Natural Gas Services Group, Inc. (NGS) Q4 2016 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group 2016 Fourth Quarter Earnings Call. At this time, all participants are in listen-only mode. [Operator Instructions] I now welcome you host, Alicia Dada. Please begin.

Thank you, Donna and good morning listeners. Please allow me a moment to read the following forward-looking statements 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 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 Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Okay. Thank you, Alicia and Donna, and good morning and welcome to Natural Gas Services Group’s fourth quarter 2016 and full year earnings review. Apparently we had some trouble with the phone number this morning. So hopefully everybody got in that needed to. As everyone is well aware, this past year is one of the toughest on record for the energy industry. Crude oil set a low price of $26 in February and the rest of the year reflected a continuing slowdown from that collapse in commodity price. NGS however continued to have positive earnings throughout the year and delivered an enviable flow of free cash. We preserved our margins, maintaining relatively better pricing and stringent cost controls. It appears that utilization is bottoming. We continue to think that our production oriented business will continue to see pricing pressure in the mid-year. Well I'm fairly confident that we're seeing early signs of recovery it won’t be without it's fits and spurts. Longer term and over the next couple of years in particular, NGS is well-positioned in markets that should prosper and along with our expanded product offerings we think we can deliver notable incremental earnings. Additionally and we'll talk to the details later, this fourth quarter had a couple of extra moving parts in it, primarily the retirement of some rental fleet equipment and inventory adjustments due to lower cost in market and obsolescence reviews and a positive tax rate. Now with all that said let's move to the financials. Starting with total revenue and looking at the year-over-year competitive quarters, our total revenues decreased by $9 million from $25.8 million in the fourth quarter of 2015 to $16.7 million in the fourth quarter of 2016. Rental revenues [ph] were off $5.1 million this quarter compared to the same quarter last year while compressors sales revenue was down $4.4 million. For the sequential quarters of Q3 2016 compared to Q4 2016 total revenues were up about 3% or little over $500,000 to $16.7 million. Our rental revenues decreased by $660,000 or 5% this quarter, while total sales saw an increase of $1.3 million over Q3, 2016 and drove total revenue growth for the quarter. On a 12 months full year basis of 2016 total revenues decreased 25% to $72 million with rental and sales revenues off 26% each. As I refer to gross margin on this call, what I'm describing is a non-GAAP adjusted gross margin that does not include depreciation. Looking at gross margin and comparing the fourth quarter of 2015 to the current quarter, total gross margin declined from $13 million to $9.1 million. Our gross margins in all three segments rental, sales and service and maintenance were as strong or stronger than last year's fourth quarter. And overall gross margin grew from 51% to 55% of revenue compared to last year. Sequentially total gross margin eased over $200,000 to $9.1 million, which was 55% of total revenue. Gross margin was up as a percent of revenue in all segment except rental, which was 62% compared to 66% last quarter. We call out last quarter's rental gross margin was a record high and this quarter 62% is more typical of our operations. On a full year basis 2016's gross margin was $39.8 million and we maintained it at the same 56% of revenue level that were recorded in 2015. In fact, on a full year basis, in 2014 we delivered a 56 gross margin too. That was a record at the time, but in the mist of the severe down turn we have been able to maintain that same level in 2015 and 2016. Selling, general and administrative expenses for the year-over-year quarter declined 23% and we are at 13% of revenue in the fourth quarter of 2016. Sequentially SG&A was up 4%, but down 18% in the full year period. While we have maintained SG&A at a low level a large part of this current savings are due to non-cash stock expenses, primarily from an extended vesting periods and reduced awards. In this fourth quarter we retired 63 years from our rental fleet, and recorded a $545,000 charge. This is approximately three tenths of 1% of a total book value of compression equipment on our balance sheet. These units were all older designs [ph] and vintages. They were primarily under-utilized dry gas equipment. They had an average age of over 14 years and an original cost of $4.7 million. Considering the rental revenue generated the original cost and the cost of maintenance over live equipment we made an average annual return of over 17% on this equipment. Operating income in comparative year-over-year quarters is down approximately $3.7 million to nearly $1 [ph] million. This is primarily due to lower revenues, higher level of relatively fixed depreciation expense and the equivalent write-off. Sequentially operating income fell from $1.8 million to $1 million with the largest factors being the decline of rental margins and equipment retirements. On a full year basis operating income was $8.4 million in 2016, compared to $15.1 million in 2015. In comparative year-over-year fourth quarter net income decreased to $1.2 million this year compared to $3.3 million in the fourth quarter of 2015. Sequentially net income declined from $1.5 million to $1.2 million and the full year decline was from $10.1 million in 2015 to $6.5 million in 2016. I do want to point out that we had a positive tax impact in the fourth quarter that resulted from research and development tax credits for the past three years and a domestic production deduction. This resulted in an effective tax rate for 2016 of 23.6% compared to 30.4% last year, and a net tax credit of a $134,000 this quarter. Now as I refer to EBITDA in the following discussion, it is the non-GAAP measure of adjusted EBITDA which is the same as EBITDA we used in prior years, without any impact from the non-cash equivalent retirements we experienced this quarter and last year. On a year-over-year quarterly basis EBITDA declined from $10.2 million in the fourth quarter of ‘15 to $7 million in this current fourth quarter ‘16. While sequentially EBITDA decreased 4% from $7.3 million to $7 million. Comparing the full years of 2015 and 2016 EBITDA decreased from $42 million to almost $31 million and averaged 44% and 43% of revenue for respective years. On a fully diluted basis earnings per share this quarter was $0.09 per common share with our full year EPS at $0.50 per common share. This compares to $0.79 for 2015. Total sales revenues, which include compressors, flares and aftermarket activities for the year-over-year quarters declined from $7.8 million for the fourth quarter of ‘15 to $3.9 million in the fourth quarter of ‘16. For the sequential quarters total sales revenues increased over $1.3 million from $2.5 million in third quarter of ‘16 to $3.9 million in the fourth quarter of ‘16. Reviewing compressors sales alone in the current quarter they were $2.6 million compared to $7 million in the fourth quarter of 2015 and $1.7 million last quarter. We ended 2016 with $10 million in compressor sales compared to $13.8 million in 2015, with both years being within the $10 million to $15 million range I had forecast on previous calls. This is the same range we’re aiming for in 2017. Our sales revenue held out fairly well, but gross margins declined from 26% to 18% for the comparative years, led by declining compressor sales gross margins from 21% to 12%. Part of this decline is from an inventory write-off in our fabrication operations due to obsolescence and lower cost of market evaluations, with the remaining impact being due to competitive price in 2016. Without the inventory adjustments our sales gross margin this quarter would have been 15% an excellent margin in a market where we have seen single-digit margins being quoted. As mentioned during this quarter we also took some charges against our inventory, primarily with fabrication which totaled $566,000. Our compressor sales backlog was strong at approximately $6 million as at December 31, 2016. This compares to $4 million as of the end of December 31, 2015 as well as 2014. We estimate that this will be built out over the next couple of quarters. But it's encouraging that this represents 50% of 2016 compressor sales revenue and approximately 60% of the lower end of our 2017 sales projection. Rental revenue had a year-over-year quarterly decrease from $17.6 million in the fourth quarter of 2015 to $12.5 million this current quarter. The gross margins held at 62% for both quarters. Sequentially, rental revenues were lower about $660,000 to $12.5 million, with gross margins of 62%. This was down from 66% in the previous quarter. We recall that 66% was a record level and I mentioned in the last call that it wasn’t likely to be repeated. There are variations quarterly in our rental margins, primarily related to overhaul cost, so I remind you that we experience no cat loss [ph] and field employee overtime in winter months due to tougher operations. However, our full year average gross margin came in at 64%. Looking at rental revenue on a full year basis, revenues were down from $76.4 million to $56.7 million. Significantly our gross margins for rental revenue have actually expanded during this downturn, averaging 60% in 2014, 62% in 2015 and 64% in 2016. From a pricing perspective, our average fleet rental rate this quarter was down less than 1% from the year ago quarter and actually up 1.5% from last quarter. On a spot pricing basis which is the rental price seen on newly set equipment over the last 12 months, we have got anomalies in the data, that being the wide variation in pricing we see between the small VRUs and the large horsepower equipment, since that equivalent has been significant part of the newly set [ph] equipment over the last year we’re seeing wide swings on a monthly basis for average new set rental unit pricing. As such, the data doesn't tell us much. However, we reported an average 15% lower pricing on new sets in last quarters call, and I’ll estimate that we are still seeing market pricing down 12% to 15% year-over-year. Fleet size at the end of 2016 were 2,530 compressors. In 2016 we added 18 new units, 15 of which are new our VRUs and three are new larger horsepower units. This is down from our 2015 year end fleet size of $2,622 [ph], due to retirements and some fleet sales. Our fleet utilization this quarter was 51% and reflects what we think maybe a bottoming of the downward trend we saw all through 2016. As I postulated in the past pressures on utilization and pricing will likely continue in the first half of this year, with periods of the extreme deteriorations past us. In 2016 we spend a total of $4.3 million in capital expenses, with approximately $3.6 million of that on the new fleet compression, already mentioned. This amounts was down significantly from the past couple of years when our total capital spend was over $53 million in 2014 and $12.5 million in 2015. In 2017, we project total capital spend between $5 million and $10 million, with 90% plus been for real fleet additions. As of today we have already committed $5 million towards new higher horsepower equipment, meaning engines and compressors are ordered and fab spaces allocated. Summarizing that impact of the extra outage we have this quarter, before the equivalent inventory adjustments, whilst we see positives tax impact, we had a negative net income statement effect of $386,000 or approximately $0.03 per common share. Now going to the balance sheet, as of December 31, 2016 our total debt remains less than $500,000, with cash in the bank of approximately $64 million. Our cash flow from operations was $32.8 million in 2016 compared to $41.6 million in 2015. As a percentage of revenue, free cash flow averaged 40% of revenue in 2016. We also went back and looked at a couple of other longer term value indicators in our business, those being the shareholder equity retained earnings. For the past five year period during which at least half of that was the recent downturn. NGS' shareholder equity per share grew 36.5% and retained earnings per share grew 68.8%. While we can deliver excellent operating metrics on a quarterly basis, we also deliver longer term value for our shareholders. Now every day there are articles saying one of two things about the future oil price, it is going up or it’s going down. However based on what I can discern the upside is greater than the downside. Among some of the more visible macro factors we’re just starting to see the impact from the OPEC oil cuts in November. Crude oil shipments of OPEC countries and others are in fact lower. Inventories were trimmed lower over 2017 due to this development and the fact that oil revenues in most OPEC countries fuel their social and infrastructure programs, means that they need the higher price as much as we do in the U.S. Global demand is also stronger than estimated just a few months ago. Now from an industry specific perspective we’re seeing higher rig counts and pressure pumping drillers in companies are starting to raise prices and operators have almost universally increase their capital budgets. I mentioned earlier that NGS is well positioned to take advantage of any resulting activity increase. Specifically what I mean by that is multi-dimensional. We have established operations in the prominent oil shale basins that will likely provide most of the activity. We have maintained our margins during the downturn. We have protected our pricing in relatively better manner than the market. We’ve expanded our product offerings in the VRU and higher horsepower segments and we have maintained a debt free structure. We think we can grow back into the market over the next 18 to 24 months with very little capital required. This is unusual for capital intensive company in a cyclical business. But this is what I mean when I say we think we will see strong incremental earnings over the next couple of years. We do think the year will be back end loaded as far as growth but we are positioned and prepared and praying. That’s end of my prepared remarks. I’ll turn the call back to Donna for questions anyone might to have.

Thank you very much. [Operator Instructions] Our first question is coming from Jason. I am opening your line now. Please state your question.

Hey good morning Steve.

Hi Jason.

Appreciate all the commentary, was just curious again, I think the rental business is going quite as you had expected. The product sales side continues to do very well and you kind of walked through the numbers of the backlog. Could you maybe just talk about are you just continuing to see a lot of domestic demand, or is that changing as well or is it mostly still kind of International stuff that you’re working on, on that side of it?

That’s a combination of both, as it has been for the last couple of years. As I mentioned in the past we’ve got a couple of legacy U.S. customers are continuing to buy through the downturn and then we have been able to capture some International business, primarily Mexico and Argentina. We’ve had a couple in the Mediterranean also but it’s not the same as what we’re seeing, combination and it varies percentage wise quarter-to-quarter where it’s 50:50 or two-thirds or one-third, domestic/international but that backlog is probably about half and half the same as we've seen in the past.

Okay and then one on the rental side, with what we seeing in gas prices of late maybe kind of to real-time freeze it maybe common but are you seeing a resurgence of the pricing pressure discussion, just [indiscernible] that the year seemingly started out pretty strong specifically on gas but for both commodities and obviously this week included we’re starting to see some concern on the prices or is that probably too soon to tell from your aspect?

The gas price line is you are talking about moving targets. And a couple of calls ago I don’t know if we talked about - I don't know if it was just you and I or just on a call or you all have some discussion with investors and of course everybody got really excited three, four or five months ago by gas price and yeah, I wouldn't be excited about too much anymore as far gas price go and certainly it went away pretty quick. The price pressures we are seeing are actually from competitors and not as much from customers. Obviously the customers are the ones asking for because the competitors continue to go out into the market with low pricing, and we talked about this before, a little I think, most of our competitors are MLPs and they have got high distributions, high debt loads and cash is king to them and we still are [ph] on net income. So we’re still seeing that pressure from the market, but again it's more from competitors with some high cash requirements and lot of equipment in the yard, and we have got lot of equipment in the yard too, but we’ve chosen to more so just like the last downturn taking more of a margin and profitability approach to this than a market share approach.

Okay, and then if I can sneak one more in. Steve, just I think current facility I saw it went current and obviously you don’t have much on it. Could you just maybe talk about the plans there as far as your re-upping it or even letting it expire given your cash balance?

Yeah, no, It's going to be renewed. So they are part of many plans - I’ll say the plans are part of the same as last six to seven years we have had it. It's nice to have, we don’t anticipate any the current requirements obviously with our cash position, but you never know, this market takes off quicker or some other opportunity becomes along but no we intent to maintain it.

Great. I’ll turn it back. Thank you.

Great, thanks, Jason.

Thank you very much. Our next question is from Rob. I am opening the line now.

Hey Steve.

Hey Rob.

You mentioned the high horsepower market seeing some additional CapEx spending in that business. Could you just give some color on how that business has ramped up and what kind of demand drivers were there?

We - when we first introduce that product you'll recall, we introduced the 400 horsepower in the year right, 2015 and then we introduced the 600 horse last quarter, actually in last call. So last half of the year. All of the equivalent we have is rented. So I’ll point out that’s a 100% utilization, but it’s only 10 to 12 units. So we’re building more, because obviously in this market you got to have this stuff in inventory, nobody waits. Down market like this with as much surplus equipment around there, nobody waits around for equipment. So you don’t have to. So we are building up some more 400 and some 600 horsepower units, so that we have got them in the year ready to go and put them out. And I said $5 million I projected $5 million to $10 million capital spend in 2017. We have already committed to half of that, 5 million of it and it's all that 400 and 600 horsepower.

Thank you. And then on your fleet size you took some out of the fleet this quarter, how do you characterize that fleet at this point, is there any more of that kind of older underutilized equipment left, do how much of that like gas equipment is still avail?

Yeah, I mean we think, I’m going to sound like broken record probably for everybody. I don’t know if everybody got a long enough memory. If you remember back Q2 of 2015 when we did the first write-off and that was that $4.4 million. So we took a lot more equipment out of that 250 units back then. And I think you have the same question. Of course at the time we thought that was adequate. Now little more now we have two more year's downturn and this was relatively minor as far as dollars go and this is essentially a 95% of depreciated value. So we’re comfortable with the fleet and think if we are in an upturn that we will start to see this stuff go back out. This equipment is just like the stuff we retired in 2015. It's rentable equivalent there is nothing mechanically wrong with it. but it's been chronically idle, dry gas equipment and we’re into seven or eight year from that gas downturn and away to 10 roughly. And that mortgage has not come back, just like Jason mentioned. Gas prices just teases everybody every year. So to shorten the comment, we control the fleet right now. I don't anticipate any more especially for - heading into a recovery period which we think we are - or we think [indiscernible] that we are we think we're probably adequately situated.

Okay. Thank you, I'll turn it over.

Thanks.

Thank you very much. [Operator Instructions] Our next question is from Tate, I'm opening the line now.

Just a little more on the expected life of your equipment to following up that comment. I think you said the equipment you retired had a 14 year life, is the useful life for most of your equipment 15 years?

Yeah. Well, yeah perhaps confuse that a little. We do book depreciation of 15 years. This had an average this stuff we retired had an average usage of 14.2 a year. So essentially 95% of the book life was used.

And then I mean if you don't have any more write-downs get with recovery, I mean will you depreciation and expense meaningfully dropping recovery, well I guess the extra equipment you're adding will more -

Yeah. You'd like it to be of course, takes a long time, everyone 15 year. So we saw little drop last year with the equipment last year. This is a going to be pretty negligible, it's not that much to lower $500,000 like I mentioned, especially three times or a 1% of the net book value on the books, so again I can see much, much positive impact from it, one to appreciate it anyone.

Okay. And then I mean with $64 million of cash on your balance sheet five to 10 at CapEx in 2017, I mean how have you talked historically about looking to initiate a nominal dividend through the cycle, I mean I would imagine that opens you up to more potential investors to?

Yeah. We're actually considering all these options as far as cash goes. We're going to take a look at how quick the market drives recovery, here the next couple of quarters. Again, I don't think we'll need $6 million over next couple of years, to advantage of it, but just go back to 2010, 2011 we're come out last one, in those two years and those were just starting years into recovery, we spent $20 million to $30 million. So it can go pretty quick, but we are actually considering uses of cash as far as whether fleet grows. Of course that depends on the market or dividends or whatever it may be. But as I mentioned, we think products in next 18, 24 months, we won’t need appreciable capital to participate in the - in any upturn that comes up. So there is plenty of cash there and maybe some other opportunity comes along, that we don't anticipate right now. But we're looking at all those avenues.

Okay. Thank you. And then a couple of ones I think your K will probably come out here but can you comment ahead of that on your customer mix in 2016, did it change meaningfully. I think in 2015 you identified Devon and Oxey [ph] is your largest customers?

Right, right now that, it essentially stays the same, if you look back our five years you get some movement in there but year-to-year, those guys are still going to be our biggest players, where it's rental or sales and unless something else comes up, but we'll - I imagine this couple of years we won’t see much change in those.

Okay. Thank you very much, Steve.

Okay, thanks Tate.

Thank you very much. [Operator Instructions] There are no more questions.

Okay, well, thanks Donna and thank everyone 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 Natural Gas Services Group 2016, fourth quarter earnings call. Thank you for attending.