Natural Gas Services Group, Inc. (NGS) Q2 2013 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter Earnings Release Conference Call. [Operator Instructions] Your call leaders for today's call are Lindsay Naylor, IR Coordinator; and Steve Taylor, Chairman, President and CEO. I would now like to turn the call over to Ms. Naylor. You may begin.

Thank you, Ross, 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 of 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 and the 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 Group 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, Lindsay, and thanks, Ross. And good morning, and thank everyone for joining me for Natural Gas Services Group's second quarter 2013 earnings review. I'm actually delivering this report on my way back from the Bakken Shale in North Dakota and Montana, where we were visiting customers and reviewing some of our plans for the area. We have a good quarter to report on. And we think the balance of the year will continue to be active and growing. Although I will discuss more in detail, rental demand remains strong and gross margins across all business lines were higher this quarter. Our compressor sales revenues continue to exhibit a high degree of variability, and have declined on a comparative basis. But that's due to a large extraordinary sale on last year's second quarter, a robust first quarter this year and our stated intent to sacrifice sales fabrication for rental fabrication through the year. We also had some sales revenues anticipated for the second quarter that were delayed until the third quarter. I'll go into details later in the call. But with that introduction, let's move on to the numbers. Looking at total revenue in year-over-year quarters, for the second quarter 2013, revenues decreased to $20.3 million from $24.5 million in the second quarter of 2012. This decrease was primarily due to the large extraordinary sale of about $5.5 million we had in some rental equipment when you compare it to the second quarter of last year. Rental revenue, however, increased a little over $3 million or 22%. For the sequential quarters of the first quarter of 2013 compared to the second quarter of this year, total revenues declined $3.7 million. Rental revenue increased 5%. But as I mentioned on last quarter's call, our sales business had a better-than-anticipated first quarter due to some holdover 2012 sales. And this reflects some of the decline we expected and announced. Comparing the second quarter of 2013 to the second quarter of 2012, total gross margin, in spite of the revenue decline, increased 12% from $11 million to $12.3 million. This was due to a greater contribution from our rental business and higher margins in all 3 primary areas of our business: rentals, sales, and service and maintenance. Sequentially, gross margin was essentially flat at $12.3 million -- an increase as a percent of revenue from 51% to 61% because of the higher relative contribution from rentals. SG&A decreased a little over $300,000 in the year-over-year quarters, but increased a little less than $200,000 sequentially. SG&A continues to run at 9% to 10% of revenue, although both year-to-date periods of 2012 and 2013 are in the 8% to 9% range. For operating income and looking at the comparative year-over-year quarters, operating income reflects a 21% increase from $4.8 million in the second quarter of last year to $5.8 million in this current quarter. We think this is pretty impressive considering the comparative revenue declines we saw. Sequentially, operating income decreased approximately $300,000. As a percent of revenue, it climbed from 26% to 29% this quarter. Besides revenue impact, operating income was affected by a small increase in SG&A and a higher depreciation from additional fleet equipment. In the comparative year-over-year second quarters, net income increased 28% from $3 million last year to $3.8 million this year. Although our total top line was lower, a strong rental contribution, our margins across the company and lower net tax rate enabled us to deliver a higher net effect. Without the lower tax rate, we would have still seen a net income increase year-over-year of 19%. Net income was essentially flat between sequential quarters at $3.8 million for the same reasons just mentioned for the year-over-year quarters. These first quarters of the year did exhibit net income in the 17% to 19% range of revenue. EBITDA increased 18% from $8.7 million in the second quarter of 2012 to $10.2 million in the current quarter. Sequentially, EBITDA in the second quarter of 2013 was $10.2 million, which was off $0.5 million compared to the first quarter of this year due to the lower quarterly revenue levels. EBITDA did come in at 50% of revenue. On a fully diluted basis, EPS this quarter, earnings per share, was $0.31 per common share compared to $0.24 in the second quarter of last year and $0.32 last quarter. Looking at sales revenues in the year-over-year quarters, total sales revenues decreased from $10.6 million in the second quarter of 2012 to $3.3 million in the second quarter of 2013. About $5.5 million of that decline was the extraordinary sale of rental compression equipment last year, while the balance was an anticipated decline in compressor sales volumes. Sequentially, total sales revenues, which includes compressors, flares and parts, fell to $3.3 million this quarter from $7.8 million in the first quarter this year. This was coming off a strong first quarter sales results due to the shipment of some delayed 2012 equipment. Gross margins did very well and increased from 38% to 52% in the sequential quarters primarily due to a higher relative level of flare sales. Looking at compressor sales alone, in the current quarter, they were $650,000 with an extremely high gross margin of 41%. This compares to compressor sales of a little over $5 million in the first quarter of 2013. As you recall, I mentioned in the last quarter that we anticipated that the remaining 3 quarters of compressor sales this year would approximate $5 million, which would have been a little less than $2 million per quarter. We had only $650,000 of sales in the second quarter of this year, but an additional $1.5 million that we had projected for this quarter was delayed by the customer and has in fact shipped in July. So this was delayed and not lost revenue, and our backlog is still intact. But as is often the case, we're realizing some of the sales in different months or quarters. As mentioned, our compressor sales backlog at the end of the second quarter was approximately $5 million. Rental revenue had a year-over-year increase of $3 million or 22% from $13.7 million in the second quarter of last year to $16.7 million for this current quarter. We had very good gross margins this quarter, with them running at 63% compared to 57% of revenue in last year's comparative quarter. These better margins are attributable to a generally lower level of make-ready expenses on fleet equipment and the movement of higher-priced, new oil shale equipment to the field. Sequentially, rental revenues grew almost 5% with an increase of over $700,000 to $16.7 million this quarter. Margins exhibited sequential improvement from 57% to 63%. We ended the second quarter with rental fleet unit utilization at 79% and horsepower utilization at 80%. These numbers are identical to the first quarter, but we have continued to grow. The utilization calculation can be misread in a quarter like this, but we moved relatively more new equipment into the field than idle fleet units. The growing utilization we have seen in the past 2 to 3 quarters has been primarily from our ability to redeploy used equipment due to some vapor recovery contracts we have won. While we still place equipment like this monthly, we may not see large contract wins directed at idle equipment every quarter. As we have seen in the past, this may cause some periodic flat unit utilization, but we will see continued redeployment and continued progress in growing our utilization of the existing fleet. Fleet size at the end of June was 2,392 compressors. This is a net addition of 65 compressors this quarter compared to 49 in the first quarter. You can see that according to plan, we have made some progress in ramping up our rental throughput. Approximately 40% of our utilized fleet is now in oil shale and liquids plays. This precis [ph] has been steadily increasing since 2010 when we placed our initial unit on an oil shale well. We spent $10.7 million for capital expenditures in the second quarter compared to $7.7 million in the first quarter. This is a total of $18.4 million for the first half of the year, with 96% of this going for rental fleet additions. I've noted in the past that we thought our capital expenditures this year would be in the $30 million to $35 million range. But with our growth and market penetration, we now see this advancing to between $35 million and $40 million this year. Going to the balance sheet, our total short-term and long-term debt was approximately $850,000 as of June 30, 2013. And cash in the bank was $29.3 million. Our cash flow from operations through the first 6 months of this year was $19.4 million. For my general comments, from a macro general perspective, we think that oil pricing stays in a narrow band through 2014 from approximately $90 to $100 a barrel, and continues to encourage operators to stay active. That, of course, will continue to drive our oil and liquids expansion and growth. Gas-wise, I'm not predicting price anymore, but I think the trend for 2014 will be set by this winter. If we see relatively cool weather and the price heads back towards $4 per MCF, I think we may be able to sustain itself -- price may be able to sustain itself through next year. If winter is a non-event, I think we're back to the nominal $3.50 plus or minus sort of pricing for another year. I will make a couple of comments about the Bakken Shale since I was just up there. The activity everyone hears about is true and is widespread. We traveled from Sidney-Plentywood, Montana region over to Williston-Tioga, North Dakota area and that span of over 125 miles, which does not cover the full extent of the play, is busy everywhere. As in all the liquids plays, the commodity choice is oil. But there's always a fair amount of associated gas being produced. The Bakken is no different except that it is further behind in gas infrastructure than most. This is being remedied, but it does take time. It is significant that Continental Oil, one of the largest, if not the largest operators in the area, recently announced they are committed to eliminating flaring and other gas emissions totally within a short few years. That means that gas would not be flared, but probably gathered and transported. That takes compression and is good news for us. We have set a modicum of equipment in the area, and we think it will grow, albeit at a slower-than-normal pace. The real growth here is for gas and heavy equipment will be in a couple years down the road. But we think positioning now is important. That's the end of my prepared remarks. Now I'll turn the call back over to Ross for questions anyone might have.

[Operator Instructions] Our first question comes from Jason Wangler from Wunderlich Securities.

Just maybe following up on those last comments in the Bakken, can you give us maybe just an idea of how many units you have up there now? And I guess just where you see that going in terms of the infrastructure coming in and is just -- you just start putting more and more up, I guess, as the equipment starts -- or the infrastructure starts getting in there?

Yes. I won't give the exact number, just from a competitive standpoint. But I'll say it's -- let's say it's between 0 and 50 up there right now. So it's still a relatively small area for us. But as I mentioned, we think there's value in prepositioning there somewhat. It's a -- as everybody knows, the gas infrastructure there is not as well developed, There are gas pipelines going in of course. In fact, we saw some gas plants [ph] being installed. Then we get announcements like Continental. I think it's going to be a pretty good area, ultimately. We do think it's a year or 2 down the road. Once everything gets in and going and some compression starts moving. And there's not a whole lot up there from anybody, us or any competitors. I think it is going to be growing. It's an area that's fairly insular from a point that it's so remote, such a hardworking environment that you have to kind of get up there and be part of that community for a little bit. And that's what we're in the midst of trying to do.

That's helpful. And then just make sense, obviously, the CapEx bump. I mean, how many compressors do you think you're targeting to add in the second half of this year?

Well, if we -- we've got about $19 million. I mean, we're about halfway. If we go to $35 million, $40 million. If we just take $40 million as a number, yes, we've got a little over -- a little less than half of that spent and about a little, what, about 110 units. So we'll be in the 225, 250 range by the end of the year we think.

Next question comes from Joe Gibney from Capital One.

Just one quick question, just trying to understand a little bit the additional flow-through progress on ramping up your throughput. Is this just a function of shifting over to Tulsa a little bit more? Is there some outsourced fab embedded in that lift? Just trying to get a little better feel for any additional throughput.

No. It's mainly our own facilities shifting more into Tulsa for them to take on more there. We're still looking for some outside fabricators. We still think we might be able to push a little more if we had a little more capacity. But first, we're working on our internal requirements. So that's mainly opening up Tulsa, as I mentioned in the call last time. That's why we have ramped down the sales revenue a bit for the year and that's what we're seeing right now. And then it being taken -- its place being taken by the rental fab. And we do anticipate or we are hoping that we can find some external fabrication. It's just, number one, everybody's busy; and number two, quality issues are always foremost.

Next question comes from Peter Van Roden from Spitfire Capital.

Just one quick question, how was the VRU deployment coming along right now?

We've got a couple of contracts towards the end of last year or first of this year. We're still -- the lowest contracts we're still deploying equipment. Of course we passed the flush deployment on it, but we're still putting stuff out. And in fact, I think we're making a little more penetration into that customer than we originally anticipated. The second contract is really just starting to ramp up, not a whole lot this year. We'll see more next year. I think the final EPA rules on this, the VRU stuff for tank vapors were issued the other day. They did keep some of the VRU requirements for April 2014, but then moved some of the other VRU requirement back to April of 2015. So they've given the industry about another year to implement some more VRUs. So -- which is not a bad thing necessarily because the industry was pushing from the point that you just can't get that much equipment out in the field. So I think it's going to be a little more of a manageable sort of thing. And we anticipate to continue to grow certainly through this year and the next couple of years. And then it's just going to be a steady stream after that.

Okay. And then one follow-up. How has -- I know Extern came out a couple of days ago and said that they saw a lot of equipment come out of dry gas plays this past quarter. How has your business been there?

We've pretty well held our own there. You can look at our dry gas volume in a number of compressors. And it's really been pretty steady the last 3 to 4 years, it just hasn't varied 5%, probably. And in fact, we've seen maybe just a little in -- cautious about saying this because I said it last time, and everybody thought dry gas was back. But we've seen a little movement into dry gas in a couple of areas, just not by any stretch, a trend or anything to really get too excited about. But I think it just continues along with the trend we've seen where we're able to really pretty well hold in the dry gas and then the growth coming from the liquids plays.

[Operator Instructions] And we do have a question from Craig Hoagland from Anderson Hoagland. Craig Hoagland - Anderson Hoagland & Co.: Steven, what is -- what do you consider the useful life of the new units you're building for the fleet now?

Well, they're like all of our units, they're book depreciated on 15 years. But we expect them to be a 20-year piece of equipment. It's all heavy duty oil field stuff, good engines, good compressors. We design and build this stuff ourselves. So we know exactly what goes into them. And then, of course, we maintain them ourselves. So really, if you look at a unit -- and we don't have any that are 15 years old. We haven't even depreciated any fully yet. But so you take a look at a 10-year old unit, it may have a couple coats of paint on the outside, and it looks like it's been through the oil field for 10 years. But you have to remember, about every 2.5 to 3 years, that equipment goes through an overhaul. So all the internal running gear's still pretty new. So that's the important part. That's what keeps the equipment in good shape and running. So we don't have any concerns about it lasting a good couple of decades. Craig Hoagland - Anderson Hoagland & Co.: So they're just perpetually renewed, basically?

Yes, yes. It's just -- we do preventative maintenance inspections every couple of months on them. Of course, we're out there all the time if there's any mechanical problem. And again, these are our guys. So we know exactly what's going on with the equipment. And it's just a process of rebuild. After you get the new stuff out there, about every 3 years, you start going on a rebuild schedule.

[Operator Instructions] And we do have a question from Ian Breusch from Private Capital.

A quick question for you. On the addition side, on adding units, looks like you added about 65. And I know you're still looking at adding outside fabrication. Is there a number you have in mind in terms of what would kind of satisfy the growth that you're seeing out there in terms of how much you could conceivably add to your fleet every quarter or every year?

You mean if we brought in some outside fabrication?

Yes, yes. I mean, in other words, are you leaving a lot out there on the table by producing 50 to 60 units a quarter as opposed to maybe 75 to 100?

Yes. I wouldn't say we're leaving a lot. I mean, there's certainly some jobs that we missed because we can't get equipment out quick enough. And that's pretty frustrating to us all and that's what we're trying to ramp this stuff up. There's not a whole lot. And a lot of these customers that we work with are good long-term customers and they're tending to wait on us. We've got -- and we don't really quote a rental backlog per se. But our fabrication scheduled up through about November is pretty well-committed on the rental side. So all the stuff we're building next quarter is pretty well already spoken for. And you'll see, you get the issue of any other customer coming in or maybe an existing customer wanting to add some more equipment, having to put him at the end of that line. And that's where we're trying to get those incremental or layered-on fabrication to take care of some of that stuff. So I'm not -- we're not missing -- of course, we missed some. You can't -- I don't know if you ever want to catch at all because sort of with the balancers, it enables us to keep our pricing a little higher. Yes, we're not missing a whole lot. And we are -- as I mentioned, ramping up internally and looking for some good external providers, too.

At this time, we have no further questions.

Okay. Thanks, Ross. Thank you, everybody, for joining me on this call. I appreciate your time this morning, and look forward to visiting with you again next quarter. Thank you.

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