Natural Gas Services Group, Inc. (NGS) Q2 2015 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group 2015 second quarter earnings call. [Operator Instructions] Your call leaders for today's call are Alicia Dada, IR Coordinator; Steve Taylor, Chairman, President and CEO. I will now turn the call over to Ms. Dada. You may now begin.

Thank you 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 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 the 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 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 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 Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Thank you Erika, and good morning everyone and welcome to Natural Gas Services Group's Second Quarter 2015 Earnings Review. I think we have little confusion on the phone numbers this morning, so I appreciate everybody that’s dialed in twice. Our second quarter results demonstrate the optimum position occupied by NGS. Our production-oriented compression services somewhat insulate us from the severe swings experienced in the rig-dependent portion of the industry and contributes to our ability to better weather any resulting storm. NGS's capacity to execute results in the excellent margins, superior cash generating capability and mitigated revenue impacts achieved this quarter. This is a strong quarter and I'll comment on more details while we review the financials. Starting with total revenue and looking at the year-over-year comparative quarters. Our total revenue has increased 10% or $2.2 million from $22 million in the second quarter 2014, to $24.2 million in the second quarter of 2015. We had revenue gains across all product lines this quarter compared to the same quarter last year with rental revenues up 1%, sales revenues almost doubling and service and maintenance revenues increasing 6%. For a sequential quarter of the first quarter 2015 compared to this current quarter total revenues were down a little over 2% from $24.7 million to $24.2 million. Sales revenues grow almost 10% for the quarter or noted $400,000 which partly after a decrease of 4% or nearly $900,000 in the rental revenue. Reviewing the competitors six month year-to-date period's total revenues were up 11% with rental revenue increasing 5% or $2.1 million. Sales revenue were up $2.6 million which is about 50% higher than last year's six month period. Moving to total gross margin and comparing the second quarter of last year to this current quarter total gross margin was up 8% from $13 million to $14 million with both periods holding in the 58% to 59% of revenue range. Sequential total gross margins was up 1% to $14 million, but in six months year-to-date comparison gross margins dollars were up 12% from $25.1 million to $28.2 million. As a percentage of revenue gross margin this year-to-date is averaging 58% compared to 56% to 57% in the respected six and twelve month periods of 2014. This is actually even better than it looks considering the sales which deliver lower gross margins, are our larger component of revenue this year than last year. Our sales, general and administrative expenses continue to be the lowest in the industry and typically we were in the 10% to 12% of range of revenue. We were 12% this current quarter compared to 10% last quarter and 12% in a year ago quarter. The comparative six month year-to-date period, SG&A dropped from 12% in 2014 to 11% this year. If you read our earnings release this morning, you are aware that during the first half of this year NGS initiated revenue which it has been optimize our rental fleet. Pursuant to that review we decided to make adjustments for rental equipment that has been relatively underutilized over time. This equipment is primarily older gas compression packages with an average age of 11 years old, they’re originally designed for dry natural gas shale operations. As a result of this review this quarter NGS reported non-cash, pre-tax charge of $4.4 million related to the retirement of rental fleet equipment and additional $100,000 for normal increase in bad debt and inventory allowances. For perspective, while the 258 units were retired represented about 9% of the rental fleet they account for only 2.6% of a net book value. Although the equipment is mechanically functional, the gas market is oversupplied and the economic viability of the equipment going forward is limited. However, over the rental lines these retired units generated revenue equal to 2.3 times their cost which resulted in gross margin dollars totaling a 140% of the investment. In the following comparisons for operating income and net income, I'll note the effect of the fleet retirements on the second quarter results such where the impact. Operating income increased by 6% in the comparative year-over-year quarter to $5.4 million, but decrease down was 6% in sequential quarter comparisons. This decrease was primarily due to lower rental revenues in the second quarter 2015 compared to the first quarter this year. Operating income is running at 22% of revenue for the quarter compared to 23% for the second quarter 2014 and the first 2015. Concerning the equipment retirements operating income in this quarter -- current quarter goes from $5.3 million to an adjusted $919,000. On a six-month year-to-date basis operating income increased 19% over $1.7 million and is running at 23% of revenue compare to 21% of revenue last year. In the comparative year-over-year second quarters, net income increased 4% to $3.5million, up from $3.4 million in the same quarter of 2014. The sequential quarters of Q1 ’15 and Q2 ’15 saw net income dip from $3.7 million to $3.5 million. Considering fleet retirements net income was reported as $614,000 in the second quarter. In the six month year-to-date period net income increased 16% from $6.2 million to 7.2 million. Our net income continues to run at 14% of revenue in all comparative periods. On a year-over-year basis EBITDA increased 7.5% from $10.4 million in the second quarter of 2014 to $11.2 million in this current second quarter 2015. Sequentially, EBITDA was down 4% or $460,000 from $11.6 million. On a six-month year-to-date comparison EBITDA increased $3 million or 15% from $19.8 million to $22.8 million. NGS' EBITDA to revenue ratios continue to run between 45% and 47% in all comparative periods. Since our fleet optimization adjustments for non-cash items there is no effect on our EBITDA metrics. On a fully diluted basis earnings per share for the effect of any special items was $0.28 per common share, up 4% from $0.27 from the year ago quarter, but down $0.01 per common share from the previous quarter. Reported earnings per share were $0.05 including these special items adjustment. As I review our operating segment the financial comparisons will not reflect any impact from the fleet optimization adjustments we've made. Total sales revenues which include compressors, flares and aftermarket activities, increased significantly in the year-over-year quarters from $2.3 million in the second quarter of 2014 to $4.3 million in the second quarter of 2015. This increase was primarily attributable to higher compressor sales of last year. For the sequential quarters, total sales revenues grew nearly 10% from $3.9 million $4.3 million. Reviewing compressor sales alone, in the current quarter they continued strong at $3 million compared to $500,000 in the second quarter of 2014 and $2.5 million last quarter. Year-to-date the comparative six-month periods, compressor sales have doubled when compare to the same period last year and gross margins have average 19% this year. Our sales backlog has held up the last couple of quarters with the current backlog at approximately $3.5 million as of June 30, 2015. Last quarter's backlog was essentially the same, so we have been able to replace everything that we're building and shipping with new business. This portion of our business is proven to be surprisingly steady this year. Rental revenue had year-over-year quarterly growth of nearly $250,000 or 1% from the $19.5 million in the second quarter of 2014 to $19.7 million for this current quarter. Rental gross margins exhibited a healthy increase from 60% in last year's comparative quarter to 64% this quarter and up from 62% in the first quarter of this year. This margin expansion combined with our high rental revenues contributed to 8% higher rental gross margin dollars in this current quarter. Hats off to our field management and personnel, they continue to do an excellent job controlling their direct expenses while maintaining our service response to our customers. Sequentially, rental revenues dropped a little over 4% from $20.6 million to $19.7 million. The gross margin increased to 64% for the current quarter. Our rental margins have averaged 62% over the last 4 quarters with this being the high watermark over the past couple of years. While we have managed our operating expenses well we do anticipate continued pressure on margins. Rental fleet size including the results of our optimization exercise at the end of June was 2,662 compressors and our active [ph] utilization was 75% for the quarter. Counting active and contracted compression our utilization is at 77%. Counteracting some of this utilization pressures is our pricing strengthened. Average rental rates across the active fleet increased 6% in the comparative year-over-year second quarter periods and still posted a 1% sequential gain in this past two quarters. Looking our pricing for new listed equipment only which gives a more real time pricing picture as compared to the average pricing we just talked about, rental pricing in the year-over-year second quarter periods was up 5% to 6%, but sequentially it was flat. We've had excellent pricing power over the last few years and have constantly increased our rental average rental prices, but to no one’s surprised it looks like it's starring the peak. We continue to experience pricing pressure from customers and competitors and I expect this to continue going forward. The good news is that we have built up a reserves so to speak, the premium pricing, that we can employ to our advantage. Turning the capital expenditures, I'd mentioned in the past that we anticipate we would spend only $10 to $15 million for the first six months of this year. We came in a little under that and year-to-date we have spent $9.6 million of which $8.6 million that was rental fleet compression with the balance being the surge [ph] vehicles and shop tools. Looking at for second half of 2015, unless we see an uptick in business or some special projects we don’t anticipate, I doubt we will see capital expenditures exceed $5 million, and that will be primarily allocated to our 500 horsepower compression packages in smaller vehicle cover units. Going to the balance sheet, our total short-term and long-term bank debt is approximately $400,000 and cash in the bank was approximately $21.5 million both as of June 30, 2015. Our cash flow from operations was $13.7 million for the quarter and $25.3 million for the year-to-date. This increase was aided by working capital improvement in conjunction with a $4 million tax I've mentioned in the last call. Our free cash flow this quarter was $15.8 million. Summarizing, I'm pleased with our performance this quarter, specially are cost discipline and superior growth margin results. EBITDA operating income and net income were strong and cash flow accelerated this quarter. NGS is well positioned and as I mentioned in the last call we continue to roll out our new products, expand our sales forces as opportunities dictate. Looking forward I think the market will be increasingly tougher, oil pricing does not appear to mitigate consistent strength until well into 2015 and I expect utilization and pricing pressure to continue. Our capital spending is expected to continue at a low level and we'll generate exceptional yields from our free cash flow. Our balance sheet has no peers in our industry and we remain confident in our abilities to maneuver this resolve to market. Erika that’s end of my prepared remarks. I will now turn call back to you for any questions.

[Operator Instructions] Our first question comes from Rob Brown from Lake Street Capital Markets. Please go for question.

On your fleet optimization do you feel like you sort fully taken out that business now and you are set for a while or is there some risks in that in that cash side as well going forward? That you are due for another optimization?

No, no I don’t think so. When we've look at it for few months here and just trying to figure it out and as I mentioned it is primarily a lot of older gas shale driven, kind like of the Barnett shale areas sort of equipment, that’s around the equivalent, but obviously the gas market hadn't done much for past few years so it just looked like it was the time to make a decision on decent equipment, we still got it, we're not going to cut it up, but if we can use it, we can it. But the economic viability of it in this low gas priced market that continue just seem to be a limited.

Okay, Okay but then you mentioned pricing trends getting a little tougher, how do you sort of see that going out? Is it down 5% to 10% what is sort of range that you are thinking there?

It's hard to quantify that and there is two sources of pressure, obviously, you have pressure from customers needed some pricing relief. Then you have the pressure from competitors. You know the customers we always seem to have better luck with, because obviously we got a relationship there, we can negotiate there, our equipment, our service capabilities and things like that and we tend to come out pretty good shape of those. I'm happy with where we are from those negotiations we had. And I think we’ve probably got the majority of our larger customers behind us on that stuff and we haven't -- our range has been -- on discounts has been in the -- probably the 5% average plus or minus a couple of points around that. So I'm happy for that, the wild cards are the ones -- obviously hard to predict is what competitors are doing and that varies by competitors in the region and geographic because different players in each area, they've got different utilization, they've got different cost basis, they've got different strategies and market’s still on [indiscernible] and everything else. So that's one that's a little tougher, from a -- all I have to go on is if you look back in ’09 and ’10 that the pricing deterioration we saw back then, over the full span of the downturn being a couple of years, we saw about overall 10% price deterioration on average pricing and that again took a couple of years to fully get baked, it wasn’t overnight, it is over period of times. So I don’t know if that’s right or wrong, that's really kind of the market we've got to look at.

Our next question comes from Joe Gibney from Capital One. Please state your question.

Where these compressor sales orders are coming from? Just surprised by the resiliency, you've certainly referenced that in your remark, just curious to if you’re getting some international mix or just it's been surprisingly resilient there in the inbound order side so I was curious if you comment on that?

Yes, you're right and as I comment because normally going into this sales takes are hidden and obviously sales is the big piece of our business compared to other competitors. Competitors tend to have a bigger sales component, we've intentionally reduced as overtime to cuffing more rentals. So it has been a little surprising that it's held up. It's a mix the international stuff certainly didn't get hit as hard in a downturn like this. The capital tends to hold up better, but we've been able to capitalize on some new customers coming in and we've got 2 or 3 legacy customers that just continue to put in orders, I mean these tend to bigger guys that march through these storms. Obviously they have cuts backs too, but the others have corridors that they are looking at development and keeping going. So your combinations was some international stuff and then just some good core legacy customers, just staying busy.

And also curious if you can talk a little bit about your horsepower mix and the initiatives that kind of move a little bit higher on the horsepower side, I think last call you've talked about a couple 400 horse units getting deliver into the field and now with the fleet retirement over 200 units here just trying to get a sense of sort of how you characterize average horsepower in our rental fleet now and maybe brought a strategic initiative to get a little bit higher there?

Yes, this 258 units rationalization as you can assume is typically much lower horsepower steps. So it's really equipment in the 100 horsepower average. So this will move the -- just that alone move the average up a bit, not a whole a lot, but we may move up 10 horsepower so just on an average. The bigger part of that initiative is this 400 to 500 horsepower frame that we're building and coming out with in our ship compressor line. And now the full rollout is really not going to happen to about Q1 of ’16 where we have our frame ready for the patterns being build, frames being cast and machines and things like that. And to refresh your base memory, this is our own compressor line built from the ground up. We commission and cast these machines and everything else, so there is a lead on some of that stuff. Now the equipment that we're putting out now is other compressors we're buying in the market patching up and putting out there. Good compressor lineup enrolled with them, but not -- won't be our go to line as we go forward. So we've got those 7 or 8 units I've mentioned the couple of calls. I don’t think about half of them are out on locations yet haven’t start up yet. The other half, 3 or 4 will be delivered next 30 days, so those are going out, we're getting some traction from the sales guys on units going. We've actually -- we'll start building some more equipment. We'll start building some idle inventor up in that 45 horsepower range too. Then hopefully by Q1 ’16 when we got the -- we’re ready to go into more robust production with our online that we've got some of this little more traction in the market, people know us little more for that horsepower and everything else. Going above that horsepower right now we don't have any plans from the point of anything on paper, we're always looking at that market just to see what's going on with it. Yes, there is some attraction to us too, to be a bigger horsepower markets. We think we can make even incrementally better margins on it because typically when you're building higher horsepower equipment on dollar per horsepower basis it's cheaper to build, it's cheaper to operate and things like that. So we think overtime we'll be continuing to creep up into that. Obviously we haven't been -- we’ve entered very fast, but this downturn gives us an opportunity to move into that 400 to 500 horse where we think there is a pretty good opportunity for us through existing customers, existing areas, et cetera, but also we think we just like that probably not a really -- maybe more of an underserved market that we can really capitalize on.

Our next question comes from the Jason Wangler from Wunderlich. Please state your question.

I was just curious on the inventory side on the balance sheet you still have quite little bit there, could you just walk us through kind of the thoughts as we wind down the built program. Just how you see that cadence going is there some cash flow to unlock further on that or what we have there?

Yes. Some of that is -- a byproduct of these slow down. So one of things, first addresses this rationalization we've just talked, about a 1 million of that is coming off the balance sheet and going in the inventory, we’re using some of that -- that wasn't written down obviously but we are transferring our assets to inventory because some of these equipments again -- equipments good and we can reuse some of this equipment in some future building, so that’s going increase the inventory right there by about a $1 million. When you get into these downturns that the last couple of them happened so fast, you’re witnessing oil price drop or gas price drop happens over a quarter and if you remember a year ago engines were about a six month delivery. So when we get a difference in timing of like that, we and probably everybody else having engines coming in that you don’t need and you can't cancel. So that builds inventory, they are two -- we are not going build this stuff just because we’ve got engines, so we preserve the engines, stack them and good think about an engine, it doesn’t go bad overtime, so we'll use it when things turnaround. But you do some get some inventory increased in that way. So I guess some of that’s just by virtue of going into a downturn, obviously we’ve got enough cash on balance sheet to stand that hit, but we are looking at -- trying to -- we're looking at the initiatives going on, look at the inventory, to see what we need to, have to do and want to do and things like that. We increased that inventory reserve just a little, not much, but we're constantly looking at them. Yes and hopefully there is some other working capital items we can release some more cash out of.

Okay. Maybe just as I think about it based on that, you're probably pretty close to getting done with the orders of inventory just given the live time and it’s August now, so maybe it's a relatively static number but what it basically does is when you get back to building, that’s just basically what you can use to kind of kick off that program I guess, that makes sense?

Right, right. These down turns will typically carry a -- little counter intuitively a higher level inventory you want just because you got that equipment coming you couldn’t -- you thought you were going to need and you couldn’t been shut off.

Sure.

Yeah. You won't see a climb, I mean you will get quarterly variations in it, but from perspective of climbing anymore, no you shouldn’t expect that.

Okay. Great. I'll turn it back, thanks Steve.

Thanks Jason.

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

Okay. Thanks Erika and thank you everybody for joining me on this call. I appreciated your time this morning and I’m looking forward to visit with you again next quarter. Thank you.