Natural Gas Services Group Inc (NGS) 2005 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen, welcome to the Natural Gas Service Group First Quarter Finance Results Conference Call. At this time, all participants are in a listen-only mode. After the presentation, we will conduct a question-and-answer session. Operator assistance is available at the present time during this conference by pressing star 0. Your call leaders for today's call are Jim Drewitz, Creative Options Communications, Wallace Sparkman, Chairman, Steve Taylor, President and CEO. I would like to turn the call over to Mr. Jim Drewitz. Mr.Drewitz, craw may begin.

Thank you very much. Ladies and gentlemen, please allow me to read the forward looking statements. Except for historical information contained herein, the statements in the 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 actually 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 products and services, and new governmental safety health and environmental regulations which could require NGS to make significant capital expenditures. The forward-looking statements 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 the Company's annual report on From 10-K-SB filed with the Securities and Exchange Commission.

With that completed, here is Mr. Steve Taylor President and CEO of Natural Gas Services Group. Steve?

Thanks, Jim. I want to start the call first with thanking the employees of NGS for their hard work. The results I'm about to report are due to their efforts.

I'm going to start with the financials, and then hit the operational achievements, and then give you an idea of where we think the company and industry are going. Before I go to the financials, I'm first going to tack about our acquisition of Screw Compression Systems or SCS out of Tulsa. We closed on that acquisition January 3 of this year, so this is the first full quarter we have had a consolidated operation.. The primary we reason we bought SCS was to increase our fabrication and manufacturing space so that we could pace with the demand in our rental business. We quadrupled our fab space of 30,000 square feet to almost 125,000 square feet, and will be able available to incrementally 70 to 75 units to our rental fleet on an annualized basis. We also had a strong built to sell basis, it contributed 6.1 million in net revenue this quarter after inter-company adjustments, and $346,000 in net income. They have a proprietary [reciprocating] compressor product called the CIF, CIC compressor, this enables us to get into new, high-pressure markets we did not participate in in a large manner before.

To get to some of the financials. We're going to talk about the earnings going forward and some figure and historical comparisons. We're basing them on operating results. We did have a one-time nonrecurring income item last quarter, or Q1 of '04, due to proceeds from a life insurance policy, but we're not inputting those in the comparisons going forward, so we want to give a valid picture of the results of our ongoing operations.

Our revenue in Q1 of the '05 was right at $11 million. This is a 209% increase over the comparable quarter last year. Third party sales, which consist of compressor sales, flare sails and parts sales, grew to $7.1 million, up from $890,000 last year same quarter. This, of course, was due to the acquisition of SCS. Our flare revenue continues strong and almost doubled to 323,000 this quarter versus the same quarter last year. Rental revenue continues strong. The revenue was $3.4 million this quarter, up from $2.3 million in Q1 of '04. Rental revenue now makes up about 31% of our total revenue, Sales are 65%, and maintenance and services 9%. As you know in the past our rental revenue was the strong part of our revenue component, with the SCS acquisition, that has reduced that. We intend to decrease those relative components as we go forward.

Rental fleet growth we had a 885 units in the rental fleet at end the of 2004. At the end of this quarter, Q1, we had 661 units, so we grew by 76 units. We have previously forecasted a total of 850 to 900 units in the fleet by the end of 2005, and we're on track to make that. Our rental horsepower increased to a little over a 73,000 horsepower at the end of Q '05, and utilization continues in the 92% to 93% range.

From a backlog perspective, for the rental fleet, build schedule, we're out to October in what we have got scheduled to build. Half of those units have already been committed to customers. One third of that total billed schedule consists of the CIF reciprocating compressors. This represents an encouraging buildup of customer acceptance for this product. Our build for sale backlog, which is primarily out of Tulsa, stretches out now to October or November, and includes some larger 1,000 horsepower units we're building.

From a gross margin standpoint, the company wide margin rose 49% from $2 million comparable quarter in '04 to $3.9 million in this quarter. Sales margins are at 21%. This is a little off of the mid-20s that we see sometimes, but we had some consolidation movements, logistic issues, moved some equipment between Tulsa and Michigan and Midland to get the right fabrication in the right place, and also a ramp up of the CIF compressors I mentioned. We expect the sales margins to get back up into the mid-20s.

Rental margins are at 65%. We've had some pretty big winter weather and rain effects in Farmington, which is our single largest location this quarter, that caused a lot of overtime, vehicle expenses were a little higher. We had some delayed unit settings to the wet weather out there. And it had some advance expenses by having mechanics in place and not being able to get some compression out to locations. We feel strongly that the margins in that business will get back up to our typical 70% range as the operations normalize.

Our G&A increased from $488,000 last year same quarter to $900,000 in this quarter. That's of course the additive effect of SCS, but as a percentage of revenue, it decreased from 14% to 8%. Our EBITDA doubled quarter to quarter, $1.4 million Q1 '04, up to $2.8 million in this quarter. NGS was 1.95 million of that, and SCS was $850,000 of that EBITDA.

From a capital perspective, our capital expenditures increased to $4.7 million Q1 '05, up from $2.5 million in the comparable quarter last year. Our cash flow from operations went from $1.2 million at up to $3 million quarter to quarter.

Our CapEx budget is consistent at $16 million to $18 million, that we announced last call. We have a bank line in place for a range up to $12 million of that, and we will fund the balance with cash flow. We do have an issue of $1.5 million publicly traded warrants outstanding. Those can be called at our option once our share price hits $10.94 per share for 20 consecutive business days. That will provide us with cash infusion of approximately $9.3 million. We use those proceeds to retire debt and/or extend our compressor fleet.

Long term debt this quarter was $28 million. That includes $4.5 million of subordinated notes, $3 million of those were to SCS's owners as part of the acquisition, $7.8 million of that was the funding for the acquisition from bank debt. The remainder of the debt, $15.7 million, and that went to fleet expansion, gas compression. This compares to $10.1 million that we invested in the fleet comparable period last year. Up from debt standpoint. Now, comparing that, about 5 million increase in debt to the increase we've had in equipment, we're about $10 million up on equipment, so we've got about a two to one leverage on our debt to asset situation right there on the rental fleet. We concertedly amortized this debt fully over five years.

Our earnings per share on diluted share rose from $0.08 Q1 '04, up to $0.13 in this applicable quarter.

Now I want to get into in some operating highlights, and let you know what we're doing and where we've been, and where we're going. Farmington, New Mexico, and Bridgeport, Texas, continue to be our largest areas. Farmington continues to grow at a very rapid pace, and up 50% in size over the last year. We somewhere new rental orders for the Raton Basin, which is the southern Rocky Mountains, and three larger units we just received a couple of weeks ago going into West Virginia. These are all non-conventional gas areas. If you recall from last quarters call, these are new geographic areas that we had targeted. We're also setting a number of units for large [INAUDIBLE] in the Permian Basin. Over the last six months, we've set 25 for them. We're now opening a service location in Southeast New Mexico to handle those and other units.

Our fabrication facilities continue at a high rate of utilization. In Tulsa, at the beginning of the year, we leased an additional 40,000 square feet of shop space. This is to handle the increased fabrication demand. We doubled our shop size, and helped ramp up production of the SIFT compressor. To further increase the capacity in Tulsa, we are starting on the second shift. In Midland, we have outsourced vessel fabrications to free up more floor space for compressors, and we've purchased an additional five acres of land here in Midland for potential expansion.

From a sales perspective, we've added sales people in Dallas and South Texas in the last six months. We did implement a price increase effective on April 1 on new units going out, and we are considering a general increase this summer on existing rentals in order to recover some of our increased service and maintenance costs.

From a [history] standpoint, we typically use the Department of Energy Information Agency data that's published by the government for a couple of reasons. Number one, they have all of the resources together to crunch all these numbers, and their methods of forecasting are consistent, much easier to track how they calculate and their trends versus just independent sources all the time. Pricing is a primary driver, is a primary driver in this market for the producer, it means cash flow and the ability to drill and produce.

Now, according to the DOE, the natural stop price was over $7.30 an MCF in April of '05, so just last month. That compares April 2004 when it was $5.88. So quite a dramatic increase, about a dollar and a half an MCF. Stop prices are falling and will ease during the spring/summer, but natural gas conditions remain tight. Stop prices are expected to average $6.50 to $7.00 per MCF through the all summer. This is in spite of natural gas storage being 22% above five-year average levels.

But prices continue to be supported by high world oil prices, continued strength in the economy, and limited prospects for growth in domestic natural gas production. Gearing up prices are projected to average $7 per MCF in '05, $7.30 in '06 and this compares to the average in 2004 which was $60. You see the price continues to stay and go up. From a natural gas price aspect, the model gives a 95% confidence level that it is unlikely gas prices will fall below $4 per Mcf an a worst case basis in '05 and '06. That's certainly less than $6 or $7, but still a good market for producers gas and to drill more.

A recent Lehman Brothers survey of over 300 EMP companies, producers use an average gas price of $5.39 per MCF, versus $4.17 last year. Their asset guess would average $6 or would happen, 31% said they would increase their budgets. These are not producers predicting natural gas prices, but these are the hurdle rates they've set to drill and produce gas at. So they are taking a very optimistic look and a very confident look at the pricing going forward, which of course help drive a lot of the business.

Demand drives this prices, demand is expected to increase an average of 2.2% over the next two years. Domestic natural gas production is estimated to remain flat in '05, same as it was in '04, which is essentially about a 1, or 1.5 points lower than demand, so we continue stop supply/demand imbalance. There are more gas wells being drilled, more completed, about a 13% increase is expected this year, and these are shallower typically nonconventional average wells. These are the wells that are going to decline faster and are less prolific, and coincidentally, gas compression prone. The big driver of gas consumption is, of course, electric power generation. 95% of the generating plants built in the last 10 years have been gas fired. Electric generating demand is expected to increase 5 to 6% over the next couple of years.

Now where is all this gas going to come from? The fastest growing component if the U.S. of gas production is nonconventional gas, 35% of the U.S. land based gas production to date from nonconventional courses, and this is going to raise to 44% by 2025. Today the single largest component of land based gas inside the U.S. is nonconventional gas. The majority of this gas growth will be from the Rocky Mountain region, and most of that will be non-conventional gas. In 2003, the Rocky Mountains provided 27% of the total U.S. gas production. That will grow to 38% of total production by 2025, and it has been said that 80% of that gas has not been drilled yet.

There are only two other areas of increase in gas production in the U.S. between now and 2025. Rocky Mountains, like I just mentioned, the other two areas are the Northeast and the Southwest. There are no other domestic or imported sources of natural gas supply coming on-line anytime soon. Alaskan gas isn't expected to hit the lower 48 states until 2016. Canadian imports are declining, U.S. has a net export of gas to Mexico, and L&G there not alleviate any tight supplies until at least 2015. It is only domestic U.S. production we have to rely on for years into the future.

What does this mean for NGS? We're a company that has very positive short and long term prospects. We're very well possessioned to take advantage of the price and supply scenario. Current commodity prices drive our customer's business, and in turn drive ours, and support our rental prices and margins. There's a continuing supply and demand imbalance which supports prices and drives gas well completion activity.

NGS is already in the geographic product areas which are predicted to grow. We're established in the Southwest, but still have areas we can expand into. We have targeted the Rocky Mountains and the Northeast, and in fact have started to move them. Our growth has been and will be driven by non-conventional gas production. Those are wells that typically need compression sooner, at a higher frequency than the conventional sources, and is a main source of U.S. gas growth for the next 20 years. It is a very positive picture going forward.

Thanks for your time, and we'll open up for questions now.

Thank you. Ladies and gentlemen, at this time, we will conduct a question-and-answer session. [OPERATOR INSTRUCTIONS] Our first question comes from Zane Gurley with Nightenger, Tucker and Bruner. Please state your question.

Whoever wants to answer this is fine. First of all, congratulations on a hell of a quarter. How does -- the current quarter that we're in, second quarter, can you give us a feel if it's -- if you're continuing at an agressive pace? And perhaps you could give us some sort of a range on where you think you might be at for the year, if that's possible, so just -- I'm listening.

This is Wallace. Zane, how are you?

Hey, Wally, good.

Zane, we previously gave a range for revenue for the year of 35 million to 45 million. I think you can see by the results in the first quarter that we're certainly going to be at the upper end of that range. Business continues strong into the second quarter, and we don't see any abatement anytime soon. So that will give you an idea for the revenue. You can look at our financials and look at margins and extrapolate what you think the year will be, but if you just hold it flat and say each quarter is going to be the same, that would give us an EBITDA of about 12 million and earnings in the 3 million-plus range, so, you know, that makes for a very decent year. I hope that answered your question. Is there some other part of it that you would like to hear?

No, I have another question. I hear your comments about pricing on natural gas. I've been around this Company since 1999. I have seen us flourish and gas prices at $1.60, $10 and everything in between. My experience with compression is that it's somewhat price resistant if the price drops. Would you care to comment on that because, I'm not necessarily thinking that we need the highest prices, or the high prices to do well.

Zane, I think you're right, you don't need the highest or the lowest. I think what you need is some confidence in what they're going to do, and where they're going to go, that's what we're seeing from the -- not necessarily just the DOE stats, but the Lehman Brothers survey where the producers have increased their hurdle rate for projects on gas and oil prices. That's what's going to go the furthest, I think, with producers feeling that there's some -- having some confidence that prices are going to be up there, going to stay up there, going to stay steady, and we're going to get the fluctuation, we'll get the highs in the winter sometimes, and the lows. But I think what we're seeing is the lows are only -- well, according to predictions, $6.50. That's not very low how.

My only question -- first of all, when is your annual meeting? What's the date of the annual meeting?

Its June 14th at 9:00 a.m. in Midland Texas.

Is there going to be a meeting afterwards at the Hog Pit?

Could be. If you bring your billfold.

Can you comment, either specifically or just in general, the effect that Sarbanes-Oxley had on our margins, on your operating expenses? I'm just curious because of all of the comments that have been made about the effect on the smaller companies, so I would like to hear it from a smaller company.

Zane, you know, we started into that probably six or seven months ago, and we're right in the thick of it. When, of course, the S.E.C. changed their mind and extended the deadline. We're still continuing with that effort. I don't think our expense will run over $100,000, from what we're seeing. So it's not out of hand, and there's really no appreciable effect on our margins or financials. In fact, it's actually coming in to be a good tool for us to use with the consolidation as we go forward in trying to get a lot of processes and procedures put in place, we're able to leverage off the work we've done for those mandated requirements, and use them internally to, you know, help us consolidate a little quicker and better.

That's all I have. Again, congratulations on a wonderful, wonderful quarter. I think that it's a -- it's quite an achievement to consolidate this quickly and this efficiently.

Thanks.

Our next question comes from Michael Burns, a private investor.

Hello, gentlemen, congratulations.

Hi, Michael.

I had a quick question on the projected 250 to 300 units in the leasing fleet for this year. Could you give me a little breakdown, if you can, as to what kind of horsepower those various units will be. In the Northeast, is there a particular demand for a fine of horsepower, and where do you see the total production of horsepower based on your plant capacity say in 2006?

Well, the -- Michael, the breakdown horsepower-wise, our average horsepower runs about 110, 115 horsepower. That's just an overall average of what we're putting out. So the 75 or 76 we grew in the first quarter has a little over 8,000, 8200 horsepower right there.

Going forward, I don't expect that average to change too much. Of course, we've got a big base we have to work that average off of. We'll hit some upticks in particular jobs. The West Virginia jobs are 300, 420 horsepower units. I'm not going to say that's the norm out there. Actually, that's probably a little different, going to more of a gathering system situation. The Northeast has a lot of old mature wells that are lower pressure and lower volume, so they're typically going to fit into our -- the sweet spot we have anyway, which is that 100-horse area. And we'll pick up some of this these bigger ones.

Now in Tulsa we're build something bigger units, and in Tulsa, SCS has always built units to units to custom order, we'll see some of those come out, 1,000, 1200, 1500 horsepower units out there, but those go where the customer wants them, however they want to buy them and spec them.

I do recall the Devonian shale in West Virginia for some investments about 20 years ago, and I'm curious is Mexico or Canada, either areas that have become more attractive with responsibilities than just in the lower 48 the place to stay at?

Michael, we currently are building 2,000 horsepower units going into Mexico, and we're building three smaller horsepower going into Mexico. That market down there looks like very attractive market. These are sold units, not leases.

Canada, they're doing more and more coal bed methane drilling now, kind of stepped up that program. That is an open market. We have not explored it yet. Steve had experience when he was with HRM, the Halliburton compressor company, and opened up operations in Canada, so he's familiar with it. But we're concentrating more right now on the Rocky Mountains and the Northeast, as well as our existing areas.

Okay. Do you notice that there's a particular demand for the term of the leases? Are people trying to look in their lease terms for a longer period of time, or they want more flexibility?

No, it's just staying pretty much the same. It's a 6, 12-month term. Now, we pick up some longer terms on certain ones, but it's not anything that you can predict. These units into West Virginia are longer term. But it's typically staying pretty much the same. I don't think people see it as locking in something long-term, necessarily.

It will stay flexible.

We have practically no units that come back, Michael, once they're out.

Right.

So the term really doesn't bother us that much, because it goes evergreen after the end of the primary term, and it's month to month after that.

Right.

But we don't see any coming back, and if that changes, then certainly we would probably have to relook at that.

And just one point. I think my note may not have caught it. When you were looking at increasing the leasing rates, that was more new units going out the door, and possibly increasing maintenance rates on your existing units for additional costs? Was that right?

Well, what we did April 1 was increase our price schedule for new units going out. What we will likely implement June 1 is a general increase for all units out in the field running right now.

Prior to June 1.

Yeah, anything existing on a lease, on rental June 1 will get an increase. So that will be -- and it's primarily aimed at our service and maintenance expenses.

Okay. I think that's all my questions, and Dad do you just want to say hello to everyone? We're on a conference call. Hello, everyone.

Hey, Bill, hello.

How are you, Wallace?

I'm fine, fine.

They've been reporting on some very good numbers. Good. I would like to be rich before I die, Wallace.

Okay, we've got to help you, Bill. Let's make that a long time.

I want people to genuflect before my casket. How you folks doing?

We're doing fine.

That's wonderful.

You take care of yourself now.

Okay. Thank you, gentlemen. Thank you.

[OPERATOR INSTRUCTIONS] Our next question comes from Geoffrey Kerr with Kerr Financial Group.

Good afternoon, everyone. Question, Did you say the SCS revenue for the first quarter was 6.1 million?

Yes, sir.

Okay. So that means the old NGS, if you will, is about 5 million? Is that right?

Yes. Yeah, 4.9 million.

That's pretty good growth from last year's first quarter. The-- in the margins, I realize that the margins compressed a little bit because of the SCS doing more sales. I'm speaking of the gross margin. Where do you think that that ends up, say, at year-end?

We will -- that margin will to continually improve, because of the additional units we're able to add to the rental fleet.

Right.

Ideally, if we could -- can get there would be that 70% of our units go into the rental fleet, and 30% are sold. And that will bring the margins up dramatically. Steve is maybe looking at the margin for year-end?

Yeah, we've already always talked about getting back to a two thirds, one third rental/sales ratio, 70/30, that's what we'd like to certainly bring the margins back up to what we're used to, Company-wide and historically. And if we get up to that area -- and we think that will take -- that's not going to be a real quick thing, because you saw the dramatic shift we got overnight, just on the sales side, but over the next couple of years, we ought to be make something pretty good headway on that, but we'll be able to get back into into the -- I think we're running Company-wide about 50% prior last year on that, so we ought to be able to get into the 50% range certainly in, I would say, you know, bin the end of '06, and then to consolidate from there.

And another thing, I missed this, the line of credit, is is that 12 million you said?

Yes.

And then final question I guess with the expansion into West Virginia and into the Rockies, does that represent new customers, or old customers into those areas?

Well, right now that's new customers, essentially. The Raton Basin, which is at the southern end of the Rockies, and a big coal bed methane play, and that is, in fact a very good sales customer that we picked up with the SCS acquisition, and these are some of the first units they've put out on rental. So we have some advantage from the acquisition there in that respect, but this gets us into the coal bed methane play and get us a foothold the southern Rockies, be so it's a new rental customer there in the Rockies.

Out, out in West Virginia, that's a brand-new customer, period, and there's a very big producer out there, and we have big hope. What we'll do, Geoffrey, is just -- nothing secret over our usual, we'll get these units in there. We are making plans to arrange for servers to get one of our guys in, there and in the mean team, we'll have the sales guys go out and build up the revenue, so by the time the we hit the ground and get it going, we have a good business going.

Was the West Virginia business, was that for rentals?

Yes.

Okay.

Those are long term rentals.

I'm sorry?

Long-term rentals

On the Colorado business, let me make sure I understand this. There's an old SCS customer that used to buy, and are who are now renting.

Right. They still buy a lot, but rentals fit their pistol on this deal. One of the things before SCS, they would get some rental inquiries, but weren't in that business, and couldn't address them, so we're more than happy to pick those up

Well, yeah, the rentals we do real well on.

Right.

Okay. Thank you, and good luck.

Thanks.

Our next question comes from Mike Hunt with Mark One Management.

Hi. I was wonder if you would speak to the whole CIF compressor arena, so to speak, how you're doing as far as meet your on demand, what you're doing to meet the demand of other fabricators and users to get the message out there that ariel compressors may be 20-week deliveries, and what are CIFs delivery times? More or less what can we expect the CIF compressor line to have with NGS profits going forward?

Well, from a delivery standpoint, as you mentioned, aerial and most other reciprocating compressors are in the 20 to 22-week rental delivery time frame. CIFs we're in the 10 to 12 week typically. Not only did we get the CIF proprietary frame and design in the purchase, but this also gives us some upstream control over our supply chain, which becomes more and more important in a demand-driven market like this, where it's becoming harder and harder to get equipment, so we've got a pretty good handle on those deliveries. As I mentioned, of the forward-build schedule on the rental side, just about a third of those units are CIFs. We're probably running at twice the rate of reciprocating compressors due to the CIFs now than we have historically, and maybe even more than that. So just by virtue of the fact of having our own compressor available a rental base to go out there on a reciprocating basis is really showing some pretty good incremental growth.

The other thing, as I mentioned is, this compressor itself being a high pressure machine versus our traditional compressors puts us into a whole new market where we can address some of these high pressure pipelines.

Another significant part of the one third rental units being CIFs, these are not cannibalizing in any stretch our standard rotary screw compression business, so we're see something good incremental growth out of it, we're seeing some good customer reception, and that's the best way to get this stuff marketed. We are working on a sales and marketing plan to bring that in.

From a distributors standpoint, we are working with others to get these out. That's good sales there, but we're going to be very cautious on how we go forward with it. We're going to protect our supply from the point of our rental fleet comes first, and try to balance the demands of our rental fleet and the market.

Very good. Thank you.

Thanks, Mike.

Our next question comes from John [Crulech] with Monarch Consulting.

Hello, gentlemen.

Hey, John.

On this rental revenue segment, you grew by about 50% in this quarter over quarter basis. Is that some of that due to SCS business? And, secondly, what rate of growth do you think you can sustain in leasing revenues going over the next few quarters?

Well, no, in wasn't any of that pertaining to SCS, I don't think. You know, we might have -- I think we built some units, I don't think they were out yet, so that's pretty much pure just on the rental side.

They had, rental unit, John, and it's about, revenue wise, about $7,000 a month.

Okay. So that was purely our existing NGS business, that growth rate?

Right, right. And, you know, as far as going forward, I mean, we ought to be seeing -- in other words, you know, 50% is a big number I always hate to see those numbers, but with actually that's what we predicted to announce the growth in the rental fleet by year end, we'll be at 50% growth in units, and of course that's cumulative, we'll get that effect after we get those all out, so looking at year from now, we ought to say probably sustained 45 to 50% growth in rental revenue.

Okay. Great. Very good quarter. Thank you.

Thanks.

At this time, we have no further audio questions.

Steve, why don't you go ahead and wrap it up then.

Okay. Well, thank you for everybody joining us. We look forward to a good second quarter, and reporting on those results when we talk to you next time. Thank you.

Thank you very much.

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