Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Fourth 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’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 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 call 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. Welcome to Natural Gas Services Group’s fourth quarter 2017 and full-year earnings review. We are pleased with our full-year 2017 results and are encouraged that our fourth quarter results provide an indication of recovery in our business. For the first time since the first quarter of 2015, the beginning of one of the worst cyclical downturn in our generation we saw a quarterly increase in rental revenue. Our sales revenue for compressors and aftermarket partner services were also strong throughout the year. Additionally, pricing has shown some recent strength something we are certainly please to see. Our growing contracted rental demand we have the largest backlog of compression fabrication working over four years. As we have previously announced we entered the larger horsepower arena now two years ago and recently accelerated our penetration into that market. Our activity in this segment is going well and we look for it and the rest of our business to grow in 2018. As we review the financials I’ll note that this fourth quarter had a couple of moving pieces in it. Primarily the reduction in the federal income tax rate in Q4 and the attended very large increase net income and some minor inventory adjustments due to lower of cost to market in obsolescence reviews. Considering all these factors are part of our earnings per share this quarter was $1.42. However, without the effects of the tax decrease and the inventory adjustments our adjusted earnings would have been $0.05 per share. Now with all that said, let's get to the details. Starting with total revenue and look at the year-over-year comparative quarters. Our total revenues were essentially flat running to $16.7 million in both the fourth quarter 2016 and 2017. Rental revenues were up approximately…

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

Good morning, Steve.

Hi, Rob.

On a larger horsepower market, you talked about kind of a runway there of demand. Can you give us a sense on what's driving that and your view on the – with the runway?

Well, as we mentioned a couple of years ago when we first started looking at 600,000 horsepower, back then we saw three primary drivers. Number one was just larger wells. We're getting extreme lateral lengths, a huge number of stages and frac jobs in these wells. So we're getting bigger wells, number one. So the main thing to remember is more volume means more horsepower. So larger wells, number one. We saw a trend towards certainly pad drilling. I think 3/4 of the wells now are pad-drilled, so you've got multiple wellheads per location. That aggregates gas, it means a bigger horsepower. And then you start seeing some centralized gas lift facilities. Still a lot of gas lift is done on a wellhead, well-by-well basis. We're starting seeing some centralized facilities too, where they're bringing in multiple wells into larger horsepower. So we saw those three things going on two or three years ago when we started moving into the 400 to 600. This larger market is – these initial jobs we've got our centralized gas lift, so we're seeing that. Plus, we're seeing just a lot more midstream activity in some of these. And in this 1,300 horse range is pronged in the smaller to middle part of any midstream requirements, but you're starting to see more pipeline activity out of that, too. So yes, those four items look to be driving all this. I don't think you're not going to reverse any of those items because they're all, number one, the midstream activity is driven by just the number of wells being drilled, gas need to be moved and out of basins, and the other three are economic factors that the operators continue to dwell on.

Okay, thank you. And then on the make-ready activity, how long do you think that you'll see some margin degradation because of that?

That's a double-edged sword, we kind of hope for long-term because that means there's revenue coming after it. But again, it impacts the margins somewhat. So the only thing I've got to go on is if you look back in coming of the 2008, 2009 downturn heading oil shale stuff in 2010. And we had quite 12 to 18 months of some pressure on margins, due to some of this make-ready activity. Now again, as we've fairly quickly, as so it's a good thing, but you have to remember, when look at the loan margin that there's revenue coming behind it And in addition, that's good margin revenue because those incremental margin on the stuff going out. If we're doing make-ready, it's obviously that's the equipment shipping the yard, so incremental margins on this stuff going up is very high. So you have to spend that money before you make that revenue. But I would estimate – boy, this is rough estimate. As long keep growing that rental piece of it, it will – yes, we can see 12 to 18 months of it.

Okay, good.

I’ll remind everybody also we expensed all that. A lot of peers, I think all of our peers capitalized a fair amount of that some of the maintenance. So ours is all expense, so we take the full hit at that time. So at least, you don't have to worry about showing up later somewhere else. So it's all fully absorbed when we spend it.

Okay, good. And just to clarify on the CapEx, if you can give some numbers $20 million to $25 million? Was that just the fleet piece, or did that grew the building?

Yes, just the fleet.

Okay. Thank you.

Yes. And both of those would be spaced throughout the year. Whether you're building the equipment now. The equipment we have more – the engines and compressors are coming in certainly beforehand on that. So the money going out for capital will be spaced up throughout the year, it's not all going to hit at one-time. So whether it's a building or the fleet growth, we'll see it spaced out. And then certainly from a fleet standpoint, as this stuff starts going into – yes, this is all contract – well, 80% of the build is contracted, so as we see that stuff go into service, that will contribute some operating cash back into it, too.

Okay. Thanks a lot Steve.

Okay. Thanks Rob.

Our next question comes from Mike Urban from Seaport Global. Please state your question.

Thanks. Good morning.

Hi Mike.

So you're talking a little bit faster, my fat fingers could type there, on the inventory charge, was that all in the sales side or was that some of that allocated to the rental piece?

No. Probably I think 90% of it was on the sale. So it's primarily fabrication inventory.

Okay. Gotcha. And you talked a little bit about the makeready and startup costs, which makes sense, and as you said, kind of a positive essential to meet demand is going up. But what about underlying cost inflation excluding that? In other words, it's a very tight market out there, you are seeing a little bit of pricing at this point, but not a ton? And presumably you've got – presumably you've got to compete for labor with some of the other parts of the oil pads. What are you seeing on that front? And is that something that you're able to fully offset either from an efficiency or pricing or pass-through perspective?

Well, it's tight. That's not new news to anybody out here. Yes, I think the nationwide unemployment for, and I think I heard it’s about two. So everybody wants to work, it's working. And there's not a – there's not a pool of people sitting around and looking for a job. So it gets competitive, but we see this every time in these markets. So you end up having to usually pay a little more to get people in. And this is primarily on the fabrication piece. The field side isn’t quite as bad. Yes, the problem you have here in Midland is everybody's in the Midland now. And when activity ramps up, you've got a population base out here between Midland and Odessa of probably no more than 300,000 to 350,000 people. So you don't have a big labor pool from. That's why unemployment goes down so quick. So the field doesn't have near as much a pronged because it’s more scattered out, you can pull from a lot of different places. Fabrication here tends to be the issue. But yes, you have to pay a little more, you have to make a little – better place to work and things like that. But we see it every time. We're able to overcome it every time. As far as covering those costs, it takes all those – trying to push pricing a little. Certainly, efficiencies wasn't what we're doing, costs control and things like that. It's just a multitude of things that we try to do to keep it intact. But there's – there will be constant pressure for a while on it.

But net-net, I mean you think you can at the very least can hold the margins flat, and maybe improve a little bit of the pricing dynamic gets better, is that a decent way to think of it?

So I think now are you looking at two pieces that were here. One is the sales pricing, if you're building stuff to sell and that's typically you can more so pass it along. Because we know those costs, we're bidding those costs different everyday, so those costs are going up, our prices going up. So sales is pretty easy to handle. Certainly, you've got to still be efficient from a competitive standpoint, but it’s an easier time to pass this cost through. The rental standpoint, those costs get capitalized into the equipment. We had to be careful with those right there as far as how that goes out. Now that’s where probably on a more direct operating basis – you have the field comes in to play more so, who were going to watch the labor out there from a gross margin standpoint. Yes, so again like I say, it's a combination of what you can pass through and how efficient you can be in all aspects of the operation.

Okay. Gotcha. And then last one for me, the timing of the rollout into the market of the large horsepower units still the same unscheduled there fairly kind of ratable deployment schedule over the next year or so?

Yes, I think we had a total of 17 big units awarded to 3 or 4 are already out in 2017. So we've got – there are some gaps in the schedule and the schedule moves a little over once in a while. Generally, you could say over the – through the end of 2018 is they're going to be fairly prorated over that period with - you might have some bumps and grinds along the way – but we intend on having all built by the end of the year. And then maybe some drift into first quarter of 2019 as far as rental rates are implemented.

Okay. Gotcha. That’s all for me. Thank you.

Okay. Thanks Mike.

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

Thanks. Good morning, Steve. Just a question on your mix, your average horse lot of changes certainly where we've been historically and where we are going now with 1,300 units. But I'm just curious, so out of the – so 85% to 90% of your spend in 2018 on the larger horsepower? Are you including 400 to 600 in that large horsepower designation or you strictly talking about the 1,300 units there? Just trying to understand sort of your build in 2018 there from an horsepower perspective. And I'd be just curious as you exited 2017, what was your 400 to 600 percentage of your fleet mix? I think you're kind of are on 25%-ish? I'm just curious where that's exiting the year?

Yes, a question – I should have clarified that a little. Yes, when we're talking about – price is a bigger horsepower, we're including the 400 and 600 horsepower units in there, so probably more of a mid to big horsepower build. So the 85% to 90% of the capital going towards big horsepower, we're referencing 400 horsepower and higher. So it's included. Now tell me again on exiting 2017, what were you looking for there.

The 400 and 600 horse – basically the large horsepower percentage of your fleet mix, and was it in that 25% ballpark? Or isn't that moving higher now that you have three or four these largest 1,300 horse units in the fleet?

No, 25% – well you’re talking about the build?

Maybe total number - yes, in total number of units maybe is probably an easier way to think about it?

Well in 2017, we didn't – I think we – what was our – in 2017, we had $6.6 million in new fleet compression. 85 of that was spent in the last half of the year on larger horsepower. And really that – there was probably – there might have been 200 or 300, 400, 600 in there. But the majority of that half year spend was the big 1,300 units.

Okay, okay. And this shift in utilization, I just want to understand sort of what you're indicating there. Obviously, you've got and as you indicated puts and takes with larger horsepower going out in the field and then some come back on the smaller horsepower side. But you kind of sort of expecting flattish here in 1Q and 2Q as we get going, kind of bouncing along in low 50s or upward bias of second half weighted? I was trying to understand what specifically you're talking about in the cadence of the utilization list.

Yes. Well, I think the bias will be upwards and the pressure will be upwards. But just to resolve this quarter, we had increase from top and the pressure will be upwards. But just to resolve this quarter, we had an increase from rental revenue at really no move – maybe 20 basis point movement in utilization. Not really much to talk about. So what we're seeing is the bigger horsepower is starting to go out. And we have historically measured on the buy per unit on a unit utilization, which totally changes as we start moving to bigger horsepower. And we're going to need to start reporting on the horsepower and a unit utilization basis going forward in all aspects whether it's utilization or costs and stuff like that. So I think we'll have probably, your rented bottom trough have been they're essentially all of 2017 that utilization has been held in there, that 49%, 50% range. But I think now we'll – maybe quarter two, it might still be in a trough, but the pressure starts coming up a little from the point that certainly, horsepower-wise it will, but on unit utilization, I think it can take a little longer to start showing some appreciable movement on it. But horsepower will see a pretty quick, I think, as we roll through the year. So that's a – probably not answer. But generally, upward bias, I expect us to see a greater utilization growth in horsepower then units just because the big difference we had in those units. On a revenue basis and horsepower roughly, these bigger 1,300 horse units are average horsepower before this movement in the big horsepower is about a 140, 150 horsepower. So you're getting almost a 9:10:1 ratio on horsepower on a per unit basis. So that's the dilemma we're seeing in utilization right now. It's not going to be a real good indicator. Obviously, I’m going to put you more towards revenue and how that represents the growth for the next couple quarters.

Okay. It makes sense. And last one for me and I'll turn it back. Just an update on the VRU market. You referenced that few units can put out there just anything new on that front and what you're seeing in that market will be helpful. I appreciate it.

Yes. We are continuing to build those, I think we've slotted – I know we slotted some more into the build schedule this year. These guys will probably get the big horsepower at one end then you go look in the 50 to 100 horsepower VRU market, and we're sold out. So it’s the big or the small right now that's active. So we're still putting those out and still building them and will be as long as that market continues to be active and looks like it might stay active.

Okay. Thanks Steve.

Thanks Joe.

Our next question comes from Jason Wangler from Imperial Capital. Please state your question.

Hey. Good morning, Steve.

Hey, Jason.

I was curious just to make sure the uptick in costs on the rental side, that was or I should say on the revenues that didn’t have anything really to do with pricing that was more of something you're seeing in first quarter or even more in real time, is that correct?

Yes. It’s not pricing. We saw a little about a 1% increase in pricing sequentially, but a lot of that was from the bigger equipment to, the contribution it was making. But no, there's not been a whole lot of pricing impact to drive revenues up. It's just been on activity.

Okay. And then the larger units, I’m assuming the answer is the Permian, but could you just maybe talk about – you talk about the addressable market being pretty significant. Is that specifically in your backyard there? Or are there some other areas that you guys are kind of initially working on as you kind of get into that market?

Well, the Permian is going to be the driver, as it is in anything, right, right now. So that's going to be the biggest piece of it in and these results are getting our Permian base. But we think this gives us entree into the Marcellus which has been a big horsepower market for long time, very little wellhead out there. So we think this gives us an opportunity to start talking to people there. The other areas, everybody needs bigger horsepower essentially in some respects, so we think there's opportunities in the Oklahoma area on it. Some in the Rockies, maybe, probably a little more limited there. But yes, you got some of the basic areas of Permian, Oklahoma and a little less, Marcellus. So I think those – mainly what you look at. The other thing we see is the opportunity now to start talking to a little more Midstream companies. We're restrictively wellhead. Midstream guys don't need wellhead compression. It's a segment you don't worry about. But now moving up into the bigger horsepower, and this is more of the bigger horsepower than the 400 to 600. The bigger stuff, you see a lot more opportunities there to start talking to people. So we think there's some geographic expansion. We can accomplish besides just some customer penetration in different segments.

I appreciate it. I’ll turn it back.

Thanks Jason. End of Q&A

At this time, we have no further questions.

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

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