Natural Gas Services Group, Inc. (NGS) Q2 2019 Earnings Report, Transcript and Summary

Good morning ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter Earnings Call. [Operator Instructions] Your call leaders for today's call are Alicia Dada, IR Coordinator and Steve Taylor, Chairman, President and CEO.I will now turn the call over to Miss. Alicia Dada. You may begin.

Thank you Ross 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 risk 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 cash and 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 to Mr. Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Ross, and good morning. And welcome to NGSG’s second quarter 2018 earnings review.This morning, we reported second quarter 2019 results, and we are pleased with our operational and financial performance. Rental revenues grew 19% when compared to the same period last year, led by the strong performance on our large horsepower segment.Our compressor sales have continued on a good pace with the gross margin percentage this quarter being the highest since the first quarter of 2018. Gross margin, net income and the EBITDA dollars have all improved in all comparative periods.Cash flow from operations for the quarter was $10.3 million or 52% of revenue, and our balance sheet cash remained strong at $30 million.As we continue through the call I will further discuss in detail these financial parameters, as well as make additional operating and market related [ph] comments. NGS reported total revenue of $19.9 million for the second quarter of 2019, a 9% increase compared to the same quarter of 2018. The increase was primarily driven by a 19% increase in rental revenues, offset by a drop in total sales revenues compared to year-over-year results.From a rental perspective, we had 127 more units running in the second quarter of 2019 when compared to the same period of 2018.Sequentially, total revenue increased by 11% when compared to the first quarter of 2019, mainly due to an increase in compressor sales. Rental revenues increased 1% over the first quarter of 2019.Comparing the six months year-to-date 2019 period to the same period in 2018, our revenues increased approximately $5 million or 15%.Total adjusted gross margin for the three months ended June 30, 2019, increased to $9 million from $8 million or 12% for the same period ended June 30, 2018. Adjusted gross margin, which does not include depreciation, as a percentage of revenue for the three months ended June 30, 2019, was 45%, an increase from 44% for the comparable period of 2018.Sequentially, adjusted gross margin for the second quarter of 2019 increased from $8.3 million to almost $9 million, or 8% from the prior quarter. Adjusted gross margin as a percentage of revenue was 45% in this quarter compared to 46% in the prior quarter.Year-to-date, adjusted gross margin increased 9% to $17.2 million for the six months ended June 30, 2019, compared to $15.7 million for the same period in 2018. Selling, general and administrative expenses were $2.7 million for the quarter, up $370,000 compared to year-over-year and up $190,000 compared to the previous quarter.SG&A continues to run at 13% to 14% of total revenue for all periods. Compared to operating income of $226,000 in the second quarter of 2018 and $209,000 in the first quarter 2019, operating income more than doubled to $593,000 this quarter.For the six months ended June 30, 2019, operating income was $802,000, up $226,000 or 39% when compared to the same six-month period in 2018.Net income has increased in all comparable periods. For the three months ended June 30, 2019, we reported net income of $573,000, up from $247,000 for the same period ended June 30, 2018.Sequentially, net income increased $216,000. Income taxes were up dramatically in the comparative year-over-year period, which negatively affected our earnings per share by $0.01 this quarter. This increase was primarily caused by a lack of R&D tax credits this quarter.For the six months ended June 30, 2019, we reported net income of $933,000, almost twice the $472,000 we reported for the first six months of 2018. For the second quarter 2019, the company posted earnings per diluted share of $0.04, compared to $0.02 in 2018.Sequentially, diluted earnings per share increased $0.01. For the six months ended June 30, 2019, we reported earnings per diluted share of $0.07, compared to $0.04 for the same period -- for the same six-month period in 2018.Earnings before interest, taxes, depreciation and amortization, or EBITDA, for the three months ended June 30, 2019, was $6.5 million, a 12% increase from $5.8 million for the same period of 2018.EBITDA increased over 6% sequentially. EBITDA for the six months ended June 30, 2019, was $12.5 million, compared to $11.4 million for the same period ended in 2018. EBITDA margins continue to remain robust, and have ranged between 32% to 35% of revenue in all comparative periods.Total sales revenues, which include compressors, flares and aftermarket activities, can be somewhat unpredictable and are the most volatile segment of our business. Sequentially, sales revenue increased $1.7 million or 41%, largely due to an increase in compressor sales.On a year-over-year basis, NGS sales revenue was down 9% primarily because of the decline in flares. Year-to-date sales revenues increased by $560,000 or 6% for the six-month periods ended June 30.Second quarter 2019 total sales gross margin was 24% of revenue, compared to 10% in the first quarter of 2019 and 23% a year ago. This is the highest gross margin percentage for the sales segments since the first quarter of 2018.For the year-to-date period, we reported gross margin of 18% for the six months of 2019, compared to 24% for the comparative six months of 2018.Second-quarter 2019 compressor-only sales increased from $2.7 million in the first quarter of 2019 to $4.8 million this quarter, an increase of almost 77%. Compressor-only sales revenues were essentially flat at $4.8 million for the comparative year-over-year quarters.Year-to-date compressor-only sales were up $930,000 or 14% to $7.5 million for the six months ended June 30, 2019. Compressor-only sales margin was 21% for the three months ended June 30, 2019, compared to 18% for the same period a year ago, and increased to a more normalized amount from a breakeven situation last quarter due to high freight expenses, which were explained during last quarter's call.Our sales backlog as of June 30, 2019, was approximately $7.5 million, compared to approximately $11 million in the first quarter of this year. I do want to mention that our sales backlog includes only gas compressor packages being billed for sale and does not include the tremendous backlog of contracted rental units we are also building.Moving to rental revenue. We continue to be pleased with our rental results, with rental revenue of $13.6 million for the second quarter 2019 and $27 million year-to-date. Rental revenues increased in all comparative periods and have increased quarter-over-quarter for the past four quarters. Comparing year-over-year 2019 to 2018, rental revenue increased 19%.Sequentially, we saw a 1% increase. And comparing six months ended June 30, 2019, to 2018, rental revenues increased 18%. As of June 30, 2019, 23% of our utilized horsepower was classified as large. This represents a significant shift in our fleet makeup over the past couple of years and, again, demonstrates the strategic direction we chose then was, in fact, the correct one. Compared to the first quarter 2019, our average rental rates, on a per-unit basis, increased 1% or were down 2% on an average-per-horsepower basis.A slight decrease in per-horsepower rates is expected due to the relatively large magnitude of horsepower being set to reflect the economies of lower cost and associated revenues per horsepower.Rental rates increased by an average of 7.4% per unit in the year-over-year quarters mainly due to our entrance into the larger horsepower class, but we have also been able to capitalize on rate increases on some medium horsepower units.Rental gross margins this quarter were 53%, a decrease from first quarter 2019 rental gross margins of 56% and last year's quarter of 55%. The fabrication volume of our contracted large horsepower units has grown, and the margin impact is primarily attributable to higher labor cost and greater overtime expenses associated with installing and commissioning these units.Fleet size at the end of June 2019 totaled 2,572 compressors, an addition of eight units or a little over 7,000 horsepower during the second quarter.Over the past 12 months, we have added 33 new fleet units that totaled 33,010 horsepower, with 98% of those classified in large horsepower category. This represents an increase of 8% in total fleet horsepower.Our utilization as measured by horsepower, climbed from 59% last quarter to 60% this quarter. Our unit based utilization was 53%. Activity in the large horsepower portion of our fleet continues to be robust. In the mid-range horsepower segment, our rental activity remains positive, but somewhat volatile since the beginning of the year.We're essentially running at breakeven in this segment year-to-date with respect to utilization, but we have seen a good increase in July. In spite of this, we had 27% more horsepower and 10% more revenue producing units running in the field year-over-year and 4% more horsepower sequentially.I noted in last quarter's call that we anticipate our capital expense this year for rental fleet compression to be in the range of $37.5 million to $40 million. We are increasing our estimated capital equipment requirements to between $40 million and $45 million for 2019.Approximately 75% of this increase is attributable to additional rental commitments we have received for specialized equipment, with the balance being the addition of larger horsepower equipment that we are sold out of.Looking at the balance sheet, our total bank debt is $417,000 as of June 30, 2019, and our cash balance remains strong at $30 million.This amount is down about $23 million since the end of 2018, with the vast majority of the cash being invested in our new high horsepower rental compression equipment, and our new corporate office, the majority being the high horsepower equipment. We had positive net cash flow from operating activities in this quarter of $10.3 million. This represents 52% of our quarterly revenue.In closing, we are pleased with the progress in our rental, sales and service businesses. I don't think it's a secret to anyone that there's a lot of volatility in our industry right now.Commodity prices and activity levels are up and down and there is always a degree of uncertainty. However, I think our company is one the best positioned to move forward and potentially take advantage of any opportunities that may present themselves.We still have a good contracted backlog ahead of us for the fabrication and rental of large horsepower units. And our income statement, balance sheet and overall liquidity remain among the best of our peers. We view the balance of the year positively.We continue to be presented with and to look at a broad array of options to deploy the cash in our balance sheet and potentially expand our product and service menu in complementary ways. We've kicked a lot of tires, explored a number of possibilities, and we'll continue to do so.However, the continued volatility in commodity prices and uncertainty in oilfield activity makes it even more important to remain vigilant in our discipline in deploying cash and conservative in our assessment of new opportunities. We are eager to execute on ideas from our company. That said, however, we are not eager and will not offer those opportunities or be lured into opportunities without a reasonable forecast for future growth.Our conservative approach toward managing cash has served us just well over time, and we will continue to protect our balance sheet during these periods of uncertainty.In conclusion, we are pleased with the continued progress in activity in all of our businesses. Ross, that's the end of my prepared remarks, so please open the phone lines for questions.

[Operator Instructions] Our first question comes from Rob Brown from Lake Street Capital. Please go ahead, Rob.

HI, Steve

Hi, Rob.

You talked about an uptick in the large horsepower, and I guess that's driving your CapEx uptick. Maybe just, could you characterize the backlog in the large horsepower business and what you're seeing in terms of market demand in that segment?

Well, what it is, is its increased volume going through the shops right now. So we've seen that volume increase somewhat. We've had some additional rental orders come in, large and essentially some medium horsepower high-pressure stuff. So that's driven that CapEx requirement up over what we had anticipated even last quarter.So, it continues along pretty much business as usual on the large horsepower. We still got that backlog that stretches out till Q1 of next year, 2020, and these are just some additional orders that have come in, in the interim.

Okay, great. And on the gross margin of the rental side, I think you talked about some additional activity in setting the units and the depressed gross margin. How can that recover? Or do you see that lower margin in the interim will need to get put in place and then it recovers in the future? Or maybe just any color on the gross margin improvement potential?

Well, I mean, certainly, there's improvement potential, and we're working on that. We're trying to try different methods, do different things on some of the overtime. But the fact remains, you've got this big equipment. And our small and medium horsepower is pretty easy to set, pretty quick.In a day, you can have equipment under 300 horsepower set and running, pretty easy to do. This equipment is huge. It weighs 175,000 pounds and may take three or four trucks to move it and everything else it creates to set it. So you're into a pretty long period of time to get this stuff out there, get it set, get it commissioned, start it up, troubleshoot, et cetera., et cetera. I mean, the -- it's not a light switch.So that stuff just takes more time. And part of it is, you can't say, well, 40 hours up, we've got to stop. I mean, you got to continue once you start to fruition, and get the equipment running because obviously the operator customer in on a deadline, and they're wanting cash flow too. So it's one of those things just -- I guess, it's a necessarily evil right now on some of these bigger horsepower. Like I say, we are working to mitigate that, get that better managed, working with the customer too on how we can do things differently.But I think we are going to have that component in there as long as we're setting this stuff. We saw a depression here of a couple of points because we've had a higher volume going out, so more equipment, more time. And that's not a bad problem, right? But we do have some depression in the interim. And then once you get -- once we get all this stuff out there, say you got no more orders period, I mean then those -- that margin will naturally climb back up because you don't have this diminished upfront need for people and labor. So, I expect it to -- and I don't want to say its depressed margin, it's just a margin for initial set expenses and then that will improve as the equipment gets set. Although, frankly, it's -- we don't want to improve too much because we want to keep contracts, and setting that kind of equipment.

Okay. Oka, great. And on the medium horsepower, I think you said an uptick in that market is happening as well. Is that utilization rate now looks to increase kind of each quarter on more of an improving basis? Or is it still too early to tell?

Well, we think it's going to be on an improving basis. 2008 showed real good movement in all classes, large and medium and some small. And then we kind of get in the first couple of quarters of this year and it slowed down a fair amount. The growth in this business comes from, obviously, number one, setting more equipment than you're getting back. And our termination rates take about the same first couple of quarters, but the set rate declined somewhat.And so obviously, that margin comes down a little bit and the utilization stayed flat. And I think part of it is a couple of things. Number one, obviously, the Q4 volatility there, based on 2018, kind of put a little chill on some activity coming into the year and hopefully, this July shows some movement out of that. And then there's still a fair amount of properties changing hands.That always -- you always net out a little drop in some of that stuff because there's efficiencies going on and new operators look for economy. So we're seeing both those things. I think it's primarily just the activity in the field had dropped somewhat. But now July looks pretty good, so we're hoping that continues. Now I'm not going to guarantee it, but if overall, some of the big horsepower, but overall, even with the medium and small, we've been able to increase revenues, number of units set, horsepower going out and stuff like that. So in spite of some of the slowdown we've seen in the first part of the year on getting some of that medium horsepower out, we're still positive and moving forward on it.

Okay, great. Thank you. I'll turn it over.

Thanks, Rob.

Our next question comes from Richard Dearnley from Longport Partners. Please go ahead.

Good morning.

Hi, Dick.

Hi. How's everything? Given your -- given the -- what are the folks in the industry saying about the flare and gas issue and the green movement? And this, that and the other in regards to your -- so what are your flare customers talking about or worried about? Is this a problem coming at us?

Well, I don't -- yes. I presume -- I assume a bias here toward the energy industry. I don't consider it a problem really. Now for the New York City, I'd probably change my tune, but yes, it's a problem from the point of, unfortunately, it's necessary at times when you're drilling wells and don't have gas outlets and we got to do something with that gas to produce the oil.So that's just a natural result and phenomena going on. Now there's -- obviously, there's been a lot of press, a lot talk about all flare had gone here and stuff like that. And forgive me, but some of it is just sensationalized.

Yes, of course.

But the operators are well aware of it. They're operating as efficiently as they can. They do have to flare, they do it on an as minimal basis as possible and those flares typically don't last very long. Now you typically put flares on about everything, even if you're not flaring, but certainly, the flaring has been bigger in everybody's mind here lately. So yes, the operators just -- you're not seeing much, I mean, it's just like, I guess, it's damn it, I need a flare sort of thing.Nobody wants to waste any resource, but we're seeing some -- yes, the flare sales are down a bit. We're seeing actually some activity picking up in flare maintenance and things like that. So I think the activity for us, I think, will pick up a bit toward, as we go through the year, and on until some of these pipelines, some are in and some are still coming. So I think it's just the natural phenomena of about pumping more oil right now.

Right. Okay. Thank you.

Thanks Dick.

Our next question comes from Mike Urban from Seaport Global. Please go ahead, Mike.

Thanks. Good morning. I wanted to follow up on a couple of previous questions, specifically around the increase that you saw in July there. Again, maybe don't want to read too much into it given that it's just a month here. But is that -- I'm guessing that's primarily been in the mid horsepower range given that you're pretty well deployed and sold out on large horsepower stuff and small hasn't really seen much improvements. So that primarily been in the mid horsepower range?

Yes. Yes, it is.

Okay. And then, just kind of following up on the margin commentary for rentals. As you continue to roll out that larger horsepower units as you said, there is some of that expense out there. I mean, should we think about kind of this range for kind of a normalized level? Or can you improve on it based on some of the things that you talked about in terms of just getting better at it, learning curve, working with the customer, a little bit more closely?

Yes. I think will -- it will improve on for all those reasons you said. It's -- some of it's just going to happen, just a process, setting this big equipment and get it running, but we are working on different ways to handle some of the installations, commissioning, things like that. Different ways, maybe spacing some of this equipment out a little better from the point of -- when you have three come out once versus one three times in a row, it's a little different. So it's a lot of different things and, to backup, because I don't want to imply that we think it's going to be 53% from here on.I do think we're going to see some improvement. I'm not going to -- I don't want to put a specific number out there, of course, but I would say, yes, we'll be in the mid-50s while we're setting this magnitude of equipment, and that's probably for the rest of the year. We've got a lot of equipment being built and coming out. And of course, there's this present backlog will tail off the first half of next year. So I think we'll see some improvement anyway going forward as we learn a little more about efficient ways to do this and how we can work together with the customer on it. And then I think as we get these out -- and you have to remember, a lot of this cash flow hasn't started coming back at us yet.We're just suffering expenses now, with very little cash coming back on some of this stuff. So once we start getting into 2020 and the majority of this equipment starts to be set, and for rentals to start to roll in, we'll get a natural uplift just because we got more cash flow come in. But yes, definitely we're going to see some improvement. As margin going through the rest of this year, I would tag them that mid 50% range. Now I think in the next year, we'll get back up into our normal high 50s, low 60s.

Okay. So there, it sounds like nothing's really changed on that front. I mean, the large power -- large horsepower units, all else equal, should generally carry a higher-margin percentage, if you kind of look at that mix?

Yes. Yes, generally it will. Now we won't see it. We'll see it on an individual basis. You won't see it from a company basis for a bit until, number one, all this stuff gets out and running. And frankly, we're -- yes, we get more units into the fleet. Now we've got about 23% of the horsepower now is -- active horsepower is large horse, large. So we'll start to see some uplift, and overall, we anticipate the first part of 2020, but certainly about mid-2020, when all this equipment is out, before rentals are started. Yes. We should see some contribution from the large horsepower margins.

Okay. And then last one for me on the CapEx, the increase there, you said it's just some additional orders coming in on the rental side. It sounded like you were still going to build some spec units in there for large horsepower, just given the demand there and that you are effectively sold out. Is that the case? Or is there any kind of hesitancy there, given what you're -- what we're seeing in the market there for your customers?

Yes. Some of the -- like I mentioned, about three quarters of that increase was contracted stuff. So we're building it, it'll go right down and start making money. About a quarter of it is spec, so we do -- and that spec is larger horsepower. Now I'm not going to say exactly what sizes because we classify a larger horsepower as 400 and higher, but right -- and we're sold out of those. So we think that's still a good market on the spec units for building and the larger horsepower and that, we're not overly concerned about committing capital to that.We will, more likely, now obviously, we're going to watch it pretty closely over the next couple of quarters. Yes, but right now, we think we will continue to build some spec units into 2020 in the larger horsepower range. But we'll take that quarter by quarter and see how the market shapes up and reacts.

Okay. Sounds good. That's all for me. Thank you.

Thanks, Mike.

[Operator Instructions] And Steve, at this time, there are no further questions.

Okay. Well, I appreciate everybody joining us for the call, and well, I look forward to visit with you again next quarter. Thank you.

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