Natural Gas Services Group, Inc. (NGS) Q2 2018 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second 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 including in this conference call are made as of the date of this call and Natural Gas Services undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from the expectations reflected in the forward looking statements include but are not limited to factors described in our recent press release and also under the caption Risk Factors in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission. Having all that stated, I will turn the call over to Stephen Taylor who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Erica, and good morning. Welcome to Natural Gas Services Group's second quarter 2018 earnings review. NGS exhibited a significant increase in total revenues of 24% compared to the sequential quarter, led by our overall sales volumes. Rental revenues were flat, but we see encouraging trends in the real business, that should result in improved revenues going forward. We place more actual horsepower in the field led by our shift into the higher horsepower real compression market and our backlog of contracted rental equipment was significant. Our rental margins were lower due to expenses incurred to prepare equivalent to meet pending rental demand, a necessary current cost to capital future revenues. We continue to see opportunity in future especially in the higher horsepower market. And I'll comment more details to review the financials. Starting with total revenue and look at the year-over-year competitive quarters, our total revenues increased 12% to $16.2 million in the second quarter of 2017 to $18.2 million in the second quarter of this year. Sales increased by $2 million or rental revenues saw a slight increase, but our overall rentals remain fairly flat. For the sequential quarters of Q1 of '18 compared to Q2 of '18 total revenues increased $3.5 million from 14.7 million to 18.2 million. The increase was primarily in our sales component which saw an increase of $3.4 million while rental revenue again remained fairly flat, summarizing, total revenues up in both year-over-year and sequential quarters. Looking at gross margin and comparing the second quarter of 2017 to this current quarter, total gross margin is from $8.1 million to $8 million and was 44% of total revenue compared to 50% of total revenue in the second quarter of 2017. Sequentially, total gross margin increased about 3% from $7.8 million to $8 million. However, total gross margin as a percentage of total revenue declined to 44% from 53% in the first quarter of 2018. I’ll discuss the individual margin impact on the total margin later, but we are seeing a mix shift between higher-margin rentals and lower margin sales revenues, which will also lower the overall market. So, this current quarter was 35% of total revenue, there was 27% of total revenue year ago and only 20% last quarter, so we are seeing an appreciable mix shift. Our sales, general and administrative expenses decreased over $75,000 in the year-over-year quarters, was up less than $300,000 in sequential quarters of Q1 ‘18 to Q2 ‘18 was down over $1 million in the year-to-date comparisons over the prior year with this large reduction being due to the accelerated non-cash stock experience we took last year. SG&A as a percentage of revenues were up 13% of revenue this quarter. In the comparative year-over-year periods, operating income decreased from a little over $400,000 to little over $225,000. Sequentially, operating income decreased from approximately $350,000 to little over $225,000. The impacts to operating income in these periods were due to higher than traditional expenses in our rental business primarily due to makeready expenses were incurred prepared compression units before they go in contract. It’s important to note that the operating income impact is larger when compared to our industry peers because we do not capitalize any maintenance costs, but instead expense all of it, which has a more significant impact on current operating income. We believe that is a more appropriate measure of performance in our business. The comparative year-over-year second quarter's net income dropped towards $125,000 to about $250,000 this year. Sequentially, the second quarter 2018 saw a slight net income increase from nearly $225,000 to approximately $250,000. On a fully diluted basis, earnings per share this quarter was $0.02 per common share, steady with $0.02 since last quarter. On a year-over-year quarterly basis, EBITDA increased slightly from $5.7 million in the second quarter of 2017 to $5.8 million in the current quarter. Sequentially, EBITDA increased from $5.7 million to $5.8 million. EBITDA margins have roughly averaged about 35% of revenue in all comparative periods. Total sales revenues, which include compressors, flares, and aftermarket activities increased by 45% in the year-over-year quarters from $4.4 million in the second quarter of ‘17 to $6.4 million in the current quarter; for the sequential quarters, total sales revenues more than doubled reflecting an increase from $3 million to $6.4 million. Compressor sales for the current quarter were $4.7 million up from $3 million in the second quarter of last year and $1.8 million last quarter. This quarter’s total gross margin is 23% compared to 27% in Q1 and 15% a year ago. This is quite a bit of margin variation quarter-to-quarter and in our sales business due to scheduling and the different projects that might be on the floor at any given time, some with lower margins than others. But significantly the margin is averaging 24% on a year-to-date basis this year compared to 17% year to date last year. Our backlog as of June 30, 2018 was $4.1 million has grown to $7.3 million as of July 31, 2018. We also anticipate further significant sales in the next 30 days in this backlog number. Rental revenue had a year-over-year quarterly slight increase for the remainder of approximately $11.4 million in both the second quarter of 17 and the second quarter of 18. Sequentially, rental revenues were up about 1% from $11.5 million in the first quarter of ’18. Our rental revenue in numbers have utilized compressors are relatively flat in compared to quarters, we have the seen the average horsepower running the field increase 5% sequentially and 8% year-over-year. The significant declined in rental revenues in the past couple of the years has been arrested and we’ve seen active horsepower and utilization grow this quarter. The revenues will remain relative flat due to downsizing in consolidations standby rentals rates and some large horsepower stations and pricing pressure in smaller size units. Downsizing as a natural economic transition as well as mature and compressing needs are correspondingly less. The results have now changing near count the lower revenue per compressor. Standby rental rates on some large equipment have been implemented due to construction delays, but this is only delay and we will see full rates kick in over the next couple of quarters. We also saw a 1% decrease in rental rates per unit and 5% decrease per horsepower in the sequential quarters. This average pricing decrease is due again to customers downsizing compression equipment and continuing price pressure in the smaller horsepower alliance. There continues to be too much capacity in the small horsepower part of the industry, but we’ve been able to mitigate most of that weakness with our large horsepower penetration. Our transition to a higher horsepower fleet is working just as we expected. Larger horsepower units and revenue are not only replacing the moderation in lower horsepower metrics, but will over time provide more robust revenue margins when compared to our traditional lower horsepower fleet. We expect this trend provide better rental revenue and margins in the coming quarters. Gross margin this quarter is 65%, down from last quarter last year's of 63% in Q1 ‘18 margin of 59%. The impact to our margins this quarter was due to a large amount of overhaul work as performed on rental compressors being prepared to go out on contracts. I discuss this in previous calls as we start to stay more equipment we will experience higher current expenses, getting them ready and this will be reflected in the income statement. As I mentioned, we do not capitalize this maintenance costs, but recorded them as a current expense contrary to most others in the industry. This impacts current quarters, but does give the public a more accurate review of our actual spending. For example, in the year ago quarter, we overhauled 12 compressor packages. Last quarter, we get 31 in this quarter we made ready 74. We spent $330,000 more this quarter on makeready cost then we did in the year ago quarter. We do not overhaul equipment less is contracted, already or has a higher likelihood of being rented. As such, revenue will be attached to this equipment in the future. Lots of moving parts with combined balances show some underlying positive trends. We’ve more equipment going out and we should see margins and utilization start to catch up. Fleet size at the end of June was 2,557 compressors in addition of 6 units this last quarter. This represented 4,350 horsepower of which 95% was our 400, 600 and 1,380 horsepower units are larger horsepower units. Our utilization measured by horsepower climbed to 51% in this current quarter, our unit based utilization grew to 49%. There are two items to note this quarter as far as utilization goes. First, all three months and each months of this quarter had net positive sets. Last time we had this was happening was in the third quarter of 2014. And second, the higher utilization that the companies are shifting to large horsepower rental units is starting to be reflected in the overall fleet utilization. Over the past 12 months, our total fleet horsepower increased 5.7%. The rent horsepower increased 8.7% over that time period. Our fleets in the industry have essentially bifurcated as the smaller horsepower classes, accompanied by different utilization dynamics. For example, our largest horsepower equivalent utilizations presently at 91% for our medium and small, lower pressure compressors are presently in the mid-40% to mid-50% range. As we set additional large horsepower compressions and the wellhead compression market picks up more, we will see steadily higher utilization but presently we are in a transition. Over the past 12 months, we've added 31 new fleet units that totaled 21,000 -- little over 21,000 horsepower with again 95% of that being in our large horsepower category. To demonstrate the growth and penetration we’re seeing in our large horsepower line as of June 30, 2018, a full 14% of our active horsepower is classified as large. Additionally, we have an equivalent amount of large horsepower in various stages of construction with the majority already contracted. We indicated last quarter that capital expenditures for rental compression in 2018 would be $20 to $25 million. Year-to-date, we have spent 13 million of that but we now anticipate that number will grow to between 25 and 27.5 million. Looking at the balance sheet, total bank debt is $417,000 as of June 30, 2018 and cash in the bank was a little over 62 million. This amount is down about 11 million since out cash peaked to last year and solid investment bank into the Company, but the vast majority for new horsepower rental compression equipment. In closing, NGS continue to deliver good results and this quarter demonstrates that as follows. Our sales business continues to live a good revenue and margins. Our renal business looks to have good underlying trends as demonstrated by the backlog of equipment to prepare for contract. We are year-end into our movement of the high horsepower market and our utilization of market attraction and penetration are showing good results. We have raised our capital expenditures target for the year about roughly 15% for rental compression and our cash flow on balance sheet continues to provide the capital stores and flexibility required to fund our growth in the future. All of this fuels our optimism about the market and our performance as we finished 2018 and head into 2019. Erica, that's the end of my prepared remarks. So please open the phone lines for any questions.

Ladies and gentlemen, at this time we will conduct the question-and-answer session. [Operator Instructions] Our first question comes from Joe Gibney from Capital One. Please state your question.

Just a question on the smaller horsepower price pressure. What tranches specifically are you seeing that as this is very low horse? And then where regionally I guess you are seeing more of that pressure is just broad based?

It's primarily where we have classified is smaller roughly 125 horse and lower and that varies between some of the reciprocating units and the low pressures screw units, but primarily lower pressure, lower volumes screw units. And we’re seeing most of it in matures areas, you get the old Barnett, some of the Central Texas mature stuff, San Juan Basin, things like that. So, it really trends along with what we’re seeing in the overall just dry natural gas market, right? Kind of static pricing, static activity etc. etc. So when you get static activity and somewhat oversupplied market, I would say that’s where we’re getting some of the pricing pressure.

And on the standby rates side, you referenced construction delays somewhat from the higher horsepower units. Is that regionally specific to areas of the Permian or just where exactly is that are you encountering some of those this year on a standby side?

Yes, it’s primarily Permian, and again I want to reiterate it’s just construction delays the rental rates will take place. It’s not -- everybody probably goes on point as to, well, in the bottlenecks or things that we hear about in the Permian, but it’s not that, it’s just some delays in construction. And yes actually that’s good because there’s so much construction going on just taking time to get crudes and get things set up. So -- but those rates will kick in, they contractually bound to kick in. So there’s just not an indefinite delay and yes, it was put in there for instances like this.

And last one for me just on the compressor sales margin. On the quarter, I didn’t catch that and it seems like sales aggregate margins bit all over the place, you referenced just some timing there. Tough to peg just a little help there and then maybe based on compressor sales margin and then how to think about that on a go forward basis?

Yes, let’s say the margin this quarter -- we had total gross margin -- I didn’t -- well hold on -- I must not have given you the compressor sales. Did you want our compressor sales or total sales?

Yes, the compressor sales margin, I think you did 4.7 million in sales just trying to get the margin number on that one?

Yes, the compressor sales margin this quarter was 18% and that’s up from last -- last year, it was 5%, and last quarter 26%. So, you’ve get -- again you get -- the variation as I mentioned I think it's -- we’re averaging higher year-to-date than we did last year, but it’s just up -- and it depends on -- some equipment has got higher-margin and some got lower just kind of depends on the schedule as it goes forward.

Our next question comes from Rob Brown from Lake Street Capital. Proceed with your question.

First on the sales revenue, I think in the past, you talked about a shift away from sales to rental and now it seems that the sales stronger. What’s kind of driving that what are the sizes and what are the market dynamics going on there?

It’s -- our sales have been strong throughout over the last 3 or 4 years, I mentioned in the past kind of contrary to what we’ve been thinking at downturn. And it’s just continued that way, so we have got a couple of pretty good legacy customers just have discontinued the buy through the downturn and actually have started to accelerate repurchases a little. So, yes, we’re just seeing a continuation of what we've experienced the last three or four years. And it’s -- yes, I don't think it's -- well, I’ll say this -- I was going to say, I don’t think it's a permanent fixture although it's been going on for 3 to 4 year, but as a rental, I mean the high horsepower rentals and starting to really get some traction, and certainly we think the other wellhead type or size rentals as we go forward. So, I think we'll get that mix shift back to our traditional ratio between rental and sales but right now it's just been right now is pretty strong has been really for last 2 or 3 years.

And then on the makeready work you did. Is that -- was that in wellhead compression units that are starting to get contraction again? I guess what's going on the wellhead market specifically or is this just shift to high horsepower?

Now, that’s primarily wellhead stuff because all of the high horsepower essentially new. So it’s out on contractor, goes out on contracts, as it’s being built. Well, we have 31% utilization on that so obviously 9 out of 10 are going out right away. But yes, all the makeready is our traditional business and is primarily -- what we saw from 2010 on, the wellhead type gas lift equipment. So we -- that looks like it's picking up pretty, pretty well and we expect that to continue.

Okay and then I guess in the same vein, should we expect additional makeready margin compression for the rest of the year? Is that kind of over at this point?

No, we will continue to see it, and like I say, we -- it’ almost a double edged sword right to you -- you like it, but it does impact current results, but there's a revenue attached to it. So it’s just a typical part of our business since we do expense all those costs, we take those hits currently and don’t capitalize them on the balance sheets. So, we’re taking currently, but again we will see revenue come from the next couple of quarters. But we expect that will continue, now it's hard to say how long it will continue, but I think I probably maybe commented last couple quarters that we can see 4 to 5 quarters of this. But again, once it starts, it keeps rolling as long as things keep growing. We will have those maintenance expenses and this is our biggest quarters so far. But we ought to have corresponding revenue going forward too to take care of them as you go in the future.

Our next question comes from Richard Gurnley with Longfoot Partners. Please state your question.

I'm new to your company and when you were saying, you did 12 overhauls in the second quarter of ‘17 and 31 the first 74 in the second. Then you said, was it $30,000 of makeready cost increased year to year?

No, it was 330,000.

Okay. Now, how does that number compared to the roughly there are 800 basis points of difference in rental margin year to year, which would be about $900,000? What’s -- if the overhaul was 330, is the rest of it some other kind of makeready or…

No, I mean, we highlight that because we always see that coming out, but we also had -- there are couple hundred thousand dollars in increased all expenses year-over-year because as everybody knows, oil has come up. There was some appreciable overtime expenses last quarter due to the extremely hot weather out here in the Permian, a lot of cooling issues on equipment, things like that. So, they all the expenses go into it mainly highlight the makeready because, they are somewhat extraordinary in that and they will take down overtime, but there are good indicator of what we think will be some future activity.

And so, the -- if the makeready was $330,000 and you did 74 units that would of $4,000 or $5,000 a unit?

Yes, 5,000 or 6,000.

That's the right range?

Yes, that's about typically what it will run. And of course those averages vary by quarter ago, but equipments going through there.

And then, the price per -- did you mention -- my phone disconnected in the middle. In the first quarter, you said the price per horsepower was down 5% overall. What is the -- what's the growth number for the second quarter?

It's down 5% Q -- hold on I think Q2 compared to Q1, per horsepower is 1% on per unit. Let me look here. Yes, I saw a 1% decrease in rental rates per unit sequential quarters, yes, that's sequentially.

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

I wanted to maybe ask a bit about the makeready in a different way maybe, it sounds like obviously you are seeing a lot more units going kind of out in that. I mean is there a number we should kind of think about on a per unit basis? Or anything like that as we think about kind of the expansion of rental fleet from an activity standpoint? Or is that kind of you’ve kind of figured that out as you go out and actually start working on the unit?

Oh, you mean as far as the cost?

Yes.

Yes, it's going to -- it will vary depending on what we got going through, but roughly and very roughly, it’s going to run $5,000 to $6,000 per unit per overhaul. I felt fairly steady but you can have some variation in that.

Sure, but it’s pretty nominal versus even what….

Yes, if you look at our average rental revenue that's 1, 1.5 or 2 months of rental.

And on the CapEx side, I mean you've spent a little bit of money but certainly not very much in the quarter. I mean as you think about kind of that expansion, you kind of give us the CapEx budget, but as you see it seems like there so not be much cash burn going forward really. Is it just a function of as you sees that the markets kind of participate you will kind of participate in kind? Or that’s how you are thinking about the spending levels as you move forward?

Yes, pretty much, I mean we just updated this a little from the point that we see more from coming in from the rental side. And again, all of our capital is new growth capital, so that would portend additional rental equipment going into the fleet and obviously we’re not building much more spec right now, we’re building by fleet rent. So it’s a positive indicator we think going forward. But, yes, if it picks up more next year we’ll update it then. But yes, we’re not -- yes, we’re spending capital money primarily I said 95% on our large horsepower class, which we counted as 400, 600, 1,380 horsepower. So all of the growth capital is going towards the big stuff and like I mentioned, we’ve got 14% of the active fleet now is big horsepower and we’ve got another equivalent amount in work in progress. So, we've got a fair amount of rental CapEx backlog going forward by stretching a least two or three quarters out.

[Operator Instructions] At this time, we’ve no further questions.

Okay, thank you Erica, and thanks everybody for joining on the call, appreciate your time this morning and look forward to visiting you next quarter.

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