally found in these shale and unconventional resource plays. According to studies promulgated by the Energy Information Agency (“EIA”), the production and transportation volumes in these shale plays are expected to increase over the long term due to the comparably attractive economic returns versus returns achieved in many conventional basins. Furthermore, the changes in production volumes and pressures of shale plays over time require a wider range of compression services than in conventional basins. We believe we are well-positioned to meet these changing operating conditions due to the flexibility of our compression units. While our business focuses largely on compression services serving infrastructure installations, including centralized natural gas gathering systems and processing facilities, which utilize large horsepower compression units, typically in shale plays, we also provide compression services in more mature conventional basins, including gas lift applications on crude oil wells targeted by horizontal drilling techniques. Gas lift, a process by which natural gas is injected into the production tubing of an existing producing well, thus

reducing the hydrostatic pressure and allowing the oil to flow at a higher rate, and other artificial lift technologies are critical to the enhancement of oil production from horizontal wells operating in tight shale plays.

Operating Highlights

The following table summarizes certain horsepower and horsepower utilization percentages for the periods presented.

The 1.6% increase in fleet horsepower as of March 31, 2017 over the fleet horsepower as of March 31, 2016 was attributable to the compression units added to our fleet to meet the then expected incremental demand by new and current customers for our compression services. Average revenue generating horsepower was materially consistent during the three months ended March 31, 2017 and 2016. The 4.7% decrease in average revenue per revenue generating horsepower per month for the three months ended March 31, 2017 over March 31, 2016 was primarily due to (1) reduced pricing in the small horsepower portion of our fleet in the current period and (2) an increase in the average horsepower per revenue generating compression unit in the current period, resulting from an increase in the number of our large horsepower compression units which generally generate lower average revenue per revenue generating horsepower than do small horsepower compression units. 

Average horsepower utilization decreased approximately 0.6% during the three months ended March 31, 2017 compared to the three months ended March 31, 2016.  The decrease in average horsepower utilization is primarily

attributable to the following changes as a percentage of total available horsepower: (1) a 3.3% increase in our average fleet of compression units returned to us not yet under contract, (2) a 2.2% decrease in idle horsepower under repair, which is excluded from the average horsepower utilization calculation until such repair is complete, offset by (3) a 4.0% increase in horsepower that is under contract but not yet generating revenue.  We believe the decrease in average horsepower utilization is the result of a delay in planned projects of certain of our customers, continued optimization of existing compression service requirements by our customers and our selective pursuit of what we deem to be the most attractive opportunities. The above noted fluctuation in utilization components describes the change in period end utilization as of March 31, 2017 compared to March 31, 2016.

Average horsepower utilization based on revenue generating horsepower and fleet horsepower decreased approximately 1.8% during the three months ended March 31, 2017 compared to the three months ended March 31, 2016. The decrease is primarily attributable to the following changes as a percentage of total fleet horsepower: (1) a 5.4% increase in our average idle fleet from compression units returned to us offset by (2) a 2.1% decrease in idle horsepower under repair and (3) a 1.8% decrease in our average idle fleet composed of new compression units. The increase in units returned to us is believed to be a result of our customers’ optimization of their compression service requirements. These factors also describe the variances in period end horsepower utilization based on revenue generating horsepower and fleet horsepower as of March 31, 2017 and 2016.

Financial Results of Operations

Three months ended March 31, 2017 compared to the three months ended March 31, 2016

The following table summarizes our results of operations for the periods presented (dollars in thousands):

* Not meaningful.

Contract operations revenue.  During the three months ended March 31, 2017, we experienced a year-to-year decrease in demand for our compression services driven by decreased operating activity in natural gas and crude oil production and continued optimization of existing compression service requirements, resulting in a $3.8 million decrease in our contract operations revenue. While average revenue generating horsepower was materially consistent for the two periods, average revenue per revenue generating horsepower per month decreased from $15.72 for the three months

ended March 31, 2016 to $14.98 for the three months ended March 31, 2017, a decrease of 4.7%, attributable, in part, to reduced pricing in the current period in the small horsepower portion of our fleet. The decrease in average revenue per revenue generating horsepower per month was also attributable to the 3.4% increase in the average horsepower per revenue generating compression unit in the current period, as large horsepower compression units typically generate lower average monthly revenue per revenue generating horsepower than do small horsepower compression units. Average revenue per revenue generating horsepower per month associated with our compression services provided on a month-to-month basis did not significantly differ from the average revenue per revenue generating horsepower per month associated with our compression services provided under contracts in the primary term. Because the demand for our services is driven primarily by production of natural gas, we focus our activities in areas of attractive production growth, which are generally found in certain shale and unconventional resource plays. Our contract operations revenue was not materially impacted by any renegotiations of our contracts during the period with our customers.

Parts and service revenue.  Parts and service revenue was earned primarily on the installation of equipment ancillary to compression operations. The $3.5 million increase in parts and service revenue was primarily attributable to a $4.2 million increase in revenue associated with installation services, offset by a $0.7 million decrease in the remaining parts and service revenue.

Cost of operations, exclusive of depreciation and amortization. The $1.7 million increase in cost of operations was primarily attributable to a $1.8 million increase in retail parts and service expenses, which included $2.2 million of additional costs associated with our installation services. Excluding the $2.2 million of additional costs, retail parts and services expense decreased $0.4 million reflective of a corresponding decrease in this component of parts and services revenue. Additionally during the period, we experienced a $0.5 million increase in direct expenses, such as parts maintenance and fluids expenses offset by a $0.7 million decrease in indirect expenses, primarily related to decreased property and other taxes.  The increase in parts maintenance and fluids expenses was primarily driven by an increase in fluids prices and an increase in maintenance activity during the current period.

Gross operating margin. The $2.0 million decrease in gross operating margin was primarily due to a decrease in revenues, partially offset by a decrease in operating expenses and the $2.0 million of gross operating margin we earned from our installation services during the three months ended March 31, 2017.

Selling, general and administrative expense.  The $1.4 million increase in selling, general and administrative expense for the three months ended March 31, 2017 was primarily attributable to a $1.1 million increase in unit-based compensation expense and a $0.7 million decrease in bad debt recoveries. Unit-based compensation expense increased primarily due to (1) the increase in our unit price as of March 31, 2017 compared to March 31, 2016 and (2) the increase in our unit price on the vesting date of phantom units during 2017 as compared to 2016. 

Depreciation and amortization expense.  The $2.1 million increase in depreciation and amortization expense was primarily related to an increase in gross property and equipment balances during the three months ended March 31, 2017 compared to gross balances during the three months ended March 31, 2016. There was no variance in amortization expense between the same periods, as intangible assets are amortized on a straight-line basis and there has been no change in gross identifiable intangible assets between the periods.

Impairment on compression equipment. The $1.1 million impairment charge during the three months ended March 31, 2017 resulted from our evaluation of the future deployment of our current idle fleet under the current market conditions. As a result of our evaluation, we determined to retire, sell or re-utilize key components of 2 compression units, with a total of 2,760 horsepower, which were previously used to provide compression services in our business.  The cause of impairment was due to estimated significant repair costs from previous damage to the equipment. 

Interest expense, net. The $0.6 million increase in interest expense, net was primarily attributable to the impact of an increase in our weighted average interest rate. Our revolving credit facility bore an interest rate of 2.91% and 2.51% at March 31, 2017 and 2016, respectively, and a weighted average interest rate of 2.98% and 2.47% for the three months ended March 31, 2017 and 2016, respectively. The impact of the increase in interest rate was partially offset by a $41.9 million decrease in average outstanding borrowings under our revolving credit facility. Average borrowings under the facility were $703.0 million for the three months ended March 31, 2017 compared to $744.9 million for the three months ended March 31, 2016.  During December 2016, we completed a public equity offering and utilized net proceeds of $80.9 million to reduce indebtedness outstanding under our revolving credit facility.

Other Financial Data

The following table summarizes other financial data for the periods presented (dollars in thousands):

Adjusted EBITDA. Adjusted EBITDA during the three months ended March 31, 2017 decreased $2.4 million, or 6.3%, over the three months ended March 31, 2016, primarily due to a $2.0 million decrease in gross operating margin and $0.6 million higher selling, general and administrative expenses, excluding unit-based compensation expense and severance charges, during the three months ended March 31, 2017.

DCF. The $4.7 million, or 14.7%, decrease in DCF during the three months ended March 31, 2017 was primarily attributable to (1) a $2.0 million decrease in gross operating margin (2) a $1.8 million increase in maintenance capital expenditures (3) a $0.6 million decrease in selling, general and administrative expenses, excluding unit-based compensation expense and severance charges and (4) a $0.5 million increase in cash interest expense, net, during the comparable period.  Maintenance capital expenditures were higher during the three months ended March 31, 2017 than the three months ended March 31, 2016 due to increased maintenance activity during the current period.

Coverage Ratios. The disproportionate decrease in Cash Coverage Ratio (as compared to DCF Coverage Ratio) is due to period-to-period decreases in DRIP participation by USA Compression Holdings.

Liquidity and Capital Resources

Overview

We operate in a capital-intensive industry, and our primary liquidity needs are to finance the purchase of additional compression units and make other capital expenditures, service our debt, fund working capital, and pay distributions. Our principal sources of liquidity include cash generated by operating activities, borrowings under our revolving credit facility and issuances of debt and equity securities, including under the DRIP.

We believe cash generated by operating activities and, where necessary, borrowings under our revolving credit facility will be sufficient to service our debt, fund working capital, fund our estimated 2017 expansion capital expenditures, fund our maintenance capital expenditures and pay distributions through the remainder of 2017. Because we distribute all of our available cash, which excludes prudent operating reserves, we expect to fund any future expansion capital expenditures or acquisitions primarily with capital from external financing sources, such as borrowings under our revolving credit facility and issuances of debt and equity securities, including under the DRIP.

Cash Flows

The following table summarizes our sources and uses of cash for the three months ended March 31, 2017 and 2016 (in thousands):

Net cash provided by operating activities. The $3.7 million decrease in net cash provided by operating activities for the three months ended March 31, 2017 was due primarily to $2.0 million lower gross operating margin, adjustments to non-cash and other items and changes in our working capital. 

Net cash used in investing activities. Net cash used in investing activities for the three months ended March 31, 2017 and 2016 related primarily to purchases of new compression units, reconfiguration costs and related equipment.

Net cash used in financing activities. During the three months ended March 31, 2017, we borrowed $29.5 million, on a net basis, primarily to support our purchases of new compression units, reconfiguration costs and related equipment, as described above. Additionally, we paid cash related to net settlement of unit-based awards in the amount of $2.8 million and made cash distributions to our unitholders of $29.4 million.

During the three months ended March 31, 2016, we borrowed $13.9 million, on a net basis, primarily to support our purchases of new compression units, reconfiguration costs and related equipment, as described above.  Additionally, we paid various loan fees and incurred costs in respect of our revolving credit facility in the amount of $2.0 million and made cash distributions to our unitholders of $17.7 million.

Capital Expenditures

The compression services business is capital intensive, requiring significant investment to maintain, expand and upgrade existing operations. Our capital requirements have consisted primarily of, and we anticipate that our capital requirements will continue to consist primarily of, the following: