Natural Gas Services Group Inc (NGS) 2004 Q4 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Natural Gas Services Group Fourth Quarter Earnings and Year End Financial Results Conference Call. At this time, all participants are in listen-only mode. After the presentation, we will conduct a question and answer session. Operator assistance is available at any time during this conference by pressing star zero. Your call leaders for today's call are Jim Drewitz, Creative Options Communications, Wallace Sparkman, Chairman, Steve Taylor, President and CEO. I would now like to turn the call over to Mr. Jim Drewitz. Mr. Drewitz, you may begin.

Thank you, Jennifer. It is my pleasure to read the forward-looking statements, so if you'll permit me to do that, we then will proceed with the call. Except for historical information contained herein, the statements in this conference call are forward-looking and made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause NGS'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, a prolonged substantial reduction in oil and gas prices, which could cause a decline in the demand for NGS's products and services, and new governmental safety, health and environmental regulations which could require NGS to make significant capital expenditures. The forward-looking statement included in this conference call are only made as of the date of this call and NGS undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. A discussion of these factors is included in the company's annual report on form 10-K-SB filed with the Securities and Exchange Commission. With that completed, let me turn the call over to Mr. Wallace Sparkman, Chairman of the Board. Wallace?

Thank you, Jim, and I thank all of you for joining us on this call. There's one other person available on this end of the call and that's Paul Hensley. Paul is President of Screw Compressions Systems, Incorporated, which is now part of Natural Gas Services Group.

I want to take just a minute to give you a little background. Some of you that have followed the company are aware of this, but for those listening that have not followed it, a little information might help you. A year ago or last year in March, our then President and CEO, Wayne Vincent, passed away after suffering what was a very short time with cancer. At that time, the directors elected me as Interim President and Chief Executive Officer. The directors entered into a search for a permanent President/CEO and had several applications, I think 50 some odd that were reviewed and interviews given and finally earlier this year, we found the individual that we think is the right person to go forward with the companies as we continue our growth path. That gentleman is Steve Taylor.

Steve's background is several years as a senior officer in a company that had a rental fleet of gas compressors. In fact, it was ranked number one in the U.S. at that time. Steve is a graduate with a Mechanical Engineering degree in Texas Tech university. He has an MBA from the University of Texas at Austin in business administration. He came on board about six weeks ago and because of his vast experience and background, he is totally up to speed with the company and he will be doing the report today.

So with that, I'll turn it over to Steve.

Well, thanks, Wallace. I appreciate the kind words and I hope I can perform up to expectations. Good afternoon, and thank you for joining us for today's conference call. I'll be conducting the call and I'd like to begin this call by complimenting all the employees of NGS for their hard work this past year and the resulting exemplary results. I assumed this position in mid-January, as Wallace mentioned and I have been impressed by the staff and dedication and loyalty to our customers and the company. It is my distinct pleasure to report the results of their hard work.

Our business consists of two major product lines within which there are three revenue sources. Gas compression equipment is our major product and is employed by natural gas producers to increase the natural pressure of a gas stream to enable or enhance production. Our natural gas flare systems are utilized by producers to incinerate off gas streams due to environmental or regulatory concerns. We derive revenue from these product lines in the form of sales, rentals and/or parts and service. I'll begin with the financials and will then take a bit of time to give a general view of how we see our industry going forward and the part intend to plan into.

Revenue from all sources for the fourth quarter increased 36 percent to $4.7 million as compared to $3.5 million for the same period in 2003. Revenue for the 12 months ending December 2004 increased 25 percent to $16 million when compared to $12.7 million for the same period in 2003. You can see we had a very strong year accentuated by increased revenue momentum in the fourth quarter.

Compressors rental revenue led the way for our record revenues. It increased 48% year to year and reinforces this strategic decision to concentrate on our rental compression business. Fourth quarter 2004 rentals increased 49% when compared to the same period in 2003. Rental compression now represents 66 percent of our total revenue as compared to 56 percent in 2003.

Our rental fleet group grew from 399 units at year end '03 to 585 compressors in '04 and we expect the rental fleet count to continue that same rate of growth to a total of 850 to 900 units by year end 2005. Our rental horsepower increased over the past year from 44,505 to 64,928. This is a 47 percent increase in fleet size and 46 percent gain in horsepower.

Our rental fleet utilization increased from 90 percent last year to 94 percent at the end of 2004. This utilization increase is significant. At 94 percent, aligned for equipment movement, installation and effective rental dates, we are effectively very close to full utilization. Our continuing challenge in today's market is to keep up with demand in a prudent manner.

Full year sales of compression and flare equipment were down approximately $270,000 to 3.6 million, but the fourth quarter showed year to year increase of approximately $160,000. Again, a strong year end showing. Currently our backlog of compressor units sold to customers stretches out through August at our Tulsa facility, while rental units being fabricated in Midland and Michigan through the month of May have already been committed to customers. I'll touch on our newly acquired Tulsa facility later in the call.

On the service and maintenance side, revenues rose approximately 6 percent year to year with fourth quarter growth of 18 percent when compared to the same period last year. Gross margins for the comparable fourth quarter rose 45 percent from 1.9 million to $2.7 million and increased 35 percent, or $2.3 million in 2004 when compared to full year 2003. This is largely the result of strong growth in our high margin rental business and the aforementioned change in revenue mix towards rental compression. However, all product lines increased their year to year gross margins as a percentage of revenue in the fourth quarter by 35 percent, 22 percent and 16 percent for rentals, sales and service and maintenance respectively. Gross margins for 2004 for compressor rentals were a strong 71 percent with gross margins for sales and service in the 28 to 29 percent range. Although it is a small part of our business at 7 percent of revenue, flare systems experienced revenue growth in 2004 of 41 percent, while maintaining 60 percent gross margins. As a percentage of revenue, company-wide gross margins rose from 52 percent in 2003 to 56 percent in 2004.

SG&A fell from 18 percent of revenue in 2003 to 16 percent in 2004. Operating income grew by $1.24 million, or 46 percent to 3.9 million. EBITDA for the fourth quarter rose 61 percent from $1.23 million in 2003 to $2 million in 2004 and for the 12 months rose 77 percent from 4.4 million in 2003 to 7.8 million in 2004.

I want to note that one half million of that increase a came from insurance proceeds relative to the untimely and unfortunate death of Wayne Vincent, one of the original founders of the company and my predecessor. Not counting that contribution EBITDA still had a strong year over year of $1.9 million, or 43 percent .

Our total capital expenditures increased from $7.9 million in 2003 to $11.6 million in 2004. This is funded from internally generated cash flow and bank borrowings. Cash flow is a bit over $3 million in '03 and all but doubled to $5.8 million in 2004, or a $4.3 million, 43 percent increase without consideration of insurance proceeds. We expect that cash flow in 2005 will take care of $5 to 6 million of our capital fleet needs with the balance being financed with bank debt. We are in fact in the final stages of finalizing a new bank facility that will take care of our needs through 2005.

I want to note that our Cap Ex is used exclusively for long-lived tangible assets and that we do not capitalize any-of our ongoing maintenance requirements for the daily repairs and maintenance or major overhauls. Our practice of expensing these costs is not consistent in our industry, but we think it translates into a higher quality, more transparent earnings base for the company and our shareholders.

The company has an issue of one half million publicly traded warrants outstanding that can be converted at our option once our stock price hits and holds at $10.94 a share for 20 consecutive business days. If these convert, we will receive a cash infusion of approximately $9.3 million. Proceeds from the conversion of these warrants would be used to retire debt and/or expend or compressor rental fleet. There are another 570,000 warrants outstanding that are currently being registered. These have variable redemption features, but cash proceeds to the company for the full exercise of them could be as high as $1.8 million, which would then be used to retire the underlying debt of $1.5 million in the carries of 10 percent coupon.

Long-term debt grew from $6.7 million to 9.3 mn in the same period. Our debt to equity ratio improved from 46 percent in 2003 to 41 percent in 2004. We conservatively amortized this debt fully over five years. Our current ratio improved from 0.93 in 2003 to 1.40 in 2004.

Earnings per diluted share increased from 23 cents in 2003 to 52 cents in 2004, or a 28 cents without another forementioned extraordinary income contribution. Our common share price increased from 5.55 to 9.43 or 70 percent in 2004. The stock price opened this morning at $10 per share. I also want to mention that we're in the midst of our Sarbanes-Oxley Section 404 compliance and testing and it is going well. We'll be able to meet all pertinent SEC deadlines.

I will not stop talking about the financials, but I will change course so we can move on to the good things we see going forward. We acquired SCS, Screw Compressor Systems of Tulsa on January 3, 2005. Total consideration was $15 million, of which $4 million was common stock, 3 million was a subordinated note to the owners, and the $8 million balance was funded with long-term bank debt. We previously announced that the purchase will be immediately accretive to earnings.

SCS brings a wealth of knowledge and capability to our company. In addition to their positive financials, they have developed a robust compressor fabrication, manufacturing and sales organization. We gained 54,000 square feet of fabrication space, which if you can even get access, is at a premium in today's market. This gives us the ability to allocate our fabrication and manufacturing activities to locations deemed most effective, whether it is Tulsa, Midland or Michigan. Their engineering and design expertise is second to none and will dramatically strengthen our present capabilities.

Like NGS on the rental side, they have a strong customer relationships for built for sale compressors and we anticipate reciprocal opportunities within the combined customer base. They also bring advantageous supplier relationships that can be leveraged throughout the company. One of the most exciting aspects of the acquisition is their proprietary compressor frame, the CIP compressor. SCS and NGS are primarily focused on the rotary screw compressor market, but the reciprocating compressor opens up a new market area we did not heretofore participate in.

Screw compressors are typically limited to low to medium pressure discharge applications. There is obviously a lot of business in that area, as evidenced by both company's prior and present participation, but there are also just as many high pressure pipeline as we can now potentially place compressor units on. It opens up a whole new market and product area for us and we're seeing a strong increase in CIP popularity and corresponding compressor orders. This vertical integration gives us more flexibility and leeway to effectively compete in today's delivery-driven market.

We do, however, anticipate some margin pressure from the acquisition. Our product mix will skew much towards sales and as I have pointed out, those margins are lower than those with rentals. However, I hasten to point out that as the rental favors engines heavier revenue mix through continued growth, our margins will correspondingly rise.

Our compressor rental business continues strong. Customers are continuing their drilling and production activities and their need for compression has not abated. We have a high quality customer base and our bad debt write-offs have been almost nonexistent. Our challenge continues to be keeping our production capabilities high enough to meet the majority of demand, but to not over-leverage ourselves as a company. We have met that challenge today and anticipate being able to address the areas and customers we choose.

Our strongest operating areas continue to be in the Four Corners area of New Mexico and the Barnett Shell in north central Texas. Our mission operations continue to contribute positive results and we are making plans to expand that operating customer base. We are continually evaluating new areas of opportunity, whether they are geographical or synergistic. Geographically, the Rocky Mountains and the Northeast are primary areas of interest. Present plans are to expand organically into prioritized areas, but we are always open for the combinations to make financial sense and that further our strategic interest.

NGS differentiation springs from our good service, quality equipment, and customer orientation. We apply these to a unique market we have identified and that is a small to medium horsepower space. The large industry players have decided to concentrate on larger horsepower units, large products and international expansion. That makes sense for them. They are large and have larger appetites, but we focus in the space that they have left behind. It is hard to get a good quantitative feel for the market share that we hold, but we are ranked as the fifth largest compressor company by the Gas Compression Association by number of units in the U.S. Now, not all companies participate in the Association, but knowing what we know through our own estimates, we think we are, if not the major player in our focus market.

As for industry fundamentals, after almost 30 years in the old service business, my initial reaction to the good times is to prepare for the bad. It's second nature and not a negative because it does give management a perspective that can't be learned, only lived through, but there seem to be some different factors at play in the industry now. Some of you may remember the infamous gas bowl of years ago and how it caused quite a bit of havoc in U.S. markets. Today, depending on who or what you read, demand has exceeded supply in the U.S. for the last 3 to five years. The Energy Information Agency of the DOE predicts consumption will grow by 3 percent in 2005 while supply will grow 1.6 percent, and some of that supply growth comes from extraordinary events. For example, continuous recovery in the Gulf of Mexico from the effects of Hurricane Ivan.

These numbers sound small, but when you look at the recent supply demand and balance we're running about 1.2 percent short supply in '04. If you compound the supply demand growth rates after five years, everything else being equal, we get an 8.4 percent gap in natural gas picture. That is a purely mathematical equation and I don't think we'll get to that kind of supply demand gap, something will give before that, but it apparent there will be continual pressure on the supply side and that will support activity and prices.

I've taken enough of a chance trying to predict this business out five years, but we can say that there isn't any other supply that might hit the market to improve the supply side of the equation. LNG, Canadian Arctic Gas, Alaskan Gas, et cetera, will not be available in appreciable volumes within five years. Also supporting the demand side is the fact that 90 percent of all electric generating capacity built in the U.S. in the past five years has been natural gas fired.

There's a lot of talk and consternation about the natural gas inventory level we now have in storage. Let me quote from the EIA, DOE 2005 short-term energy outlook publication.

The average natural gas spot price was $6.78 per thousand cubic feet in December and 6.32 per MCF in January. The unusually mildly winter weather in the northeast this past December reduced heating demand, which in turn lowered spot prices for natural gas in January. Working gas in storage cess mated to have totalled 2,221 billion cubic feet in January, which is 15 percent higher than one year ago and 17 percent higher than the five-year average. With the heating season now about two-thirds over and with ample storage, natural gas prices are likely to ease over the next several months. Still with, crude oil prices expected to remain over $40 per barrel in 2006 with a relatively tight natural gas supply demand situation over the same period, [Henry Hub] prices are expected to average roughly $5.45 to 5.75 per thousand cubic feet annually for the 2005-2006 period.

The DOE is essentially saying we're in a supply demand and balance of support prices till at least 2006. 5.45 to 5.75 is a very good price when you consider that $4.88 and $5.42 for the average hedge prices in '3 and '04 respectively. Our business has grown vigorously in both of the past two years and the DOE is predicting that gas prices will be the same to a little higher than what when had in '04. As far as the potential to prices to ease over the next few months, based on the EIA's predicted average, it doesn't look like it will ease too much. Remember we have a backlog over the next few months that should ease any effect we might see. It's not a bad scenario.

This is a macro picture. How does that translate into our business of running and selling compressor? One statistic that the average decline rate of a new natural gas flow in 1990 was 16 percent per year. That had risen to a decline rate of 30 percent per year by 2004. This means that all else being even, natural gas wells are declining at twice the rate as they were only 14 years ago and on average they will need compression almost twice as fast. There's also report that the number of marginal gas wells and production increase in 2002 over 2003, over 2002. Marginal wells are prime candidates for compression. Interestingly, Pennsylvania has the most trickle wells, but Texas has the most trickle production.

The bottom line continues to be that natural gas producers depend on gas production for gas for cash flow. Gas compression is usually the last equipment often in declining market and the first put back on in a rising market.

NGS had a very good year in 2004, we finished with a strong fourth quarter. This, of course, translates into a great start for 2005. We see this year stacking up very well and look forward to continued success in the future.

Again, I want to congratulate and thank all the employees of NGS for their hard work and corresponding excellent results. I'll now open the call up for questions.

Ladies and gentlemen, at this time, we will conduct the questions and answer session. If you would like to state a question, please press star one on your phone now and you'll be placed in queue in the order received. You can press pound at any time to remove yourself from the queue. We are now ready to begin. Once again, if have you any questions, please press star one on your phone. At this time, there-- our first question comes from Mike Hunt of Mark One Management. Please state your question.

Hello, Wallace and Steve.

Hi, Mike.

How are you all doing?

Good.

Good. Can you tell us a little bit about what you have done in the recent past here about adding fabrication capacity to, through NGS's corporate structure, so to speak?

Mike, I can tell you where we are today. We are effective, I think you know, building screw compressors in Midland and because we had started packaging recip compressors, it cut down the number of units we could produce here because they take more space. At SCS in Tulsa, [Follow] has stepped forward and has started producing our recip compressors up there and in addition to the 54,000-square foot facility that was part of SCS when we made the acquisition, there has been two buildings leased next door. One is for the manufacturing of the sep compressor frame, which is a vital part of our program, and the other building is being -- will be utilized to make a fabrication shop out of it where vessels and skids will be built, both for Tulsa and for Midland. This frees up about 25 percent and, Paul, if I make a mistake let me know, but about 25 percent of the 54,000-square-foot building that can be utilized for packaging.

So overall, we are equipped to handle what we see as the needs, which we publicly announced is going to be some 300 units for this year, and so with that -- and we just this week closed on the acquisition of 4 and a half acres of land adjoining the Midland facility so that as we get into the year and we see how -- what we're doing now is accomplishing our goal, we could start a building or put a building adjoining. So we're trying to stay ahead of the curve and make moves that expand our production capacity and also keep a handle on what the demand is and what we need to be building.

So all of those things have been accomplished, but it's a moving target, as you can imagine, as the customer demand grows. Then we have to look at the fabrication side of the business and -- but with those moves, we're in good shape right now.

Well, that's great. I have one other question, and it has to do with this CIP and how you see the development of that product line and growth opportunities in that area going forward.

Paul, do you want to answer that? Paul was on speaker phone. Their phone system went out in Tulsa, and so he may not be there now.

All right.

We're seeing great utilization from the sales side of the business in utilizing the CIP compressor and we're also seeing demand for rental compressors turning more and more to the higher pressure machines. So we're watching that very carefully. There are a couple of other packagers that are buying the units now, which is good, looking at the long-term because as those machines get out in the industry, the sale of parts will become a significant revenue stream for us, and profit stream.

No doubt. No doubt.

What we're experiencing right now, Mike, is we're very fortunate to have the CIP line of compressor so we can continue building our rental fleet to meet the customers' demands or needs and because the compressor we were using, the delivery time on them is now 22 to 26 weeks. We are also seeing the same thing happening to engines and coolers, so that's part of our daily plannings, is being sure we have enough of those items on order so we don't have to slow down.

Sure. Well, we're very excited about the CIP end of it and we certainly see that as a real plus with the SCS acquisition.

I just have one other comment, Wallace, and that's just to thank you for a job well done over the past year. You were called upon way above the call of duty, so to speak, and the results certainly speak for themselves.

Well, I give credit for what we accomplished in 2004 to the entire management team. It's a joy to work with them. They are all professionals, and I didn't to do an awful lot, Mike, just keep things heading in the right direction and make sure we were properly capitalized to take advantage of the opportunities. But I appreciate your comment. Thank you.

You're welcome. That's all I have.

Okay.

Ladies and gentlemen, once again, if you would like to ask a question, please press star one on your phone now. Our next question comes from Andy Vitor of Stifel Nicolas. Please state your question.

It's close. It's Andy Vitor with Stifel Nicolas. Good afternoon.

Hello.

Sounds like you've got a fair amount of Cap Ex that you're going to spend in 2005. Did you provide 2005 Cap Ex guidance, and of that, what would you consider repair and maintenance sort of ongoing sustaining Cap Ex? Thank you.

Andy, we mentioned 5 to 6 million cash flow for the year and then our Cap Ex is going to run roughly 16 to 18 million, and that's, that will be primarily rental fleet, 90 percent of that. None of that goes towards our repair and maintenance. We expense all repairs and maintenance, whether it's daily or overhaul, major overhauls or anything else, so all of that goes into, you know, the hard assets, the rental equipment that we employ out in the field to make a return. So it's all, you know, we're very strict about expensing the repairs and maintenance as we go on a day to day basis.

But none of that's capitalized?

No, not the R&M, no.

Okay.

And you might-- looking at the financials that we released, our gross margin on leasing is about, in 2004, was 71 percent. Well, that's after the repairs, maintenance and service.

Great. Thank you very much. That's helpful.

Okay.

Our next question comes from Oliver Man, a private investor. Please state your question.

My name is Oliver Man. I live in Houston. I'm curious about the acquisition of SCS. In 2005, what percentage of the total corporate sales will be represented by the SGS acquisition?

In sales, are you including rental revenue?

Yeah, if you do, I do.

Okay. I would say that it will represent 50 percent.

1-5, 15?

No, 50, 5-0.

50, okay. That's about what I was kind of figuring, but I just want you to confirm it. And that's really my only question. I wish you all the best of luck.

All right.

Thanks.

Thank you, sir.

Great.

At this time there, are no further questions.

Okay. We appreciate everyone that's joined this call and Steve or I, either one, are always open to take phone calls if you care to think of a question later and want to call in, please do so. We would be pleased to talk with you. And watch our progress this year because as you can see from 2004, it's been an interesting year and I think 2005 will be the same.

Yeah, thanks for joining us on the call and your interest in NGS and we look forward to visiting with you next quarter.

Thank you very much.

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