Natural Gas Services Group Inc (NGS) 2020 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter 2020 Earnings Call. (Operator Instructions)

Your call leader for today's call 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 statements 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 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 actual results and future periods to differ materially from forecasted results. Those risks include, among other things, the loss of market share through competition or otherwise, introduction of competing technologies by other companies, 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 now turn the call over to Mr. Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Thank you, Alicia and Erica, and good morning, everyone, and welcome to NGSG's Third Quarter 2020 Earnings Review. Thank you for turning into our call.

In my nearly 40 years in the energy industry, I've never experienced a more challenging environment in which to work. Pervasive weakness in energy demand and volatile commodity prices have created unprecedented financial and operational challenges for oil and natural gas operators. And as a result, the suppliers and service providers who work alongside them. While NGS is fortunate to have been well positioned entering this period of extraordinary pain for the energy industry. No company is entirely immune from the impact of these sharp and protracted challenges.

That said, as we noted last quarter, our ability to react rapidly to reduce our cost structure and respond to our customers' needs have resulted in less impact than many of our peers on both our financial and operational conditions. While sales and service revenues declined in the quarter, our rental revenues were solid and grew on a year-over-year basis or only modestly affected this quarter. Total adjusted gross margins came in at 50% and adjusted EBITDA was 35% of revenue.

Although not unusual, especially not in downturns, we have seen a high degree of volatility in our compressor sales business. This is primarily due to customers' budget cuts and the current reluctance to restore them in any appreciable manner. Compressor sales, already at a relatively low level from last quarter, were severely impacted this quarter by customer redesigns which delays the completion of compressor sales jobs and capacity constraints due to committed higher-margin rental contracts, displacing sales projects.

As noted in our financial statements, we did not have any material compressor sales in the third quarter but we have not had any cancellations of work and our backlog carries forward. We are confident our compression sales business will strengthen as the market begins to firm.

More important in such a challenging operating environment, NGS continues to strengthen its balance sheet and liquidity position. The company generated positive net cash flow from operating activities of $13.1 million and free cash flow of $12.1 million during the quarter.

At the end of the September quarter, NGS had a cash position of $27.6 million compared to $15.5 million at the end of the second quarter. Our cash position continue to increase through October. We continue to be vigilant in protecting our financial strength during this period of remarkable industry stress and our cash position provides NGS with significant flexibility and opportunity in any market environment.

NGS continues to have one of the best balance sheets in the industry. While we're beginning to see initial signs of a trough in oilfield activity, commodity prices remain below a consistent level that will result in meaningful new oilfield activity. We expect the trend to remain choppy through the end of 2020 and into early next year as operators remain cautious in their approach to growth as they address capital constraints. In spite of that caution or maybe because of it, as we said last quarter, we continue to see new opportunities for which we believe our fabrication capabilities, superior service and strong financial position will allow us to capitalize, and we believe those are likely to materialize in the new year.

As you are aware, we extend the time period to file our third quarter report to the impact of the COVID-19 pandemic on the Midland community and our firm. We remain vigilant in protecting the health of our team, and as a result, continue to work remotely when possible. We're operating our Midland headquarters with a severely reduced in person staff and urge our team members to take steps to remain safe and healthy.

Our field team continues to exercise appropriate distancing and health practices while working with customers on location. While these practices have added incremental cost and inefficiencies to our effort, we remain dedicated to protecting the health and welfare of our team and our customers in these unprecedented times.

With that, let's move into the details. NGS reported total revenue of $15.8 million for the third quarter of 2020, a 24% decrease from the same quarter in 2019. This decline was driven by a decrease in sales revenues and to a lesser extent, lower service and maintenance revenue. Conversely, NGS experienced an increase in rental revenues of 3% when compared to the same quarter of 2019.

Sequentially, total revenue decreased by 9%, driven primarily by a decrease in sales revenues by almost 3/4 as well as a decrease in rental revenue of 2%. Our service and maintenance revenue exhibited strength this quarter, increased by over 1/3 due to a good increase in service and maintenance work we won this quarter.

Our customers' capital budgets continue to be constrained due to the commodity price uncertainty surrounding the macroeconomic backdrop. Therefore, we expect total sales revenues to remain soft into the new year. Given the continued challenges in our industry and in the overall economy, we are pleased with our operational performance in the third quarter of 2020. Our rental revenue proved to be resilient in the quarter, declined only modestly despite the uncertainty in our industry. In fact, rental revenue for the first 9 months of 2020 is 11% when compared to the same period of 2019. Given the unprecedented challenges and turmoil in the oilfield services sector, we are pleased with this performance, which provides support for our position as a leader in energy compression rentals.

Total adjusted gross margin, which does not include depreciation for the 3 months ended September 30, 2020, decreased by 18% to $7.9 million from $9.6 million for the same period ended September 30, 2019. Adjusted gross margin as a percentage of revenue for the 3 months ended September 30, 2020, was 50%, an increase from 46% year-over-year. Sequentially, adjusted gross margin for the second quarter of 2020 decreased 11% to $7.9 million from $8.8 million from the second quarter of 2020. Adjusted gross margin as a percentage of revenue slightly decreased to 50% in this quarter compared to 51% in the prior quarter. The predominant cause of the decline in gross margin dollars in both comparative periods is due to the unabsorbed cost of our fabrication facilities due to a lower volume of work going to those plants.

Selling, general and administrative expenses in the third quarter of 2020 were $2.5 million, a decrease of 11% when compared to the same period of 2019 and 6% lower when compared to the second quarter of 2020. SG&A as a percent of revenue for the third quarter of 2020 was 16%, slightly above our general run rate of 13% to 14%.

Operating income for the third quarter 2020 was a loss of $941,000 compared to an adjusted positive operating income of $880,000 in the third quarter 2019. The operating loss this quarter is mainly due to lower total sales revenue and margins and higher depreciation expense, which were partially offset by higher rental revenues when compared to the same quarter of 2019. Sequentially, our operating income decreased from a loss of $148,000 last quarter to a loss of $941,000 in the current quarter. The operating loss this quarter was mainly due to lower total sales revenue and absorbed fabrication costs.

NGS reported a net loss of $562,000 during the third quarter of 2020 compared to adjusted net income of $967,000 during the third quarter 2019. Sequentially, net income reported in the second quarter of this year was $165,000. The decline in net income for the comparative period is primarily attributable to the decline in total sales and the associated burden of unabsorbed costs.

NGS reported a loss per diluted share of $0.04 for the third quarter of 2020 compared to adjusted earnings per diluted share of $0.07 in last year's comparative quarter and $0.01 in the second quarter of this year. Adjusted EBITDA, defined as earnings before interest, taxes, depreciation and amortization and increases in inventory allowance for the 3 months ended September 30, 2020, was $5.6 million or 35% of total revenue, a decrease of 19% $6.9 million or 33% of revenue for the same period in 2019. Adjusted EBITDA decreased approximately $940,000 or 14% sequentially from $6.5 million in the second quarter of this year.

Now to break down the revenue components a little more. Total sales revenues, which include compressor, flare and product sales, decreased $5.3 million to $536,000 on a year-over-year basis. The year-over-year decline is predominantly attributable to a lack of compressor sales. And to a lesser extent, decreases in flare and parts sales. For the same reason, sequential sales revenue decreased to $536,000 from $2 million.

Year-over-year total sales gross margins declined from $1.5 million to a loss of $461,000 with sequential gross margins decreasing from a positive $148,000 to the same $461,000 loss. Both comparative period losses were primarily due to lower sales revenues and margins with the lower margins caused by a higher level of unabsorbed costs due to underutilized compression fabrication facilities. These unabsorbed costs are largely due to the severe contraction in the industry, especially for custom fabricated capital equipment. And our need to maintain minimum operating levels at our underutilized fabrication facilities during these periods.

Our compressor sales backlog for the third quarter increased to $1.7 million, slightly higher than the second quarter backlog of $1.4 million, but essentially flat with our backlog in August 2020.

Now this backlog was worked off in the current quarter for a couple of reasons. A portion of the backlog was postponed due to a customer requested redesign of their equipment, and the balance was delayed due to limited fabrication throughput because of contracted higher-margin rental builds.

As such, in the third quarter 2020, we did not record any compressor sales. For comparison, compressor only sales were $4.7 million in the third quarter 2019 and $1.4 million in the second quarter of 2020. This is certainly not something we plan on, but it is not unprecedented and has happened before during severe downturns. Compressor only gross margins were a little more than $1 million in the third quarter of 2019 compared to losses of $127,000 in the second quarter and $607,000 this quarter.

As mentioned, losses on sales were exclusively caused by an absorbed fabrication costs. Rental revenue in the third quarter 2020 was $14.9 million compared to $14.4 million in the third quarter of last year and $15.1 million last quarter. Rental revenue decreased 2% sequentially. But significantly, we are 3% higher this quarter than last year at this time.

Year-to-date through September, rental revenues are 11% higher for the 9 months in 2020 than the same period in 2019. This is remarkable considering the dramatic appeal in our business industry over the past year is much better than many of our peers.

Compared to the second quarter of 2020, our average rental rates decreased 2% to 3% on a unit and horsepower basis. This is primarily due to the discounted rates given to customers in the second quarter when the industry felt the impact of lower crude oil prices and decreased activity. Reported rental gross margins this quarter were 55%. A slight decrease from the second quarter 2020 rental gross margin of 56%, but an increase from last year's third quarter gross margin of 54%. Our rental margins are exhibiting a strong base and would have been higher this quarter except for an increase in bad debt allowance of $180,000.

As of September 30, 2020, we had 2,339 compressor packages in our fleet, up from 2,277 units at September 30, 2019. The company's total fleet horsepower increased by just over 10% to approximately 449,000 horsepower on September 30, 2020, compared to approximately 407,000 horsepower in the same period last year. This includes the addition of 37 large horsepower units to the company's fleet over the past 12 months.

41% of our utilized fleet horsepower and 30% of our total fleet horsepower is now classified as large horsepower compression equipment with a utilization of 89% as of September 30, 2020. This has since increased to 93%. Our total fleet horsepower utilization in the third quarter of 2020 was 64%, which is a very small increase above the second quarter 2020 utilization of 63.6% and compares to 66% in the third quarter 2019. Our unit-based utilization of 55% in the third quarter 2020 remained flat when compared to the second quarter this year and 62% in the third quarter 2019.

For the first time this year, we have seen a positive utilization increase quarter-to-quarter. It's very slight, but the fact that there is any as positive in this environment.

For the first 3 quarters of this year, we spent a total of $12 million on capital expenditures with $10.3 million of that dedicated to rental equipment. In last quarter's call, we anticipated another $8 million to $10 million in capital expenses for the balance of the year.

We spent $1 million on capital equipment this quarter and anticipate another $7 million to $9 million in the fourth quarter subject, of course, to customers falling through on their projections and timing.

From a balance sheet perspective, our total bank debt remains minimal at just over $400,000 as of September 30, 2020, and our cash balance is strong at $27.6 million. Our cash balance is up almost 80% from $15.5 million at the end of last quarter and has continued to increase through October.

We have received $4 million of the $15 million tax refund we have been anticipating and that is reflected in our cash balance. There's still another $11 million of total tax refund that is owed to us, although we are not certain regarding the timing of it. We generated positive net cash flow from operating activities in this quarter of $13.1 million, including the $4 million tax refund, which represents 75% of our quarterly revenue.

Without benefit of the tax refund, our operating cash still ran at 52% of revenue. This is an extraordinary conversion of revenue into cash.

Free cash flow for this current quarter was $12.1 million. On a 9-month year-to-date comparison, we generated $27.9 million of operating cash in 2020 compared to $21.3 million in 2019. It's almost 30% more operating cash generated this year than last year in the comparative 9-month period.

In summary, there are not many companies in the oilfield services space that have a recurring rental revenue stream, essentially no debt on the balance sheet, cash reserves in the bank and the continued ability to generate cash.

Before I take questions, I want to express my thanks to the entire NGS team for their continued dedication to making NGS one of the best energy services companies in the industry. 2020 has not been easy for any of us, yet the tireless work ethic of our team in the midst of a pandemic and the resulting uncertainty in our industry is something for which I'm incredibly proud and thankful.

While shareholders measure our company by a series of in-personal financial numbers, each of those metrics is a direct result of the effort and care of the people that comprise the NGS family. So thank you.

We don't expect a lot to change in the final 45 days of 2020, except, of course, our capital expense. We expect and hope the year will finally end. We do believe that while 2021 is likely to start cautiously. There are early signs of recovery on the horizon.

More important, NGS is well positioned with a solid balance sheet, a strong customer base and a team committed to provide an uncompromised service. With a stable to modestly improving operating environment, we believe there will be opportunities for meaningful improvement in business prospects as we progress in the new year.

Erica, that's the end of my prepared remarks. So if you would, please open the phone lines for any questions.

(Operator Instructions)

Our first question comes from Rob Brown from Lake Street Capital.

Nice execution in a pretty tough environment as you laid out. Just my first question is really around the CapEx in Q4. Maybe characterize kind of what's driving that, the type of projects that you're filling? And I think you had some high horsepower orders that comprise of, but maybe just clarify the CapEx in Q4.

Yes. It's made of primarily 2 components. One is we got a pretty good order for some 400 to 600 hosepower equipment. And that's what I mentioned, our high horsepower utilization was 89% at the end of Q3, but it's actually climbed about 93% already because the stuff that was idle temporarily at the end of the quarter has now been utilized and committed, and they were building some more, so it's primarily that. And then we've also got, I think I mentioned in the past, the potential for some leaseback purchases, purchasing some new equipment from customers and written them back to them. So those 2 pieces are the biggest part of that. And I think that the leaseback is pretty interesting from the point that it's -- it provides some capital to a customer, it's equipment we actually built for them in the past, and we get to convert in the rental revenue at good rates and long-term contracts. So it's interesting, especially in this environment that there's at least 1 customer looking to monetize equipment they own and just lease it back. But those are the 2 biggest components.

The biggest risk to that CapEx number is really timing. It's not that the projects will happen, but this is November -- mid-November. We've got holidays coming up and everything else. And that's always a crunch you get into it at the end of the year as to whether projects get done or whatever it is. So the number is pretty solid, we think. It's -- if there's any wavering to it, it would be timing, not commitments, but that's -- but those 2 components are the biggest part of that.

Okay. Good. And then on utilization and kind of the bottoming of the industry. I think you said utilization was sort of stable quarter-to-quarter here. But how much visibility do you have on sort of units coming back and going out? And maybe a sense of how the utilization plays out over the next few months? I know it's hard to predict exactly, but do you sort of feel like it's bottomed here or is it still there?

Yes. I think it's bottomed, but I think there's still going to be some fits and sparks in this thing. I mean it's -- this stuff's never a straight-line up. It's pretty jagged, and you'll have some down, some up and everything else. I think the bias is positive and that there's still -- we've still got some shut-in equipment that we anticipate coming back on a little more. If you list analyst read reports, everybody's fairly positive on oil price next year. But of course, those are -- those reports are good the day they're written and anything can change them. So yes, I think the bias for positive utilization is good, but it is going to be some up and down to it. But I think we're -- I think 2021 actually is going to be a fairly good year. I mean this year has actually been a lot better than I would have guessed back in March, when all the stuff happened because it was pretty -- is down pretty fast, but our guys have done a great job of taking care of recovering it and continuing on and watching the cost, obviously. So I think we'll see a trend up, but it's hard to say what that slope is.

Okay. And then last question is really on the competitive environment. This played through our -- are you seeing any changes there? Or is it about what you've expected in you're and very similar to historical cycles?

Yes. It's what I expected, and it is in line with historical trends and that we tend to see some questionable pricing in the market. So both those -- you typically see those in downturns, especially from people that aren't as fancy and strong as we are. We're able to pick and choose the jobs we want, the price we want, stuff like that. If we want to hold price, we can. If we want to get aggressive, we can. But we've got the choice to do that. A lot of competitors don't have the choice to do their debt or other issues. But we see some weaker pricing out there. It's probably not as much as you would have guessed 6 months ago as to what it might be due to just the fast downturn. But we still see select stuff. Now I mentioned our price was down 2% to 3%. You'll get a little drag in pricing as you put more bigger horsepower out there because bigger horsepower cost less per -- cost less dollars per horsepower. So your rental is less dollars per horsepower, and that kind of looks like it's down, but actually it's good pricing.

On the decrease we saw on a unit basis was, as I mentioned, primarily the pricing from Q2 coming to full force and being throughout the quarter. So we expect some -- to get some of that back over the next 2 or 3 quarters anyway as operators start. Number one, putting equipment back to work from a standby basis. And also, we intend to, as things solidify, going to the next -- into the new year, going back to those customers, you gave some discounts to and ask them for those back. So the 2% to 3% down is explainable and reasonable and expected but I don't think that will continue. But we do see some weird pricing every once a while. But again, overall, probably not as bad as you would have thought 6 months ago, but it's still a little more than I would like.

Our next question comes from Tate Sullivan.

Can you talk a little more about the leaseback purchases? I was just looking at your sales, I mean, $60 million of sales, compressors and other equipment understandably since the end of '16. Is this an active market historically in the natural compressor, natural gas compressor industry? Or is this new for -- I don't -- I have not heard you talk about this before. And are you uniquely situated to take advantage of customers that want to monetize some of your equipment?

Yes. I'd mentioned that, probably a little on the last couple of quarters. We probably are uniquely situated to take advantage of just because we've got money. When a customer wants to monetize, you got to pay them something. So we've got the flexibility to do that. It's not a big market. Typically, when someone approaches you on that stuff, it's stuff that we don't want. There's a reason why they're trying to monetize it. They don't want it either. And not because of financial issues, but maybe equipment is older than they want or worse shape or something like that. So most of these things just don't take very long to look at and say, we're not interested, or they don't fit our fleet makeup or they're smaller horsepower, all kinds of reasons. This came to us just a customer we've dealt with for a long time and do a lot of work with them over the years and things like that. And with -- and it's not really a situation of a customer having to have cash, I guess, from the point of being financially in bad shape or something like that. It's more a -- and this is good. It's more customers now looking at, you know what, I've got a finite amount of dollars. I can spend it on drilling or I can spend it on equipment. Drilling makes me all the money, that's where our return comes from. That's my expertise. Why don't I go ahead and spend money on that and rent equipment. Rental provide some advantages, certainly not the CapEx, you have to spend on it. But also operationally, we took care of all the stuff. If you need to downsize, upsize it, we can do it. The customer would have to go out and buy a whole another unit and try to figure out what he's going to do with these other and everything else. So I think when you start to see downturns like this as severe and faster they are plus the market demanding cash returns from operators, it feed right into rentals more and more. And we don't go out and actively market this capability. But as I mentioned, I think we can take advantage of them as they come along. And this is just -- I think we've got $3 million or $4 million dedicated to it. And as I mentioned, I think it will happen. The only question is timing. If the operator gets around to need it quick enough and stuff like that. But that's kind of the background of it, and we're comfortable with it because it's equipment we know.

Okay. And you answered my question earlier on sort of the timing of that CapEx in the quarter, and the good order you mentioned for the 400 to 600 horsepower. Can you -- if you can share, is it roughly, I mean, that size horsepower, the average rental term lengths versus your larger horsepower? Have you talked about that before, Steve?

We're getting 2 to 3 years on those on the 400- and 600-horsepower. So we're getting good terms on them and market-leading rates on them too, so just like any other Capex. We're not spending any CapEx on deals. We're not trying to use our money to go get market share or anything else. We're trying to use our money to make money. And so we don't -- we want longer terms and we want better rates. So we don't spend the money we don't have to. So we know this, and that's what we look at from those standpoints. But that's the other $7 million to $9 million this year. It's all pointed to and dedicated to longer terms and higher rates.

Is it the larger horsepower units, particularly the units -- the equipment that you've built in the last 1.5 years? Are they more than a year rental terms typically as well? And I understand that can change based on shut-ins.

Yes. Yes, the biggest ones, the -- say, the 1,400-horsepower units, yes, we typically go 3 to 5 years on those. We want a good long-term on that stuff. And it's not too hard to get that sometimes. It is -- it depends on the customer, obviously. But the equipment is so big and so expensive and takes so much time to install and operate. And the customer is paying for a lot of this, right, the installation, the freight and all the sort of stuff that I dare say you can rent it on a 1-month term, it's going to stay there a long time. But obviously, we like the security of contracted rentals. So the bigger the equipment -- generally, the bigger the equipment, the longer we go on terms. And then that kind of that mid-horsepower will do some midterm, the 2 to 3-year stuff and the smaller stuff is it's 12-month terms, nominally. We tried to extend terms overall in all the equipment to get a little longer rental period and security with it.

And last 1 for me. I mean, I know the whole industry, and I mean, the balance between more people talking about renewables going forward. Is -- have you ever talked about -- and more utilities, you are mentioning, trying to get renewable natural gas in the pipelines, and I think some of that process needs compressors. Has that market ever be in an opportunity for you or can it be going forward?

Yes. I guess it hadn't been a big over market in the past just because NGS hadn't been on the ESG part of it as much. Now obviously, that's growing. And natural gas by virtue of being a cleaner fuel is going to gain in some of that and obviously contributes, I think, to better environment, clear air, et cetera. But I think there is -- there are opportunities to capitalize on that. We feel like we've already got some real clean equipment from the point of the engines, very tightly controlled from a mission standpoint, cat eye converters or fuel ratio controllers. And actually, every one of our engines in the fleet, the engines that drive the compressors, meet or exceed the worst of any state's regulations. So typically, and I hesitate to say we exceed all of the states, but I -- it's the vast majority that we exceed, we decided that a while back. So we've got real clean engines. The skin itself is different, [gather,] fluids, et cetera. And we've got some recycling components on the units to conserve all to capture gas and things like that. But I think there is more opportunity to do more. Number one, mechanically and physically to the equipment. You have some of our practices in the field. And number 2, to adequately market that to customers so they know that. I think the customers are going to get more and more sensitive to clean equipment versus even also clean equipment. And I think we've got an advantage and taking a little more share out of that piece of it. But there's more to do, and I'll think you'll see more and more gains, and certainly out of us, more and more emphasis on that part of it.

(Operator Instructions) At this time, we have no further questions.

Okay. Thank you, Erica, and thanks, everyone, for joining me on the call. Appreciate your time this morning. I hope your holidays are healthy and happy and wish each of you a more prosperous New Year. I look forward to speaking with you about NGS in 2021. Thank you.

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