Natural Gas Services Group, Inc. (NGS) Q2 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter 2012 Conference Call. [Operator Instructions] Your call leaders for today's call are Leann Conner, IR Coordinator; Steve Taylor, Chairman, President and CEO. I will now hand the call over to Ms. Conner. You may begin.

Thank you, Erica, and good morning, listeners. Please allow me to take a moment to read the following forward-looking statement prior to commencing our earnings call. Except for the historical information contained herein, the statements in this morning's conference call are forward-looking, and they are made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, as you may know, involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group's actual results in future periods to differ materially from forecasted results. Those risks include, among other things, the loss of market share through competition or otherwise, the introduction of competing technologies by other companies, new governmental safety, health or environmental regulations which could require Natural Gas Services Group to make significant capital expenditures. The forward-looking statements included in this conference call are made as of the date of this call, and Natural Gas Services undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include, but they are not limited to, factors described in our recent press release and also under the caption Risk Factors in the company's annual report on Form 10-K filed with the Securities and Exchange Commission. Having all that stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Okay. Thanks, Leann. Thanks, Erica. And good morning, everyone, and welcome to Natural Gas Services Group Second Quarter 2012 Earnings Review. NGS had a good quarter, and our year-over-year results continue to exhibit robust growth. As we go through the numbers, I think you'll see that operationally, everything is advancing, but we did see some quarter-to-quarter decline to some measures. I will detail them as we go through the call, but they're primarily due to typical quarterly variances and compression sales revenues, incrementally higher make-ready expenses and higher noncash SG&A costs. Not to mention the comparison against a very strong Q1. I had mentioned on the last call that our challenge this year would be to stay ahead of any deterioration in the dry natural gas areas due to low gas prices with offsetting growth in the oil and liquids markets. That continued to be the hurdle, and we saw some impact from the low gas prices on our rental activity in the dry areas, particularly, but not surprisingly in this quarter. We have been able to stay ahead of it and we continue to be optimistic to the rest of the year in both our rental and sales businesses. Looking at total revenue in the year-over-year quarters. Second quarter 2012 revenues increased 78% to $24.5 million from $13.8 million in the second quarter of 2011. Almost $9 million of this increase came from compressor sales with $2 million coming from year-over-year increase in rental revenues. The sequential quarters of Q1 '12 compared to the second quarter of this year, total revenues decreased $1.9 million or 7%, primarily due to the variability of compressor sales between quarters. On a year-to-date 6-month to 6-month comparison, total revenues were up $22 million or 77%. $17 million of that increase is attributable to compressor sales. Comparing the second quarter of this year to the second quarter of 2011, total gross margin increased 35% from $8.2 million to $11 million. Sequentially, gross margin was essentially flat between quarters at $11.2 million in the first quarter this year and $11 million in this current quarter. Overall, gross margin did, however, improve to 45% of revenue compared to 43% last quarter. In the comparative year-to-date periods, gross margin grew $6.1 million or 38%. One of the anomalies we had this quarter was an appreciable increase in SG&A. It increased 61% in the year-over-year quarters and 30% sequentially but as a percent of revenue, it still ran a reasonable 10% to 11%. This is mainly a quarterly variation, and approximately 70% of the sequential increase was due to noncash accrual adjustments that will reduce over the remaining quarters of the year. Looking at operating income and comparative year-over-year quarters, we had a 50% increase of $1.6 million, up from $3.2 million in the second quarter of 2011. Sequentially, operating income decreased $800,000 but remained in the 20% to 21% of revenue range for both quarters. Year-to-date, operating income increased 60% this year when compared to the June 2011 year-to-date results. In the comparative year-over-year second quarters, net income increased 50% from $2 million last year to $3 million this year. Comparing the first quarter this year to the current second quarter of 2012, net income was off $500,000 to $3 million. Both quarters were in the 12% to 13% range of revenue. Our tax rate rose slightly from 38% to 38.6% in the sequential quarters. Year-to-date, net income was up $2 million or 44% to $6.5 million. EBITDA increased $2 million from $6.7 million in the second quarter 2011 to $8.7 million in the current quarter or 30%. Sequentially, EBITDA decreased $800,000 to $8.7 million in the second quarter of this year with both quarters in the 35% to 36% margin range. In the comparative 6-month periods, EBITDA increased $4.1 million or 29%. On a fully diluted basis, EPS earnings per share this quarter was $0.24 per common share compared to $0.29 last quarter and $0.16 last year. Total sales revenues in the sequential quarters fell $1.8 million to $10.6 million. The gross margin increased from 23% to 30%. This quarterly revenue decline is part and parcel of the volatility we experienced in our sales business, and this one in particular is primarily attributable to the delay of a large customer fab compressor delivery due the customer spec changes. Recall also that Q1 of this year reflected a very robust quarter due to the recognition of some compressor unit sales that were delayed from the fourth quarter 2011. In the year-over-year quarters, total sales revenues increased to $10.6 million in the second quarter this year as compared to revenues of $1.9 million in the second quarter of last year. Please recall that over $5 million of this was in nonrecurring sales from rental compression equipment to a large customer, but the underlying increase is still noteworthy. Looking at compressor sales alone, in the current quarter, they were $8.3 million with a gross margin of 23%. Our compressor sales backlog at the end of this quarter is $7 million to $8 million. Rental revenue had a year-over-year increase of $2 million or 18% from $11.6 million in the second quarter of 2011 to $13.6 million for this current quarter. Gross margins were 58% and 57% of revenue, respectively. Sequentially, rental revenues were essentially flat with a decrease of $70,000 to $13.7 million this quarter. This is the first time in over 2 years that we haven't seen an increase in the quarterly rental revenues, but it was primarily the result of the effect of the nonrecurring sale of rental equipment to a large customer. While we enjoyed a good increase in sales revenues from that transaction, there is foregone rental revenue associated with it. We did see an uptick in rental returns from dry gas areas this quarter, which, it being a shoulder season isn't unusual, but the underlying liquids-oriented growth is still present, and we anticipate rental gains through the rest of the year. To filter out some of the noise of this quarter in rentals, if we net out the effect of the sale of rental equipment and one particularly large single customer shut-in, our rental business would have grown 4% this quarter. Gross margin moved from 60% last quarter to 57% of revenue this quarter. We experienced routine quarterly variations in this margin, but we did have a higher level of incremental expense from make-ready overhauls this quarter. 55 units were prepared in Q1 of this year while 97 were overhauled this quarter, an 80% increase. The make-ready overhaul is where we inspect, repair and prepare equipment to go out on a new rental contract. This work is only performed when a rental contract has been signed, so it's a pretty good indicator of future growth. Coincidentally, the year-ago second quarter exhibited the same kind of quarterly increase in overhaul expense. I'll remind everybody that NGS expenses these overall costs, and they go directly against our gross margins. This contrasts with some industry practices that capitalize a large part of these costs and therefore, our margins are some of the higher, if not the highest in the industry. We ended the second quarter with rental fleet utilization essentially flat with last quarter in the 74% to 75% range with horsepower utilization running 76%. Fleet size at the end of June was 2,167 compressors. This calculates to a net addition of 47 compressors year-to-date. But we actually built and set twice that many, 97 to be exact, when you account for the rental equipment sale. We built a total of 57 compressors this quarter, but added 32 net compressors to the rental fleet. Last year, at this time, we had built and added 120 units to the fleet, so we are on pace with what we anticipated growth to be this year. Rental fleet CapEx year-to-date this quarter has been $8.6 million compared to $5.6 million in Q1. We have continued our market expansion to new liquids-oriented areas. These primarily include the Utica Shale, Granite Wash and the Niobrara. And they're all still growing. There are couple of others we're evaluating, and we'd like to move into them as the customer pool develops. We're optimistic that our rental growth will continue through the balance of the year. The combination of increased make-ready overhauls, our contract to build schedule and new markets point to higher levels of activity. Gas prices could, of course, derail this, but we think that, too, is trending up. Going to the balance sheet, our total short-term and long-term debt was $1 million as of June 30 of this year, and cash in the bank was $30.4 million. Our cash flow from operations through the first 6 months of the year was $24.4 million compared to $16 million for the same period in 2011, a 28% increase. From a general market perspective, EIA, the Energy Information Administration of the U.S. government, projections for natural gas production anticipate just over 4% growth this year with demand climbing 5% and prices predicted to be $2.58 average in 2012 and an average of $3.22 next year. These price projections have actually climbed since the last quarter and tend to point to a better winter than last year, followed by a stronger 2013. Longer term, the natural gas market continues to be attractive. For the first time ever, natural gas burn for power generation in April of this year exceeded the amount of coal consumed. The number of coal plants slated for retirement over the next 3 years equals almost 9% of the installed gigawatt capacity in this country, and those will be largely replaced with natural gas fuel generation. Retirements over the next 5 years of coal plants will be 400% more than what has been retired in the last 5. LNG exports will gather steam over the next 3 to 5 years, and there are plants being constructed now and others in the mix. Bottom line, I think, is that we're transitioning to a period where natural gas will be a larger structural part of the economy, prices will be relatively stable and consumption will grow. In all of this, larger volumes of natural gas will flow through the system, and that's how we make our money. Now from the I-have-to-laugh-to-keep-from-crying department. I started out to comment on the folly innate danger of this administration's energy policy, but there's so much to choose from. Should I revisit the purely political decision to bow to the green lobby and definitely delay the Keystone pipeline project and how it has now led to Canada inviting China into the North American energy picture? Yes, so they said they would, if the U.S. didn't want their oil. Or should I comment on the continued agenda about the EPA to hinder fracturing as a safer reliable method it is to help us extract the trillions of cubic feet of natural gas we've now discovered? This, in spite of EPA repeatedly losing their cases on the fact that fracturing hasn't been proven to contaminate ground water, damn those facts. These are still dangerous ideas. But what I'm going to talk about, I truly did not make up. We're all used to hearing about alternative energy in the form of solar and wind, and we all know that there remain problems with this widespread use, not to mention the billions of dollars wasted on it. Well, let's discuss biomass, that alterative form that also qualifies for federal subsidies. And they qualify because what they burn is renewable. Yes, do they burn stuff and they produce emissions. Well, as can imagine, although the feds can't, not everything burnable and renewable is clean. Some plants can qualify if they prove themselves to be carbon neutral. That seems impossible when you burn something organic, but for example, the feds allow you to burn wood and produce large amounts of carbon under the premise that as wood decays, it would emit the carbon anyway. Forget the fact that one, it takes a minute to burn a tree, while it takes years for it to decay. What we now have is an industry in which 85 of the 107 biomass plants that were operating at the beginning of this year have been cited by state and federal regulators for air and water pollution violations. Nearly all biomass plants receive subsidies either through direct cash payments or the ability to charge more than market rates for their power. In fact, much of the recent government funding has gone to projects that are already online. Millions of dollars in fines have been levied on the plants, but the ultimate resolution has at times been to use grant money to pay the fines or to raise the limits on allowable emissions in an effort to make the plants compliant. Well, the industry would be allowed to do this. California has, of course, been a leader in biomass, and so makes a good example of the problems with this renewable source. I won't go into all the details about violations and fines at individual plants, but as an example, in one airport district in California, 3 of the 4 plants located there have been fined for violations over the last 2 years. They all 3 burned biomass and they all received some form of subsidy. However, the fourth plant has a clean environmental record and received no renewable energy subsidies. It burns natural gas. That's the end of my prepared remarks. I'll turn the call back to Erica for questions that anyone might have.

[Operator Instructions] Our first question comes from Gary Lenhoff from Great Lakes.

Just quickly, can you tell me what you believe the rental fleet -- the size of the rental fleet will be at year end and what CapEx for the full year will be. And then if you might take -- give us a range of what you think CapEx could be for the next year that would be helpful.

Well, I had said previously we were thinking, anticipating CapEx this year to be in the $25 million to $30 million range, and that's about what we're tracking. So we'll stay in that range right there. And then that would equate to roughly an addition of 150 to 200 compressors. Now this rental fleet sale kind of skews those numbers as I went through awhile ago. So if we, for example, build out 150, it's going to net out to be about 100 because there's approximately 50 sold in that deal. Now as far as 2013, my gosh, you're asking me to look beyond lunch today. Yes, that's -- I mean, we think the margin's going to be a little stronger starting from the gas side. Oil has shown a little deterioration here, but I tend to think that's not going to get too bad. So this is a fully undeveloped thought because we don't -- that's pretty far to project. But I would guess that we'd probably be in the same range as this year from maybe a CapEx and a rental fleet addition. Although, yes, we'll net more next year because hopefully we won't sell any like we had to this year.

Our next question comes from Gary Farber from CL King.

Can you just discuss how much of the fleet is exposed to where you stand as far as the liquids business?

Yes. We've got about 20%, 22%, 23% of the fleet in liquids now. And I mentioned in the past, I think, we -- end of '11, we're at 20%; end of '10, we're at 10%. And I think I mentioned in the past, we thought that we wouldn't be going up 10% each year but probably mitigate somewhat. So I think we're probably about halfway of where I thought we would be and coincidentally, halfway through the year. Probably I would guess ending up the year in the 25% range roughly.

And then maybe just overall, how you view the pricing environment currently.

From our product or commodity price?

Your product.

Well, it seems to be kind of benign a little, I guess. We every once in a while -- it's kind of like whack-a-mole. Sometimes, every once in a while, you see something pop up over on the horizon somewhere on a deal you just can't believe was priced that way. And everybody's got reasons for pricing stuff differently. Our pricing has held steady through the year. We're up about 5% over last year. We see, as I mentioned before, all the stuff we're billing now is going out at premium 2008 level pricing. So we think pricing is okay. It's not -- we still are going to -- we still want to and try to push it because we really haven't had an overall increase in too long. And the price we're getting now is kind of incrementally driven as equipment goes out. So it takes a little longer to get the full effect. We're getting there, it's just taking a little longer. So right now, everything seems to be a little steady. Again, that seems -- right when I say it, it seems to change somewhat in some areas. But we're happy with where our price is going, and we're able to push it adequately.

Right. And then just one last one. On the cash balance, you'd expect it to go higher by year end?

No, I imagine it'll price kind of level right at -- we've had it a lot this first half, primarily from that rental equipment sale. So I think with the capital anticipated for the rest of the year and the cash generated, we'll end up within 5% or 10% of where we are.

[Operator Instructions] Our next question comes from Jeff Spittel from Global Hunter Securities.

Touching on pricing again, I guess, it's been kind of tracking in the single digits on a year-over-year basis in terms of incremental pricing in the rental fleet. Is that kind of a reasonable expectation do you think for the second half of the year?

Yes. I don't think we'll get much more than that because like I said, there's not -- the markets -- I mean, we're growing and a lot of our competitors are growing, but the market's still not strong enough to take just an overall blanket increase because there's just still too much equipment sitting idle out there. So we're having to -- like I mentioned, we're having to incrementally go up in areas and on equipment when we can. And it just takes a little longer.

Okay. And any areas in the liquids spaces in particular? I know you mentioned you started off in the Barnett combo, Granite Wash, Utica, Niobrara. Are you seeing a little bit more of an influx competitively from some of the other guys in those basins? Or do you think you're still pretty well out in front?

Well, I think we're -- it probably depends on the area. I think the Barnett combo, we're a leading provider. I think, Utica, same thing. Niobrara, we're just getting started in there, so we're probably just a little behind but not much. But that's coming on pretty quick for us. That actually looks like a pretty good area. So I think, we're either leading or will lead within the next 6 to 12 months in those areas.

Our next question comes from Joe Gibney from Capital One.

How about Eagle Ford? Just following up on Jeff's question about liquid structure [ph] growth in Utica, Granite Wash, Niobrara, for now, Barnett combo has been good. Anything going on in the Eagle Ford? Any traction there? I know it's sort of early days, but just curious to get your perspective.

Yes, it's -- probably 18 months ago, we thought that was going to be one of the quicker growers, and it really hadn't for us. We're spotty in there, and there's a couple reasons for it. Number one is a lot of the stuff going in there is bigger horsepower right now. So people are going more central stations with bigger horsepower. That's typically initial phase given some of these plays. So I think we're seeing that first, and then ultimately, our wellhead stuff will come along a little more, I think. And also, we're pushing just -- out just as much equipment as we can actually in our fab shops. So between balance and between what sales business we have and the rental stuff, we're putting out just about as much as we can. So we've chosen actually to -- may concentrate just a little more on these ones we've got a quicker uptake in and establishing some good customers and now have some critical mass and service capability there to go ahead and build those out a little quicker. And while we're still -- we've got some people in the Eagle Ford and some equipment in there, but we think our immediate growth is going to be those other areas.

Okay, helpful. On the make-ready overhaul, you had a bit of a blip in 2Q. You indicated same deal happened last year. But as you look into 3Q, does that abate back down towards kind of 4Q, 1Q levels, more normalized levels in terms of -- at least in terms of you're seeing right now?

Well, I think it will. But again, that's kind of a -- it's not all bad. I mean, you [indiscernible] expenses in advance, yes. But that revenue comes down the road. So I don't want to hope for it to go down too much from the fact that, that's equipment going out on rentals, so -- but yes, I think it will mitigate some. I mean, it jumped quite a bit, 80% this quarter, that's a pretty big quarter-to-quarter jump. And that was an impact on the margins, but I think it'll get back into -- I would anticipate getting back into the "normal range."

Okay. And then last one for me, and I'll turn it back. Just in terms of progression out of your backlog now, I mean you had a sort of a noisy couple of quarters just working through the one-time sale, so between $7 million to $8 million under your compressor sales backlog. Kind of how do we think about that flowing out in terms of revenue over the next -- at least, in terms of the next couple quarters?

I think you asked that last question last time and I answered it. I probably shouldn't answer it this time. We just -- it looks like it's -- probably right now, it's like 40%, 40%, 20% over the next 3 quarters. And throw in my disclaimer of it, just as has happened the last 2 or 3 quarters, this stuff is always slipping for some reasons. Typically, it's a customer delay from the point of adding more equipment or change of spec or something like that, but it's about as close as I can put it right now.

[Operator Instructions] At this time, we have no further questions.

Okay. Well, thanks, Erica, and I appreciate everybody joining me on this call. And I look forward to visiting with you again after the next quarter. Goodbye.

This concludes today's conference call. Thank you for attending.