Natural Gas Services Group, Inc. (NGS) Q2 2017 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen and welcome to the Natural Gas Services Group 2017 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’ll now turn the call over to Ms. Dada. You may begin.

Thank you, Erica and good morning listeners. Please allow me 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 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 following 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 statement, includes 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. Steven?

Thank you, Alicia and Erica and good morning and welcome to NGSG’s second quarter 2017 earnings review. Our earnings this quarter featured a few moving parts, but fortunately, a large part of the movement is positive. Our sales business continues to prosper. And this quarter, we received some very large orders that have pushed our backlog to the highest levels, at least a decade. In fact, the sum total of the orders represents a record level of revenue awarded in our sales business in one quarter. In our rental business, we are seeing slight improvements that seem to point to a better second half. Although this business remains under pressure, we continue to execute well and deliver industry leading margins. Our balance sheet continues to be unassailable and our ability to generate cash enviable. Among our publicly traded peers, NGS stands alone as the company providing consistent positive net income. While past performance does not necessarily provide a guaranty of future results, to-date, our net income has remained positive in each quarter of the downturn. I will comment on all of these in more detail to review the financials. Starting with total revenue and looking at the year-over-year comparative quarters, our total revenues decreased 6% from $17.2 million in the second quarter of ‘16 to $16.2 million in the second quarter of this year. Sales increased by $2.1 million. Our rental revenue saw a drop of $3.2 million. For the sequential quarters of the first quarter of ‘17 compared to the second quarter of ‘17, total revenues decreased $2.7 million from $18.9 million to $16.2 million. The decrease was primarily in our sales component with solid drop of $2.2 million. Our rental revenue decreased only $500,000. Looking at the comparative 6-month year-to-date periods, total revenues were down 9% to $35.2 million. Overall, we are pleased with the general resilience of NGS from a total revenue perspective, which saw a year-over-year decreases of only 6% in the comparative quarters and 9% in the 6-month year-to-date periods. Looking at gross margin and comparing the second quarter ‘16 to this current quarter, total gross margin declined from $9.5 million to $8.1 million and was 50% of total revenue compared to 55% of total revenue in the second quarter of 2016. Gross margin in each of our three business lines actually increased or stayed the same in this comparative period, but the overall decline in margin was due to a mix shift from rentals towards lower margin sales revenue. Sequentially, total gross margin decreased slightly from $8.7 million to $8.1 million. However, total gross margin as a percent of total revenues actually improved to 50% from 46% in the first quarter this year. In the 6-month year-to-date comparisons, gross margin dollars declined from $21.3 million to $16.8 million. As a percentage of revenue, year-to-date 2017 gross margin averaged 48% compared to 55% for the year prior year-to-date. As noted, all comparative periods saw lower gross margin due to the result in mix shift towards sales revenue. Although there is some variability in our total gross margins, we remain and have consistently remained a market leader in margins. This is evidenced by our ability to deliver very attractive rental gross margins of 63% in this quarter. Our sales general and administrative expenses, increased about $240,000 in the year-over-year quarters was down over $650,000 in the sequential quarters and is up a little over $700,000 in year-to-date comparisons over prior year. A primary factor in our recent SG&A variability is because of the accelerated non-cash stock expense taken last quarter. SG&A as a percentage of revenue has stayed within the range between 13% and 16% in all comparative quarters and we believe quarterly costs of $2.5 million or less should be sustainable through the rest of the year. In the comparative year-over-year periods, operating income decreased from $1.9 million to a little over $400,000. Sequentially, operating income increased from approximately $340,000 to a little over $400,000. When comparing year-to-date 2017 to 2016, operating income fell to nearly $760,000. This is driven by a mix shift resulting from a weak rental market that mitigated a strong sales performance. Looking at net income, the comparative year-over-year second quarter’s net income dropped from $1.3 million to about $400,000 this year. Sequentially, the second quarter 2017 saw net income increase from a little over $250,000 to approximately $400,000. On a fully diluted basis earnings per share this quarter was $0.03 per common share, up from $0.02 last quarter. On a year-over-year quarterly basis, EBITDA decreased from $7.3 million in the second quarter of ‘16 to $5.7 million in the second quarter of this year. Sequentially, EBITDA increased $50,000. EBITDA margins of 35% for the current quarter were up from 30% during the first quarter of this year. Our 6-month year-to-date comparison, EBITDA declined from $16.6 million for the first half of 2016 to $11.4 million for the same period this year. From a long-term operating perspective, we have maintained EBITDA at an average of 40% of revenue over the last 18 months. Total sales revenues, which includes compressors, flares and aftermarket activities, almost doubled in the year-over-year quarter from $2.3 million in the second quarter of ‘16 to $4.4 million in the second quarter of this year. For the sequential quarters, total sales revenues decreased $2.2 million from $6.6 million to $4.4 million. However, as we noted last quarter, the first quarter was a strong sale quarter and was the highest sales revenue we had in 18 months, which further reflects the volatility of that business. Although sequential quarters were down on a 6-month year-to-date basis, sales revenues increased $3.8 million from $7.2 million in 2016 to $11 million in the first half of 2017. Compressor sales for the current quarter were $3 million, up from $1.7 million in the second quarter of 2016, but down from $5.6 million last quarter. Comparing the 6-month comparative periods shows the year-to-date sales were up $2.9 million or 51% over year-to-date 2016. That is the first 6 months. As you can see, compressor sales are historically volatile quarter-to-quarter. Gross margins for compressor sales in the second quarter of 2016 were negative 10%. As a reminder, compressor revenues were not high enough to absorb all fixed fabrication costs for that period. However, this quarter’s gross margin is 5% compared to 15% in Q1 and 12% year-to-date comparing to 8% year-to-date in 2016. Although revenues and gross margin are volatile, this business is improving, providing additional support for our thesis that the sales margin is improving, in the present quarter, we were awarded some large compressor orders. This resulted in a significant jump in our compressor sales backlog. Our backlog as of June 30, 2017 was $25.3 million, almost 10x higher than the backlog at the end of the first quarter of this year and 5x greater than the average backlog we have seen over the past year. As important as a growth in backlog is, the length of the backlog tail is significant too. We estimate this should last through the second quarter of 2018, a full year’s worth of work. Besides a meaningful revenue impact to the backlog increase, there are a couple of other important highlights. This is the highest backlog we have had in at least 10 years and these orders not only include our standard size wellhead compression units, but also a good number of 1,000 horsepower plus packages. We hope that this larger horsepower award will further establish our reputation for being able to fabricate this size of compression. Rental revenue had a year-over-year quarterly decrease from approximately $14.7 million in the second quarter of ‘16 to just under $11.5 million this current quarter. Sequentially, rental revenues were down about $500,000 from $11.9 million in the first quarter of ‘ 17, while year-to-date rental revenues were down $7.7 million from $31.1 million for the six months ending in June. From a gross margin standpoint, we continued to post superior results. Gross margin this quarter was 63%, the same as last year’s quarter and up from 61% in the sequential quarters. Year-to-date, our rental gross margins are averaging 62% compared to 64% last year. This is quite an accomplishment by our field personnel considering the appreciably lower revenue base. Average rental rates across the active fleet decreased approximately 6% over the second quarter of ‘16 and were down about 2% from the first quarter. Average rental rates for newly set units, which more closely reflect the current market are down about 4% this quarter compared to last year’s comparative quarter, but about 4% higher than last quarter. This is marginally better overall than last quarter. I will also point out that our average rental rates and gross margin per unit are comparable with mid-2014 before the downturn began. So while we have encountered pricing pressure and experienced declines, we are still at rates and margins when oil is trading at or near $100 a barrel. Fleet size at the end of June was 2,531 compressors, same as last quarter. Our active fleet utilization this quarter was 49.5%, down 0.5% from last quarter. It certainly appears that we are in a bottoming [ph] process when we are down to quoting utilization in 0.5 percentage point increments. On these same lines, we monitor another metric called churn rate. That’s the number of compressors rented divided by the number returned in a given period. This number has also continued to improve. I hasten to add however, that with the uneven nature of what may be a slow recovery, we will see continued variability in the rental business. We indicated the capital expenditures for the year will be $5 million to $10 million, predicated on market demands. In the first quarter ‘17, we spent a little over $450,000 and in the second quarter, we capitalized a little under $200,000. So we ended the first half of the year spending approximately $650,000 in capital funds. We do have total capital commitments for about $5 million in the first half of the year, but we haven’t completed the compressor packages yet, so they haven’t been capitalized, but they will through the balance of the year. The majority of this capital is dedicated to our larger 400 horsepower and 600 horsepower units and a smaller VRU line, with three quarters of it going to larger horsepower units. I will also quickly note that these two new product lines continued to be successful with all of our available inventory rented and with the newly built larger horsepower units being rented before they are completed. Going to the balance sheet, our total bank debt is $417,000 as of June 30, 2017 and cash in the bank is a little over $73 million. We have a small reduction in our cash balance this quarter. Recounting the last quarter’s call, we increased cash by over $10 million, but I mentioned that was unusually high due to the timing issues and that we wouldn’t expect that level of cash generation to continue on a quarterly basis. Timing works both ways and in this quarter, we had approximately $3 million less from compressor sales and $6 million less due to timing of one-time payments. We anticipate our cash additions to average about the same in the second half of the year as in the first half, $5 million to $6 million per quarter. As I have mentioned, we appear to be in the trough of our activity that can be a couple quarters long and price utilization pressure continue. In spite of this, NGS has been able to execute well and deliver industry leading results. Our sales performance is exemplary, as demonstrated by our large backlog increase. EBITDA and gross margin in our rental real business continue at a high level and our balance sheet remains strong. Among our publicly traded peers, NGS stands alone as one company providing consistent positive net income. From a macro perspective, there is some trepidation about the oil price, but later there seems to be more good news than not. Inventories are finally following consistently, OpEx seems serious about limiting supply and further reducing inventory and the rig count plan has slowed. These all point to tightening supply, albeit timing is anyone’s guess. But what’s really needed is a steady price and we all know the recent volatility has had a dampening effect. We have been in the lower for longer environment, as noted by the BP CEO a couple years ago, but I don’t think we are in the long – the lower longer forever scenario as Shell Oil mentioned the other day. However, in spite of the headlines about oil being lower priced forever, there was not much talk about another important comment made by the Shell’s CEO and that is Shell’s outlook for positive future for natural gas. Shell has bet big on this and their acquisition of BG Gas and new markets for U.S. operators are becoming evident. We have had growth in power gen, petrochem. And last year, natural gas’ market share exceeded coal for the first time. There has been acceleration in LNG exports and exports to Mexico. This is not a call for a sudden resurgence in gas pricing activity, but I think we are finally seeing some light at the end of the long tunnel for U.S. sourced natural gas. To conclude my remarks and summarizing NGS’ position no debt, cash in the bank, positive net income and a huge backlog, you can’t do much better than that in this market. That’s the end of my comments. Now, I am turning the call back to Erica for any questions anyone might have.

[Operator Instructions] Our first question comes from Rob Brown from Lake Street Capital. Please state your question.

Good morning Steve.

Hi Rob.

I would like to get your thoughts kind of currently on the utilization trends, you said they are bottoming and I know you don’t want to totally predict things, but how do you sort of see those trends typically working and as you come out of a bottom?

Well, I think it’s going to be a solitude thing. What I anticipate is we will always talk about the second half of this year kind of being the potential recovery. It looks like we are getting into that. So I think it’s going to be a couple of quarters long. I think we are going to have a little solitude at the bottom. I mean we are coming down. We are getting – I think we are going to plateau at the bottom and start back up hopefully in ‘18. Now again, this is all predicated on decent commodity price, but – so I think we will have this bump along a little and there is still pressure out there. There is some – we will continue to see bad pricing and with our pricing and product, we don’t participate in all of that in this low price market as much. So there is going to be some pressure on it, but we think it looks like it’s flattening and bottoming. And once we start into the upswing, of course that’s when the fun stars, right. The incremental margins get much higher, start putting out more equipment, etcetera, etcetera. So I think we are still a couple of quarters away from that, possibly. We will still see some bouncing around the bottom, but that’s kind of what we anticipate.

Okay, great, that’s good color. And then on the sales pipeline backlog, I mean it’s very strong right now, what sort of the market dynamics that are driving that, it seems like an unusual change, is that something new in the market or just your focus has changed?

No, our focus hasn’t changed. It’s just – as we have seen in the last 3 years, this downturn, our sales has been very resilient and totally different from the downturn ‘08, ‘09 and ‘10 as they were. Sales really suffered quite a bit back then and we will not carry this. So it’s just a little loss up here and I think it’s a function of certain of the length of the downturn we have had. Rental does fine and we are still making many money off and make returns and everything else, but it gets to be a grind on rental stuff. Sales tends to be more optimistic. I think we are seeing people with pricing – of course, we have some volatility on it, but yes, it seems like the market thinks that all is going to stay maybe in this $50 plus or minus range now. There is a lot of that you can pickup report every day. Somebody is calling for $30 and somebody else is calling for $70. But I think what we are seeing in these orders, we have gotten are opportunistic operators come in to buy equipment and put out and primarily still on some pipeline stuff, but still lot of gas left.

Okay, thank you. I will turn it over.

Yes, thanks, Rob.

Our next question comes from Tate Sullivan from Sidoti. Please state your question.

Hey, thanks. Good morning, Steve. Hey, good morning. I like the conclusion of your opening remarks, too. How does it work, the interest with the compressor sales you said the burn on that backlog will be about a year I think, but do you – will you be buying new equipment to assemble for those compressors or do you reassemble your older compressors or I mean, I am especially asking since your CapEx was so low in this last quarter, too?

Yes, no, this is all new stuff, highly speced by customers. So, this is all – equipment will be buying as we go, so the compressors, engines and all other parts and pieces now. None of this stuff is capitalized, because it’s a solid piece of equipment. So you will see the – you will see some inventory fluctuation, because we are buying stuff in that inventory is released as we build it and ship it out, but you stressed that deliveries are out into second quarter 2018 and we will start to see some delivery start in third quarter, then they accelerate up for the next three quarters in that. So, we see a little bit of impact next quarter, but the real impact from these orders will start mainly because the lag time in ordering and getting the equipment to even start the fabrication of this stuff is urgent deliveries are fairly long. So, we had to factor in the component leverage in there. But the – and the first one is out, which are a quicker build and a shorter delivery time of the wellhead units are typical rental fleet size, although we are selling, these are typical size that we can pretty much just put through the shelf pretty quick. The bigger stuff takes a longer delivery, takes a longer time to build it on the floor. So we will start seeing it more towards the end of the year in the first to next, but that was really the – when we get orders like this, they are always fun, but it was really nice to kind of break into some of the bigger horsepower, then making some efforts into that for a couple of years and significantly we got some good orders on that.

Yes, that’s great. And then can you comment – have you heard from your customers, in your conversations with them or in any of their conference calls about the longer gap we have seen between drilling and completing wells? I mean, everything I read continues to be a bit vague in terms of the longer timeline.

Well, thank you for reading the same thing everybody else is thinking, everything is vague. We had that all price volatility here a couple of months ago and it drops into the mid-40s. I don’t think maybe we got down than 43 and back up. So, it’s pretty vague with customers. Everybody has got their leather cards held closely to the vest. Some of the second quarter calls and some of the operators, they are cutting back on capital plan going forward and it’s not significant. Yes, I think there is may be 5% to 10% cuts in capital, nothing significant, but certainly indications that everybody is a little vary about what the markets do. But as I mentioned, it seems to be lightly to me a little more good news than bad news and of course this stuff can turn on a dime depending on what Middle East does, but here you see – I really mentioned we have the potential [indiscernible] impact of that all has held up, etcetera, etcetera. So there seems to be a little more resolve in the market from the large producers, i.e., OPEC and there is some other side issues that may help the supply demand situation a little bit.

Okay, thank you very much. Have a good rest of the day.

Yes. Thanks, Tate.

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

Thanks. Good morning, Steve.

Hi, Joe.

Turned into a fabricator over there?

Apparently.

Just wanted to follow up a little bit there. How do I think about sort of compressor sales margins here? Presumably, you are going to get some absorption benefit from this. Just trying to think about framing that up relative to kind of this mid-teens to 5% that can gyrate, I get it, but what are some thoughts there if you work away maybe into those peak quarters where you are cranking through some of these larger horsepower units?

Yes, very competitive market on this stuff. So, the margins if you look back historically, we have aimed for the 20% plus margins, which is just barely achievable in a market like this. We have had some in the past, but it’s pretty much of a one shot sort of a deal. So orders like this, we have seen 15% and 5% this year rising. Your volatility is going to remain, because it depends on what’s going through the shop that quarter. You can have some high margin, low margin, whatever. Luckily, if you have a lucky quarter at all averages out, but our things seemed to be pretty variable anymore. So, I think, it will – we don’t anticipate into the 5%, but I think we will be in that 10%, 15% range, which is still above the market. If you look at some of other public guys, they are in the 5% to 10% market. So we are still able to get a little better pricing than the market, but the market is off. So, 10% to 15% is what we anticipate on an average going forward.

Okay. And just out of curiosity, how many customers sort of constituted this big boost in order flow and was it all lower 48%? Did you get some international mix in here? I know you had pockets of that last year too as sales were sort of surprising, but any color there will be helpful as we try to frame this up a little bit?

Yes. Now, this is a little unusual on that way too, because as you noted in the past, we have had some international mix in it, but this is all domestic stuff, primarily Permian and it’s between two to three different groups. So as I have pointed out many times in the calls in the past, we have had a couple of good customers tick with the strong sales and have provided some consistent revenue in that respect, I mean, persistently higher than what we have been used to on the sales side. So, that’s continued along with this. And again, as I mentioned, I think they just are optimistic. They see – these are good strong companies. They have got money. They see some opportunities, get properties and you go ahead and take advantage of the market and go ahead and buy some equipment and put it out. So we are hoping that obviously this rolls a little further. Now we are – with the years worth of work in this where we have got some fab space. We have tried to leave a little open, so you are not totally shut out of the market, but hopefully we can fill in some gaps with that. And then as we get towards the end of this run that we are able to add some more of this bigger horsepower would be great, but any horsepower, of course – when you run just quarter-to-quarter on backlog, any horsepower is good, but hopefully we can capitalize on this more than we see in the past.

Alright, helpful. Appreciate it, Steve. Thanks.

Thanks, Joe.

[Operator Instructions] At this time, there are no further questions.

Okay. Thanks, Erica. I want to – before we sign off, I want to really stress the significance of not only the sales award in the backlog, but also the bigger horsepower component of it because this is – we have built horsepower this size, it’s not been a big piece of our mix in the past from a sales perspective and it’s at least greater than 50% of the revenue associated with this order. So we are pretty excited about that piece of it and it may actually in the future open up additional opportunities for bigger horsepower, which is good base load and brings us good money and good margins. So with that, I thank everybody for joining me on the 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.