Natural Gas Services Group, Inc. (NGS) Q1 2019 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group First 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, everyone. 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 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, Erica and Alicia, and good morning, and welcome to Natural Gas Services Group's first quarter 2019 earnings review. This morning, we reported first quarter 2019 results and we are pleased with our operational performance. Our revenues grew 11% sequentially with all aspects of our business contributing to the increase. Compressor sales were very strong this quarter and our core rental revenues advanced 4%. EBITDA was $6.1 million this quarter, a 5% sequential and 7% year-over-year gain. We continue to construct and commission our large horsepower units, all of which are contracted, and both our medium and large horsepower units showed net gains in quarterly utilization. We entered the quarter with almost $40 million in cash with virtually no debt and remain positioned to further our growth this year. As we review of our financial results, I'll provide more detail on the operations. NGS reported total revenue of $18 million for the first quarter of 2019. As we look at total revenue, a 22% increase compared to same quarter of 2018. The increase is primarily driven by a 38% increase in sales and a 17% increase in rental revenues. Interestingly, our service and maintenance revenues almost doubled year-over-year. Although a smaller subset of our overall rentals, the associated gross margins in this segment run in the 70% range and we are receiving increased requests for third-party servicing of compressors and flares. Total revenue increased by 11% when compared to the fourth quarter of 2018, mainly due to the timing of sales revenue from compressor sales. Rental revenues increased 4% when compared to the fourth quarter 2018. Total adjusted gross margin for the three months ended March 31, 2019, increased to $8.3 million from $7.8 million for the same period ended March 31, 2018. Adjusted gross margin, which does not include depreciation, as a percentage of revenue for the three months ended March 31, 2019, was 46%, a decrease from 53% for the comparable period of 2018. Sequentially, adjusted gross margin increased from $8.2 million in the previous quarter of 2018. Adjusted gross margin, as a percentage of revenue, decreased to 46% for the three months ended March 31, 2019, compared to 51% in the prior quarter. The decrease in the adjusted gross margin, as a percent of revenue, can be attributed to shift in our revenue mix due to more sales in the first quarter 2019 which carried lower margins. Selling, general and administrative expenses of $2.5 million for the quarter increased when compared to $2 million in the first quarter of 2018. There are many components of overhead expenses that increased, among them being higher audit and health insurance expenses and non-cash items, such as stock expenses and noncontributory deferred comp. With that, however, SG&A as a percentage of revenue for the first quarter 2019 was 14%, which is the same percentage for the comparable period in 2018. Sequentially, SG&A as a percentage of revenue decreased from 15% in the fourth quarter 2018. Operating income was $209,000 in the first quarter 2019, which decreased from $350,000 in the year-over-year period, but increased from $106,000 in the fourth quarter of 2018. Operating income increased sequentially, but was impacted by lower rental margins due to a higher expenses related to overtime. Our overtime expenses are a direct reflection of the higher wage base in the Permian that most businesses operate in the oilfield have experienced over the last year. Additionally, the extra time spent to install and commission the larger horsepower compressor packages affected overtime paying this quarter. Higher SG&A expenses also contributed to lower year-over-year operating income. We reported net income for the three months ended March 31, 2019, of $357,000, up from $225,000 for the same period ended March 31, 2018. Sequentially, net income increased to a noncash adjustment for income tax expense related to executive comp, to which we've reported a net loss of $282,000 for the three months ended December 31, 2018. Excluding the tax adjustment expense, net income for the period was $351,000. Comparing sequentially with after-tax adjustment, our net income remained flat between the quarters. For the first quarter of 2019, the company posted earnings per diluted share of $0.03 compared to $0.02 in the first quarter 2018. Sequentially, diluted earnings per share increased $0.05. However, excluding the income tax adjustment expense, earnings per diluted share remained flat at $0.03. Earnings before interest, taxes, depreciation, amortization, or EBITDA, for the three months ended March 31, 2019, was $6.1 million, an increase from $5.7 million for the same period of 2018 and $5.8 million for the fourth quarter of 2018. EBITDA margins have roughly averaged about 36% of revenue in all comparative periods. Total sales revenues, which include compressors, flares and aftermarket activities, can be somewhat predictable and can cause considerable swings period to period. The uncertainty of the sales revenues can depend on the market and customer preference, which can vary period to period. On a year-over-year basis and sequentially, NGS sales revenue increased $1.1 million, primarily due to an increase in compressor sales. Compressor sales revenues of $2.7 million for the first quarter of 2019 increased year-over-year from $1.8 million. Sequentially, compressor sales increased from $1.5 million in the fourth quarter 2018 to $2.7 million this current quarter. If you recall last quarter, sales revenues came in a little light, but we caught up this quarter, again demonstrating the variability of this business line. First quarter 2019 total sales gross margin as a percentage of revenue was 10% compared to 20% in the fourth quarter of 2019 and 27% a year ago. Sales gross margins can fluctuate period-to-period due to scheduling and the timing of bidding. Additionally, we had a higher freight expense this quarter due to the income received from large horsepower equipment that impacted margins. Our sales backlog as of March 31, 2019, was approximately $11 million. This compares to the sales backlog of approximately $14 million in the fourth quarter 2018. We continue to be pleased with the results of our rental segment with rental revenue of $13.4 million for the first quarter 2019 and increasing sequentially and year-over-year. Additionally, rental revenue in the first quarter 2019 was the highest since the third quarter 2016. Comparing year-over-year 2019 to 2018 rental revenue, it increased 17% and sequentially increased 4%. As of March 31, 2019, 21% of our utilized horsepower is classified as large. This represents a significant shift in our fleet composition and demonstrates that the strategic direction we chose to pursue a couple of years ago was, in fact, the correct one. Compared to the fourth quarter 2018, our average rental rates on a per-unit basis increased 3% or essentially flat on an average per horsepower basis. Rental gross margins this quarter were 56%, a slight decrease from fourth quarter rental gross margin of 57% and last year's quarter of 59%. The slight margin impact is primarily attributable to higher labor and retirement expenses associated with installing and commissioning a large horsepower we had go out this quarter. Our fleet size at the end of December totaled 2,567 compressors, an addition of 8 units or almost 10,000-horsepower during the first quarter. Over the past 12 months, we have added 31 new fleet units that total 30,033-horsepower, almost entirely in our large category of horsepower. This represents an increase of 8% in total fleet horsepower while rented horsepower has increased 30%. Our utilization as measured by horsepower climbed from 58% last quarter to 59% this quarter, while unit base utilization remained constant at 53%. We saw an increase in rental units utilized at quarter end of 12% year-over-year and was flat sequentially, while our horsepower running in the field increased 30% year-over-year and 4% sequentially. We had 151 more rental units running in the first quarter 2019 than in the same period of 2018. As I noted in the last quarter's call, we anticipate our capital expense this year for rental fleet compression to be in the range of $37.5 million to $40 million, of which we spent $8.9 million this quarter. NGS is an enviable position in that 9% of that capital is already constructed at above market rates and long terms – or contracted, not constructed, something we are very excited about. Moving to the balance sheet. Our total bank debt continues at a little over $400,000 as of March 31, 2019, and our cash balance remains strong at $40 million. Cash flow from operating activities was negative $3.8 million for this quarter. This is mainly attributable to an increase in inventory for our large horsepower fabrication activities, which will naturally be bled down as these units are built and they add to the fleet. Receivables also increased due to a relatively large compressor sales order to a major customer had been billed but not paid by quarter end. We have, however, received the majority of that payment by the end of April. Payables were up due to a large payment for engines received in the fourth quarter of 2018. Essentially, most of the cash spent this year was for capital fleet additions and normal working capital variations. To summarize, we are pleased with the continued progress on our rental, sales and service and maintenance businesses and the associated revenues. Utilization continues to increase at a steady pace, along with pricing and we look forward to increased activity as we move through 2019 and the benefits of our focus on higher horsepower compression. As I conclude, I want to address what appears to be "a new movement focusing on positive earnings, positive returns and the need to live within free cash flow among oilfield service companies." Not only do we support this view, we have lived it for well over a decade as demonstrated through our financial results. That said, it is somewhat curious to me that this is a new great idea. It's always been a great idea. Just not an idea that many of our industry have practiced over time. In the past 15 years, NGS has never posted an annual GAAP EPS loss, which, we believe, is what has driven our consistent shareholder returns. In addition, over the past decade, we have carefully managed our balance sheet to operate with minimal leverage and focus on generating cash. That focus has served NGS well, allowing the company to invest in nearly $250 million of internally generated capital on advanced compression and new lines of business. Our model is to conserve cash as the cycle decelerates and opportunistically invest that cash as activity begins to improve to capture market share in existing markets and enter new strategic markets. That strategy allowed us to move into the gas lift compression market in the last downturn and has allowed us to make our current move into the high horsepower compression market as described over the past year. In short, our focus on full-cycle economics and our conservative approach to leverage has enabled NGS to protect our balance sheet, while consistently delivering positive earnings; not just EBITDA or adjusted EBITDA or further adjusted EBITDA, but real GAAP earnings. While we are not unique in our balance sheet management, we are proud to be one of only a few in our industry to meet these important benchmarks, which we believe have served our shareholders well. Erica, that's the end of my prepared remarks. So please open the phone lines for any questions.

[Operator Instructions] Our first question comes from Kyle May. Please state your question.

Hey, good morning, Steve.

Hi, Kyle.

I want to start off with compressor sales. So in your prepared remarks and in the press release, you talked about compressor sales really strong and then you mentioned some of the timing that was affected in the first quarter. Were there any other factors that led to the strength in 1Q? And then, I guess, looking ahead, how do you see compressor sales trending for the remainder of the year?

It's a repeat. It's just the variability we see in that business. We had a $14 million backlog last quarter. We've got $11 million this quarter. We've essentially burned off $3 million of that. It's just the up and down out there. There's nothing really magical or mysterious about it. It's just the variability we get in either getting orders in, number one, the margins are different based on the equipment being built and the scarcity of it and the market forces. And then as you put it in the queue, there's always changes in that. Some may want something quicker, later, something like that. So nothing mysterious about it. It's just a variability we see in that business. Going forward, I think that $11 million, and hopefully, we add to that as we go through and keep that backlog up, we think that's a 3-quarter backlog, say, probably got around $3 million, $3 million to $4 million a quarter in sales coming from that.

Okay. Got it. That's helpful. And do you have the compressor sales gross margin for the quarter?

I do. It is essentially flat. Well, if I can get the right quarter here. Oh no, no. It was 10%.

Okay. Got it. And then one more for me. So thinking about the focus on building large horsepower units. You've given us a lot of color on plans for the year, but maybe thinking a little bit more long term over the next one to two years, do you think there's an opportunity for NGS to continue expanding the large horsepower fleet?

Yes, we think so. As I've mentioned before, I didn't want to say at this call, our fabrication is booked up through for the next year, up to Q1 of 2020. So you'll get pretty good visibility on that. Now we're making plans to start adding some speculative units to that build. All the stuff we've got now is contracted. So we're going to add some spec units to that. Now, if it's been like the past year or so, every spec unit gets sucked up before it's even built, which is fine. But we are planning to add some spec units in 2020 on that. We don't have any room from here, but yes, I think we're in this business to stay and stay competitively and we're going to start adding some equipment to that. Now grand, we've had a flush of business come the last 1.5 years, which we're very fortunate to have. And I don't know if we'll continue on the pace of 50 units a year, but certainly, it's going to be – it's a major piece of the business now and we'll continue to push it. Let me correct that number I just gave you. The compressor sales – okay, the sales margin, which is everything, flares, compressors and everything, was 10%. Compressors themselves where just flat from, as I mentioned, the high freight expenses we had this quarter.

And that was – was that 20% last quarter?

Yes, it was – yes, I think so.

Okay. Great. That's all for me. I appreciate it.

Okay. Thanks, Kyle.

Our next question comes from Rob Brown. Please state your question.

Good morning, Steve.

Hi, Rob.

I think you talked a little bit about the pricing environment being flattish. How does it look and is there a difference between large horsepower and greater or medium horsepower?

Yes, there is a difference. The large horsepower, yes, our utilization's just like the industry's at 90%, 95% on the large stuff, pretty active. And you can press price a little more. Now we've always been probably more of a premium-priced provider from the quality of our equipment and the quality of our service, we can manage just a little more pricing, so – but everybody is busy in that higher horsepower. Our pricing is probably on the high end as we have been historically, last 15 years. So that's nothing new. But we did tend to press a little more and get a little more. The medium horsepower, we're starting to see some increases in that. It's a little more sluggish than the big stuff because there's so much more medium horsepower on the market right now. And then the small horsepower, I think we've talked about it, it's the 125-horsepower's smaller, it just kind of gives a good contribution to the business because it's not a grower and there's – that's really where you get the mom-and-pop businesses that pretty well keep pricing down. So we don't see much price on the small – pricing power on the small stuff. The medium stuff, we're seeing more and more. And the big stuff, of course, it's pretty much who's got the equipment.

Okay. Good. And then how are lead times looking? You're saying you're at capacity. Are you seeing lead time extensions from the equipment vendors? And I guess, how's that picture looking?

No actually – well, it's a mixed bag. We see engines have gotten more readily available. Compressors are staying out there, pretty long leads so compressor becomes the critical lead item. But we've seen some improvement in deliveries with engines and coolers. But it only takes one of them with a long delivery to hold the whole thing back. So all in all, it's staying about the same. But I think we'll see some improved deliveries over the next six, 12, 18 months because I think the manufacturers are at the point of catching up with what that demand was.

Great. Thank you. I'll turn it over.

Thanks, Rob.

Our next question comes from Richard Dearnley.

Good morning. To follow up on the lead time question. Since capacity probably hasn't increased a lot in the last six to 12 months, is the softening – does that imply that the demand has – we've satiated the peak and we're going down or back to normal or something like that?

And you're talking about the manufacturers' capacity, correct?

Yes.

Okay. All right. I don't think it signals much of a slowdown at this point. I mean, if you look at our – certainly, we're full and building as fast as we can. And if you look – if you've listened to any of the calls of other compression companies, two or three, their budgets are up too and primarily big horsepower. So I don't see demand really falling off a whole lot. Now, I will say that probably the last year, 1.5 years, it's been on fire, probably more demand be satisfied. And now it's start – I think you start to see everybody catching up with that demand, maybe hitting some equilibrium. But we think – and again, you tell me the oil price, I'll tell you exactly what you want to know, but we think the next 12, 18 months is a good market.

And the – your service business, which is, the way you break it out, very small, but it seems like your increased requests, revenue doubling, but the number was so small. But was that in large horsepower, medium, small? And why now?

It's all across the board. And it's really probably primarily medium horsepower. We're starting to look at picking up some large horsepower stuff, but we're very cautious about that business and we – that's a business you want to be careful with because it can just get into a bidding for labor and we're not interested in that. And when you do that, margins drop and we haven't concentrated on for a long time. We've actually been asked by a lot of people to do this stuff. And so the last year or 2, we've started to move into it a little more and we're seeing more demand from – it's not across the board all areas, two or three areas, we see the demand more. So – and some of that's just because we're perceived to have a superior repair and maintenance reputation and response in those areas. So I think it's coming up more and more. It's not – yes, I don't think it's anything associated with any sort of capital cycle or maintenance cycle or anything like that. I think we're just getting more market share out of it.

Right. Okay. And the gross margin on sales, if your compressor gross margins were in the 20s, were the flares or something else really low to drag everything down to 10, drag the total down?

No, the – okay, the total...

Or am I missing something there?

Yes, that was the number I just corrected, so make sure everybody's got it. The total sales margin was 10%. So that's everything, compressors, flares, everything, all right? The sales margin was essentially 0 because there was a lot of freight expenses. The flare margins were actually a little higher, mid-30s, a little higher than what they were last quarter and parts margins were up still like that. But that stuff's all small. It's primarily compressors and then flares. Flares contribute some there too. So ending up with a total sales margin of 10%.

Okay, good. Thank you.

Okay. Thanks.

[Operator Instructions] We have a follow-up question comes from Kyle May.

Steve, sorry, one more for me. I think I missed this in the prepared remarks. Can you give us the number of units and the unit base utilization in the first quarter?

Yes. The – hold on here. The number of units – well, number of units in the fleet was 2,567. And unit-based utilization was 53% and horsepower-based utilization was 59%.

Okay, great. Thank you very much.

Okay. Thanks, Kyle.

At this time, we have no further questions.

Okay. Very good. Thanks, and thanks everyone for joining me on this call. I appreciate your time this morning and looking forward to visiting with you again next quarter.

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