Natural Gas Services Group, Inc. (NGS) Q3 2017 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen and welcome to the Natural Gas Services Group third quarter earnings call. At this time, all participants are in a listen-only mode. [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 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 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, 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?

Thank you Alicia and Erica and good morning and welcome to NGSG's third quarter 2017 earnings review. While our markets continue to be very competitive, NGS posted another quarter of positive growth. For the second quarter in a row, we delivered higher operating income and net income. Our rental gross margins remain among the highest in the industry and our sales revenues and margins continued strong. Rental fleet utilization and churn are relatively positive and due to high utilization rates we are adding more large horsepower units to the rental fleet. Our sales backlog remains at a record high level due to the large order we announced last quarter. However, we have been asked by one of those customers to convert a majority of their purchased units to long-term rentals. This is a unique opportunity for NGS and we have agreed to do so. I will discuss this further in my later remarks. Generally, the activity trends in all segments appear to be positive. This is not to say that there won't be some volatility, but it appears that we will be well-positioned going into 2018. That said, I will comment more details when I review the financials. Stronger total revenue and looking at the year-over-year comparative quarters, our total revenues decreased a little over $250,000 from $16.2 million in the third quarter o f2016 to $15.9 million in the third quarter of 2017. Quarterly sales were up from $2.5 million in the third quarter of 2016 to $4.3 million in the third quarter this year. Our rental revenues fell to $11.3 million. For the sequential quarters of the second quarter of 2017 compared to the third quarter of 2017, total revenues were off a little over $300,000 from $16.2 million to $15.9 million. Reviewing the comparative nine-month year-to-date periods, total revenues were down 7% with rental revenues decreasing to $34.6 million. However, our compressor sales revenues are 53% or almost $5.6 million higher in the nine-month year-to-date period of 2017 compared to last year. Looking at our gross margins and comparing the third quarter of 2016 to this current quarter. Total gross margin declined from $9.4 million to $8.3 million. However, sequentially and significantly, total gross margin improved by nearly 2% from the previous quarter and grew from $8.1 million to $8.3 million and improved from 50% to 52% of revenue in the third quarter of 2017. This is due to an appreciably higher sales gross margin and the larger dollar contribution from our sales product line this quarter. In the nine-month year-to-date comparisons, gross margin dollars were down from $30.7 million to $25.1 million, but still came in at 49% of revenue. Our sales, general and administrative expenses increased about $240,000 in the year-over-year quarters, but fell about $50,000 in sequential quarters of Q2 2017 to Q3 2017. SG&A is up about $950,000 in the nine-month year-to-date comparisons over the prior year, primarily due to the accelerated non-cash stock charge in the first quarter of this year. In the comparative year-over-year quarters, operating income decreased from $1.8 million to nearly $600,000 in the third quarter of 2017. Sequentially, we saw operating income increase nearly $200,000 from a little over $400,000 to nearly $600,000. When comparing year-to-date 2017 to 2016, operating income fell from $7.5 million to $1.4 million. In the comparative year-over-year third quarters, net income dropped from $1.5 million to a little over $520,000 this quarter. Sequentially however we saw net income increase in this third quarter from nearly $400,000 to a little over $520,000. In the nine-month year-to-date periods, net income decreased from $5.3 million to $1.1 million. On a year-over-year basis, EBITDA decreased from $7.3 million in the third quarter of 2016 to $5.9 million in this current quarter. Sequentially however, EBITDA rose a little over 3% to $5.9 million. It was at 37% of revenue in this current quarter. On a nine-month year-to-date comparison, EBITDA was down from $23.9 million to $17.3 million. On a fully diluted basis, earnings per share this quarter was $0.04 per common share compared to $0.03 last quarter and $0.12 a year ago. Total sales revenues which include compressors, flares and aftermarket activities, increased to $4.3 million from $2.5 million when comparing year-over-year quarters. For the sequential quarters, total sales revenues remained essentially flat with a slight softening from $4.4 million to nearly $4.3 million. On a nine-month year-to-date comparison, total sales were up $5.6 million or 57% from $9.7 million to $15.3 million. Reviewing compressor sales alone, in the current quarter there were $2.7 million, up from the third quarter of 2016's $1.7 million and down $300,000 from last quarter's $3 million. When comparing the nine-month comparative periods, year-to-date compressor sales were up 53% from $7.4 million to $11.3 million. I think this is a commendable performance considering the current environment. Gross margins for compressor packages we fabricated in the quarter averaged 17%, significantly up from 4% a year ago and 5% last quarter. On a year-to-date basis, we are averaging gross margins of 13%, up almost double from 7% in the prior year. Our sales backlog as of September 30, 2017 was proximate $23 million compared to about $25 million in last quarter and $6 million a year ago. We have however received additional orders totaling a little over $2 million after the quarter's end. So our backlog has remained at a stable level. We estimate that this present backlog will stretch into mid-year 2018. The first unit from the large order announced last quarter will start to roll out in the fourth quarter of this year. However, as I mentioned in my open remarks, we have been asked by one of our customers to convert a majority of their purchased units in this backlog to long-term rentals and we have agreed to do so. This will reduce our sales backlog to approximately $6 million, while simultaneously increasing our capital commitments by $17 million to $18 million. Rental revenue had a year-over-year quarterly decrease of a little under $1.9 million from $13.2 million in the third quarter of 2016 to $11.3 million in the current quarter. Sequentially, rental revenues were down a little over 1% or less than $150,000 from $11.4 million in the second quarter of 2017. The year-to-date review shows rental revenues down from $44.2 million to $34.6 million for the nine-months ending in September. Our rental gross margins continue to be strong. We posted a 62% gross margin this quarter against 63% last quarter and 66% in third quarter o f2016, which was a ten-year high. Year-to-date, we are averaging 62% compared to 65% last year. Average rental rates across the active fleet decreased a little over 4% in the nine-month period of this year versus last year. Our second pricing indicator looks at the rental rates for units set in a particular quarter. This gives a better indication of current pricing versus long-term averages. On the year-to-date nine-month basis, average new set prices were $3,092 per unit last year compared to $2,983 this year, a 3.5% decrease. With the current pricing decline being about the same as long-term average decline, it appears that the pricing deterioration we have seen over the past couple years has lightened up a bit. I am not saying that the pricing pressure is gone and price levels are certainly not where they should be, but in these comparative periods. NGS has been able to hold our rates to a large degree. Fleet size at the end of September was 2,538 compressors which reflects seven new units for this quarter. These additions were all our new larger horsepower products. Fleet utilization continues to be in the 49% to 50% range where it has been since February of this year. It appears that a bottom has formed. Activity metric we look at is our rental churn which is number of units rented divided by the number terminated, therefore a positive number indicates growth. In the first quarter of this year, the churn was 0.47. In the second quarter it was 0.73. And the third quarter turned positive at 1.05. So we are also seeing a positive trend here. We continue to see bright spots on our new product launch. Of our 400 horsepower units, we have rented 12 of 13 we had in the fleet as of July and have added two more to the fleet that will last couple months of the quarter. Referencing our 600 horsepower line, we sold seven of those early this year and have built one for the rental fleet. As of last week, we rented two of them. So we have another build in process. As for the smaller horsepower VRUs or vapor recovery units, we have approximately 60 in the fleet now with utilization approaching 90%. Overall among these three new products, our utilization is running in the 80% to 90% range and we anticipate this market will continue to grow. It's apparent that we have made the right decision 12 to 18 months ago to enter into those markets. Talking about large horsepower markets. Again, referencing the conversion of a large part of the sales backlog to long-term rentals, we see this is an excellent and unique opportunity to enter the high horsepower rental market in a robust manner. We will be able to rent a good number of 1300 horsepower units on a multiyear agreement and above market pricing. As you know, we had already made the decision to move into the medium horsepower market with our new 400 to 600 horsepower products and we had designs on even larger horsepower over time. When we were approached to rent these large horsepower packages, it was an opportunity to accelerate our strategy and move into the bigger horsepower right away. Our customer purchase for this large project due to our past service in rental and fabrication relationship with them and we were able to respond positively because of our ability to immediately commit the capital. Our competitors are not able to provide the service level or the capital required. The long-term economics of these rentals are compelling. Converting from a sale to rentals increases our total non-discount EBITDA from roughly $2 million to almost $14 million. Granted, there are different timetable associated with these but the advantages of our rental business is apparent and this clearly aligns with our strategic direction towards larger horsepower. These rental units will be built and placed into service over the next 10 to 12 months. Now related to service and maintenance, it was a small part of our overall revenue. We have placed a little more emphasis on our service and maintenance business has been successfully realized. On an annualized basis, we have grown at a bit over 50% since 2015 and it actually delivers gross margins that exceed even our rental business. I have previously said that our capital expenditures this year would be in the $5 million to $10 million range and through the third quarter, we have spent approximately $5 million, with $4 million of that in this current quarter as we added seven larger horsepower units totaling 3000 horsepower car fleet. By year-end, we anticipate allocating another $2 million to $3 million in capital for larger horsepower units. Now with the sales to rental conversion we discussed, we will add another $4 million to $5 million in CapEx in the fourth quarter this year, with an additional $12 million to $13 million in 2018. Going to the balance sheet. Our total bank debt continues at $417,000 as of September 30, 2017 and cash in the bank was $73 million. Our cash flow from operations are almost $4 million this quarter and $14.2 million year-to-date. From a macro perspective, the price of oil has generally held up pretty well. It seems like we may get some stability. Crude inventories are down. The rig count has leveled towards hopefully a sustainable level and OPEC and Russia are cooperating from the supply side. We are cautiously optimistic that 2018 will bring additional activity to NGS. As I just noted in my comments, we are seeing some positive indicators in our move into the higher horsepower rental market is being welcomed our customers. So much so that we are actually being invited in as alternate suppliers for bigger horsepower. We are very excited about the opportunity that this large horsepower rental contract brings to NGS. Not only is it economically attractive, but it accelerates our strategic entry to the higher horsepower market. This is important. It represents a high level of confidence in NGS by our customers. NGS has positioned itself well for this downturn and in spite of the times our per unit results are enviable. Our margins continue to be among the highest in the business. Our sales backlog is strong. We are seeing some traction with the new products. Our debt is negligible. Our cash flow ability enables us to react to and capture opportunities we want and our ability to generate cash is exceptional. That's it in my prepared remarks. I will turn the call back to Erica for questions anyone may have.

[Operator Instructions]. Our first question comes from Mike Urban from Seaport Global. Please state your question.

Thanks. Good morning.

Good morning Mike.

Could you talk about, I wanted to go into the contract conversion here, probably I guess conversion to contract work here. It certainly makes a lot of sense strategically. Given the additional capital required here, what is the comparative return profile of what you would have generated as a product sales versus a rental? Is it attractive? Is it better? Or is there also an element of just there is a strategic initiative here that's important and you kind of have to weigh all of those factors?

Well, it's really all that, Mike. Certainly strategically, as we announced over the last year or two, you always start putting out the 400 600 horsepower designs we come up with and so we are moving into that. This accelerates it into the large horsepower, the 400 to 600 being more medium horsepower range. So these are 1,300 hp units. So strategically it just moves in and up much quicker than we were planning. So we think that's good from that standpoint. From a return standpoint, as I mentioned, just looking at the EBITDA comparisons to kind of eliminate some of the other fluff around the number, EBITDA in the sales contract itself was around a little over $2 million. Now over time and again this is a longer term contract, EBITDA will be about $14 million. Now seven times, that sounds great and it is great. Sorry, there is, if you want to start discounting, you start looking at depreciation, you start bringing in some other factors there. But generally dry from an EBITDA standpoint, rental is very attractive compared to sales and especially with this when we have got a longer term contract than what's normal. So overall, everything looks pretty good with it.

Okay. And what it the timeframe for the contract?

I don't want to into too much competitively. Well, let's say it's longer than three years.

Okay. That's great. And you mentioned that this just kind of accelerates your entry into the large horsepower market. With that contract now in place, do you see others out there? Does that kind of push other customers over the edge, say, hey these guys can do that? And then also do you have the capacity to do additional work there? Or is this a lot to play it off right now and you folks have been executing this particular contract?

Well, that's a good our question. I think it will bring to the forefront a little more that we have got these capabilities. As I mentioned last quarter when we got the order as a sales order, I said that it would demonstrate to customers that we can build this big stuff. We have built in the past, but this is a big build with a fair amount of volume. So we would demonstrate to maybe industry and particular customers that we can handle this sort of stuff. Now we take the next step, not only can we build it in volumes, but now we can put it out there and operate and maintain it. So we think it will be met with open arms by some customers now. And as I mentioned, we have actually been invited in by customers on bigger horsepower. The first 400 horsepower units we put out almost a couple years ago were at the request of a customer move into that horsepower. Now this is at the request of another customer we went to bigger horsepower. So I think the market we have got, yes, it's a little tighter market on a bigger horsepower than a smaller horsepower. So we are able to take advantage of that. But I think also our service reputation and then our fabrication ability some of the players don't have fabrication ability any more. We still do. So I think it enables us to react a little quicker. And then of course our availability of cash has helped. As none of the competitors can come up with cash.

Got you. Okay. That's all for me. Thank you.

Thanks Mike.

Our next question comes from Rob Brown from Lake Street Capital. Please state your question.

Good morning Steve.

Hi Rob.

Just wanted to dive into trends and utilization a little bit. You have talked about some flattening for a few quarters. What's your experience historically in how that turns around after a flattening and maybe your sense on the market over the next few quarters?

Well, just looking back again, the utilization up and down measured in basis points by the month since February. So for eight months, it's been within a 1% range. So it looks like certainly that's a flattening now. The uptick, we are hoping that the uptick starts fairly quickly. Now we did see, I think the last month of the quarter was actually a positive month and the churn on the quarter was positive. So we are starting to see maybe just a little increase in that now. It's hard to say exactly how that will play out over time. I think generally if you look at, say, the next 12 months, you ought to see higher utilization. But on a quarterly or monthly basis, yes, we are still going to see some basis point variation as we start climb out of it. But yes, I think as I mentioned, the 400 and 600 horsepower units are moving pretty well. The VRUs are moving very well. So if we can get the terminations slow down a bit down and operators, I think, will start doing that with the oil price hopefully holding up, those factors ought to contribute to a little higher utilization as we go forward.

Okay. That's good color. And then on the VRU market, I guess what's the trend line there? What's driving that? Or is that just kind of a steady improvement?

It's been pretty good. We are mainly seen the SCOOP and the STACKs being quite a bit in down South Texas, some in the Permian. And I was trying this morning to remember the number I have thrown out a couple of years ago as to what we are expecting. I think I was saying, yes, we would expect a 5% to 10% of fleet in VRUs over the next couple or three years. So we are at almost, we are at a little over, well almost 5% now, after say 12 to 18 months. So I think we are pretty well on track. And that's a pretty good ramp up on that. So I think the VRUs will keep growing. In fact we are trying to fit in the schedule some more because are almost 90% utilized on those. So I think that will stay pretty well. And again, obviously we think the bigger horsepower market is a place to move into and sort of this conversion helps out.

Okay. Thank you. I will turn it over.

Okay. Thanks Rob.

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

Hi. Thanks Steve for the detail on the terms of the rental commitment going from sales to rental. Is it a service challenge to service these larger greater than the 1,000 horsepower units?

It's different servicing. You start getting into this type of equipment, number one, it's very expensive and number two, it takes a pretty high level of skill into building that. Now we got service people in our organization that our familiar with this equipment and things like that. And we are in the process and have been in the process of gearing up for this once we were approached with the conversion. So it's a little different, but yes, the main thing that we think we will be able to be competitive and attractive on this is the service level. So whether it's 10 horsepower or 1,000 horsepower, it's runtime response, that's the key to the customer. So we expect we will able to be do the same thing on these. Customer expects that and we are gearing up for all that right now.

Okay. And to confirm the seven units that you introduced in the quarter. I think you said you rented almost all your 400 horsepower units. Did you rent all seven of those units?

Let's see. I think except for, we had 12 out of 13 of the 400 horse rented as of July, six out of seven of the units this quarter were 400 horse. I think we have got two idle in that. So those are renting and then one 600 horse. So we have two 600 rent. We have got another one on schedule we are going to put out. So we have still got two to three of the 400 available to rent. Again, they just get rolled off the floor in the last 30, 40 days. So those are rented. It just sometimes takes a couple of months to get it all done.

Okay. Understood. Thank you. Have a good day.

Okay. Thanks Dave.

[Operator Instructions]. Our next question comes from Jason Wangler from Imperial Capital. Please state your question.

Good morning Steve.

Hi Jason.

Congrats on the contract. I was curious, how much you might just talk about the actual use of that horsepower? Where it sits? Is it still wellhead with a lot of wells? Or is maybe a little further up the stream? And then maybe even the geographies that you guys have been working at with those pieces of equipment?

The application is one of the factors that I have mentioned over and over, is why we are moving to bigger horsepower. Bigger wells, centralized gas lift and pad drilling. This is centralized gas lift. So instead of wellhead units on this, wellhead being maybe a smaller unit that would handle one or two wells on a gas lift, this may handle, I don't know the exact number, but it may handle 10 to 15 wells on gas lift application. So more gas, more horsepower. Again, this doesn't eliminate the smaller ones some of the orders we got in October are smaller wellhead units. But this will be more of a centralized gas lift. So it's exactly along the lines that we start moving into bigger horsepower for, this is one of the primary application for looking at that and this is where it will go. And no surprise, it's a Permian location or multiple locations.

Okay. That's helpful. Thank you. And you mentioned in your prepared remarks that the sales margins look like they were quite a bi better in the third quarter. Could you maybe talk if there was something specifically there? And also just kind of as you look forward, the backlog, is it a little bit more favorable contract or is it just you guys getting a little bit better at building these larger units or just anything there?

It's probably a little of both. We had 5% margin last quarter and 4% last year. Last year was more so an absorption issue. We had a pretty low level of backlog, I think of $3 million or $4 million. So we had more expenses relative to revenue. We had to carry in the depression in margins. You will get some margin variance quarter-to-quarter. So last quarter, we had actually more smaller units go out that carried a little lower margin on it. And then we had some big units go out this quarter, which can get a little better margin on them which is little different than what you would think. You would think maybe the large units had a lower percentage margin. But it was reversed on that. So it kind of depends on the flow to the shops of what kind of jobs you have got going, who the customer is, what the bidding situation was and everything else. But we are very happy obviously at the 17%. This is kind of getting back to the good times margins. But going forward, we certainly, I think we will and like I announced last time, I think we will be in that 10% to 20% margin range. Of course that's as a range wide enough to drive a truck through but still much, much better than the industry. The industry runs single digits right now.

Sure. That's helpful. Thank you Steve. I will turn it back.

Thanks Jason.

At this time, we have no further question.

Okay. Thanks Erica and I appreciate everybody joining on the call. I appreciate your time this morning. I look forward to visiting with you again next quarter. Thanks.