Natural Gas Services Group Inc (NGS) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Natural Gas Service Group second-quarter and six-month financial 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 INSTRUCTIONS).

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 and welcome, everyone.

It is my pleasure to read the forward-looking statement and if you will permit me to do that, I will do it now.

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' actual results in future periods to differ materially from forecast 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' product and services, and new government 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 Company's annual report on Form 10-K SB filed with the Securities and Exchange Commission.

With that completed, I will turn to call over to Steve Taylor, President and CEO of Natural Gas Services Group. Steve?

Thanks, Jim. I want to welcome everybody today to this quarter's call. I want to start out by certainly thanking the employees for a good quarter we are about to report on and a good first half of the year.

As we have been doing, we will to touch on the financials and follow it by operations and then a view of the markets and the industry as we see it going forward.

From a financial perspective, all of our comparisons will be based on operating results. This eliminates the extraordinary income we had from life insurance proceeds in the first quarter of 2004.

The Company had a good quarter and first half in 2005. When compared against the same period in 2004, our revenue tripled, our net income before tax doubled and all of our primary margins increased. The Company has been profitable every quarter since the Initial Public Offering at the end of 2002.

On a revenue perspective, our total consolidated revenue for the second quarter of 2005 was over $12 million. That's double against the year-ago quarter and about 9% compared to the first quarter of '05.

Revenue for the first half of '05 was over $23 million, again an over 200% increase over last year's same period. All revenue components, whether it be compressor rentals, compressor sales, flares or service and maintenance, showed year-to-year and quarter-to-quarter growth. When looking on the sequential-quarter basis for this year, compressor rentals were up 14%, compressor sales were up 10%, flares were up 36% and service and maintenance was up 50%.

Now, service and maintenance sales, compressor sales and the flare business are prone to quarter-to-quarter variances just due to the nature of the business, but you can see some pretty strong momentum in those areas.

We are seeing growth in all of our business and (indiscernible) flare just real quickly -- revenues there have doubled over the same quarter in '04, the second quarter, and we currently have about a $0.5 million backlog in flare sales existing right now.

In accordance with our goal we previously mentioned, our revenue mix continues to move more towards the rental. In the first quarter of 2005, rentals were about 31% of revenue. In the second quarter of '05, they sequentially increased about 32% of revenue.

Let's talk about gross margins just a bit. On a dollar basis, our second-quarter 2005 margins, compared against the same quarter last year, decreased 113%, the first half of this year versus the first half of last year, so it was a 104% increase in sequential quarters this year, instead of the 12% increase in gross margins.

On a percent-of-revenue basis, for the sequential quarters of Q1 '05 versus Q2 '05, total gross margins increased from 36% to 37%. Note that the same-period comparisons are important year-to-year and quarter-to-quarter. We're also keeping a close eye on our sequential performance, this to compare our improvement quarter-to-quarter since our SCS acquisition.

Looking at net income after tax on a dollar basis, Q2 '05 compared to second quarter of 2004 showed a 193% increase. The first half of this year compared against the first half of last year is a 159% increase. Then the sequential quarters this year showed a 20% increase. For the year-to-date, sequential quarters -- our net income after tax margin as a percent of revenue increased from 8% to 9%.

Our business is very capital-intensive and we watch EBITDA, earnings before interest, taxes, depreciation and amortization, as an indication of our net operating performance. As a percent of revenue, EBITDA increased from 25% for the first quarter of this year to 27% in this most recent quarter. The EBITDA trends should continue upwards as we shift to more rental revenue and income in the future, as is our plan.

Earnings per share for the first two quarters of this year increased sequentially from $0.11 to $0.13 on a fully diluted basis with our first-half earnings per share being $0.25.

Let's touch on (ph) operating highlights a bit. Our integration of Screw Compression Systems out of Tulsa continues successfully. We are in the midst of going through a common inventory and engineering support system as we speak. (indiscernible) compressor units (indiscernible) sales have not slowed down. In fact, we're running about 33% or a third ahead of last year in unit fabrication activity at Tulsa. We recently shipped two large horsepower units to Mexico on a direct-sales basis. One of those is reflected in the second-quarter results. Our sales backlog at Tulsa is through the end of this year and on into the first quarter of 2006.

Most of you know we predicted our rental fleet would grow 250 to 300 units for the full year, 2005. Through June 30 of '05, we added 150 units to the rental fleet, so we're definitely on track to meet that 250 to 300-unit projection.

From a rental backlog standpoint, our build schedule for rental units is out to about November of this year with one-third of those already committed to customers. That's approximately the same commitment rate that we saw in last quarter's call, so that commitment rate stands pretty even.

We operate primarily right now in four geographic areas, the San Juan basin, Bridgeport, Texas, which is Central Texas/North Central Texas, the Barnett shale area, Northern Michigan and the Permian basin. The growth in rented compressors for all four areas was between 11 to 70% each on a unit basis in the second quarter, so every area is showing some good, robust growth.

We've also mentioned, in the past, our strategic areas of future growth, those being the Rocky Mountains and the Appalachian Basin. We're making progress in those. In the Rocky Mountains, we are very encouraged by the interest we've received in the coalbed methane gas shale areas of northwest Colorado and southwest Wyoming. We expect to place some units in there soon. The Rockies is a very large gas province and we intend to play a much greater role going forward. In the Appalachian Basin, we had already mentioned we had some initial compressors going into West Virginia and Pennsylvania, and we were recently awarded more equipment for the same customer in that same area, so the potential there continues to look good also.

I mentioned before, along with the SCS acquisition, we obtained a proprietary reciprocating frame that we recall the CIP compressor that we manufacture also fabricate and we are replacing some units in our rental fleet, too. We've had very good customer reception with that equipment and it continues to be popular. We have built as many this half year as we did all of last year in Tulsa, and roughly 25% of those are going into our rental fleets. So those continue to -- we continue to build more of them and continue to add more to the rental fleet at the same time.

We've been working on customer growth and diversification, and that's been a successful exercise. Our top five customers the first half of '04 were approximately two-thirds of our rental revenues. This year, that has dropped to 56%, which gives us a bit more customer diversification, yet our top five revenue from these customers has grown 28%. So although we are diversifying, we continue to grow the same customers in revenue on a rental-compressor basis.

As most of you know also, we had 1.5 million publicly traded warrants outstanding that were issued with our IPO about 2.5 years ago. Those will be eligible for redemption on July 7. That was in accordance with the issuance of those warrants where, if we hit 20 days of the stockprice closing at $10.94 or higher, those warrants were eligible for redemption. So, we hit that on July 7. As of July 25, we've received proceeds of approximately $1.3 million from early warrant redemption, and we have called for the redemption of the balance of those. If all outstanding warrants are redeemed, the Company will have received a total of $9.375 million. We will use approximately $6.2 million of that -- of those proceeds for debt reduction and approximately 3.1 million for additional rental compression going forward.

This is going to help, obviously, our balance sheet quite a bit. Our debt-to-equity ratio will go from 1-to-1 to about 0.6-to-1, and our debt to total capitalization will go from about 0.5 to about 0.38. So we are able to redeem those due to a good, strong stockprice and apply it straight to some debt reduction and building some additional equipment going forward.

From a market indication and the future of how we see the markets going, I primarily am just going to restate some already stated facts we've made in the last couple of calls. From an industry perspective, U.S. natural gas consumption continues to rise at twice the rate of domestic production. Gas flows decline rates were 14% in 1990; they were 31% last year. That simply means we need more than 2 times as many drilled wells just to stay even on gas production. When you take that, then you also consider that well productivity is down. On a gas volume per well drilled, it will take 2.5 to 3 times the number of wells now versus just 14 years ago to have the same gas production. An example, one statistic that is out currently is, comparable periods of 2005 versus 2004, the rig count is up 15%; gas production is down 3%. So you can see the effect of less prolific wells being drilled.

The third fact that we like to state is, of the lower 48 states' land drilling, unconventional gas is the fastest-growing component and is now the largest single source of natural gas in the lower 48 states. It was one-third gas production in 2005 and it will be approximately one-half of gas production in 2025. Therefore, most of the wells drilled in the future will be unconventional gas wells.

From a company perspective and taking into account those industry numbers I just went through, unconventional gas wells need compression sooner and more frequently than conventional wells. 70 to 75% of our gas compression and rental business is in nonconventional plays. Of the three projected areas of growth in the U.S. between now and 2025, which are the Southwest, the Northeast and the Rocky Mountains, NGS is either in or is expanding into each one of those areas.

In the Rocky Mountains, we are experiencing a greater growth rate. 60% of the gas production increase between now and 2025 will be from the Rockies, and by then, they will supply almost 40% of U.S. domestic gas production. That is a primary area for organic growth within NGS.

So you take the macro industry factors and just look at them; they look very good. You combine that with NGS specifics of our geographic targets and our unconventional focus, and it's an especially compelling story going forward.

There are, of course, a lot of moving parts in the gas supply and consumption picture. I think the long-term trend is up, but we will experience some flat and down periods. Some of these moving parts (indiscernible) the U.S. economy, how high energy prices may or may not affect it. The (indiscernible) term, the Chindia slowdown, which is a combination of China and India, a term I saw the other today. China, for example, cannot keep growing at 9% annually, the LNG factor, how much and how soon, and certainly our ever-present politics in the oil and gas industry.

But even with those, we think that the trend is generally up. We will see some flattish and down areas but it's a good future for our business and the natural gas business as a whole here in the U.S. You know, some of our prognosticators abilities I will repeat I guess (indiscernible) of one of my business professors a few years ago -- we are pretty good at predicting directional moves; it's just the timing is open to interpretation, meaning the direction of our business is up. There will be bumps along the way; we just can't predict when they are.

We see a very bright future for the Company, a very robust industry going forward, and we are positioning ourselves, through geographic placement, through additional equipment and serving just with the efforts of our people going forward, to continue to deliver value to our customers, our shareholders and our employees.

So, thank you. We will take any questions that you may have right now.

Ladies and gentlemen, at this time, we will conduct a question-and-answer session. (OPERATOR INSTRUCTIONS).

Zane Gurley from Nightenger and Tucker.

One question, Steve, for you and then I think one for Wally. By the way, great quarter. Congratulations.

A question for you, Steve -- when you mentioned the Rocky Mountains, are you specifically looking at the areas up around Pinedale in the anticline and over possibly in the Powder River or by Gillette? Can you comment about that a little bit?

Well, there's a lot of areas, as you know, up there, Zane. You know, Powder (ph) River, Wind River are good unconventional plays. Also, down -- our primary move right now and primary interest right now is not there but really out down around Peoth (ph) Long Center (ph), Grand Junction area, Northwest Colorado/Southwest Wyoming. There's some strategic reasons we want to do that and just some logistical reasons and the (indiscernible) Basin also, down around there. So we're starting -- you know, we have a very big operation in Farmington, so we are essentially trying to move up from there. We just -- we don't want to get overstretched on our, I guess, our eyes being bigger than what we can chew. We want to take it quickly but deliberately, and so we will start in those areas first and then move into the others.

Wallace or Steve, whoever would like to comment on this, you mentioned that you backlog -- your backlog you say is out to November in rental units. Is that the backlog picture right now? I'm guessing that that's a number on a sheet of paper. What's the reality of your backlog right now? What's the reality of the demand in the marketplace right now?

The reality is, Zane, that we can lease anything we can build. We are constrained by the number of units that can be produced and of course capital, and we are constantly striving to solve the problem of capital. The warrants are one element of that. So, the leasing business is excellent. What Steve said is we have predicted what units are needed, and that's what's in the backlog. Of those, one-third already have customers' names on it. So, that means that what we produce for the next 60 days is probably leased.

Now, our backlog of sold units goes further out. We're probably into February in backlog with sold units. Does that answer your question?

February, are you out to February for sold units?

I know that we have some scheduled for delivery in February and orders are coming in on a regular basis.

Well, okay. I think you gentlemen stated, at one time in the past, that you're looking at 35 to 40 million for the year. You felt comfortable with that. Do you still feel comfortable with that? It looks like you might crack the lower end of that by the end of the third quarter.

It looks like we will crack the upper end of it by the end of the fourth quarter. If you look at where we are at six months, I would suspect that that trend will continue.

Okay, okay. Well, it's a nice business to be in at the time, gentlemen. Good job.

(OPERATOR INSTRUCTIONS). Robert Ford from Sterne, Agee.

Good afternoon, guys. Could you talk through the margins, the gross margins on the leasing business? They've come off fairly materially over the past two quarters. Could you help me understand what's going on there on the cost side?

Yes, what's happening Robert, I think, in the last -- we mentioned, on the last quarter's call, we've had some higher expenses typically out of Farmington due to the long winter and wet winter weather out there. We've got a touch of that into this quarter.

Now, the other thing that has impacted those -- and this is a deliberate decision we made, knowing this would have some impact on the rental margins but also (indiscernible) long-term benefit -- was some additional staffing out there. That's a fast-growing area; it's a big area. It's still growing well. As I mentioned, we're going to be growing up into other areas. We want to go ahead and step up a bit. Haven't had any problems but we want to prevent any. So we've got probably a higher personnel load out there than we had before, and along with that comes vehicles, tools, just everything associated with some of that.

Okay. The personnel, is that on the sell side referenced in your last press release, or is it sales, service, everything?

No, it's primarily service and there are some sales guys in there and they are primarily service.

Robert, what happens -- this is Wallace -- for instance, we are now operating in the --.

So we are going to have a little more of the compression on the sale and leasing side, just due to expansion and geography, so it's a short-term hit on that, but it's for the long-term benefit going forward.

Okay, thanks. That's all I had. Thank you.

At this time, I have no questions.

Erica, do you want to ask if there's any other questions one more time? If not, then we will conclude.

(OPERATOR INSTRUCTIONS). At this time, I have no further questions.

Steve, do you want to wrap it up?

Sure. We appreciate everybody joining in; we appreciate everybody's support. As we just talked about, we had a good quarter, a good half and expect to have more of the same the rest of this year. We look forward to seeing -- talking to everybody at the end of next quarter. Thanks.

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