Natural Gas Services Group Inc (NGS) 2006 Q2 法說會逐字稿

Good morning ladies and gentlemen and welcome to the Natural Gas Services Group Second Quarter and Sixth Month 2006 Financial Results Conference Call. [OPERATOR INSTRUCTIONS] Your call leaders for today's call are Jim Drewitz, Investor and Press Relations Representative, Steve Taylor, Chairman, President and CEO.

I would now like to turn the call over to Mr. Jim Drewitz.

Mr. Drewitz, you may begin.

Thank you very much and good morning, ladies and gentlemen.

It's my pleasure to read the forward-looking statements, so let me get right to that.

Except for historical information contained herein, the statements in this conference call are forward-looking and made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group 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, new governmental safety, health, and environmental regulations which could require Natural Gas Services Group 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 Natural Gas Services Group 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 included, but are not limited to, factors described in our August 10 press release and under the caption "Risk Factors" in the Company's annual report on Form 10-K filed with the Securities and Exchange Commission.

With that done, I would now like to turn the call over to Steve Taylor, Chairman, President and CEO of Natural Gas Services Group.

Steve?

Thank you, Jim and good morning.

I want to thank everyone for joining me for Natural Gas Services Group Second Quarter and Sixth Month 2006 Earnings Review.

If you read our earnings announcement this morning, you saw that we continue to show very strong growth in our top line revenues.

This is in spite of a week natural gas pricing environment in the first two quarters of this year.

I will start with a general overview of the quarterly and year-to-date results and then go into some segment details.

On the total revenue side and comparing the second quarter of this year to the second quarter of last year, total revenues were up 28% from $12 million to $15.5 million.

Total revenues rose from 26% in the first six months of 2005, compared to the first six months of 2006 from $23.1 million to $29 million.

Sequentially, total revenue for the first quarter of this year was $13.6 million, grew to $15.5 million the second quarter of this year for 14% quarter-to-quarter gain, obviously a continuation of a very strong market and demand.

Comparing second quarter 2006 to second quarter 2005 gross margins, they grew to $4.7 million from $4.4 million.

Our first six months of 2005 gross margins were $8.3 million, compared to the first six months at $10.2 million, which was a 24% comparative increase.

In the past calls, I've mentioned the quarterly revenue mix and margin variability inherent in our compressor sales business.

And if you recall, last quarter we had a very high gross margin in this business with 28%.

We again saw that variability this quarter when compared to the first quarter of this year.

I noted then that I expected the gross margin to average out and that's what has happened.

Our total gross margin dropped from $5.6 million in the first quarter of this year to $4.7 million in the second quarter.

I'll get into the details of this in just a bit, but what you will hear about is a quarterly variation in our sales business, outweighed by positive top line growth, continued to strong rental fleet progress and year-to-date progress in business as a whole.

Our total gross margins for the second quarter of 2006 was 30% of revenue, compared to 37% for the second quarter of 2005 and 41% for the first quarter of this year.

Our gross margin of the first six months of 2006 was 35% of revenue, which compares favorable to the first six months of 2005 of 36%.

Looking at our indirect sales, general and administrative expenses, they ran $1.2 million in the second quarter of 2005 and grew 15% to $1.37 million in the second quarter of 2006.

When compared against our revenue growth of 28%, SG&A declined as a percent of revenue from 10% to 9% in those comparative quarters.

Net income after tax in the second quarter of 2006 rose 13%, a $1.2 million from $1.1 million in the second quarter of 2005.

The first six months of 2006, net after tax was $2.9 million, compared to $1.97 million the first six months of 2005, a very strong 47% increase.

Due to the already discussed sales margin variability, net after tax did drop to $1.2 million the second quarter of this year from $1.7 million in the first quarter.

EBITDA in the second quarter of 2005 was $3.2 million.

We saw a 16% increase in the second quarter of 2006, up to $3.7 million.

We saw a 36% increase in EBITDA from the first six months of 2005 at $6 million to the first six months of 2006 of $8.2 million.

EBITDA as a percent of revenue in the first six months of 2005 was 26%.

That grew to 28% of revenue in the first six months of 2006.

A fully diluted share basis, our earnings per share for the second quarter of 2006 was $0.10 a share, this compared to $0.13 for the second quarter of 2005.

And the primary reason for this decline is, of course, the 50% greater shares outstanding that we had due to the offering in March.

Our first six months of 2005, we had $0.25 earnings per diluted share.

The first six months of 2006, that grew $0.02 to $0.27 per diluted share in spite of a 37% increase in total outstanding diluted shares.

These earnings for the first quarter and second quarter of this year reflect a $73,000 expense in each quarter for options that weren't in last years' numbers.

Now let's look at some detail in our segments.

Third party compressor sales in the second quarter of 2005 were $5.2 million that grew 10% in the second quarter of 2006 to $5.7 million.

We also sold $2.7 million worth of rental equipment to a very good customer in the second quarter of this year and though that number is not included in the sales figure that I just mentioned, although they are in the financials.

The first quarter of 2006, our compressor sales were $6.4 million, compared to $5.7 million in this recent second quarter.

We saw this revenue drop from the first quarter to the second quarter, but the quarterly average revenue for third party compressor sales this year is averaging $5.8 million, compared to the average last year of $5.7 million, so it's an improvement there.

Gross margin for our total of sales in the second quarter of 2006 was 13%, versus our very high 28% in the first quarter of this year and 25% in the year ago quarter.

If you recall last quarter, when we talked about the extraordinarily high 28% margin that was due to the preponderance of large horsepower, higher margin units going through the shop.

I was asked if that was expected to continue that high in the future and I had noted that I expected us to get back to the average we're used to, which is in the lower 20% range.

This quarter the opposite happened.

A predominate mix of small lower margin horsepower units were delivered.

We also incurred a little higher level of contract layer of expertise on these units to stay ahead of our backlog and this all combined to deliver the lower margins we saw in the second quarter of this year.

Year to date 2006 is, however, at 20% gross margin in this business.

This is right in line with our historical average and expectations.

I also want to point out that our margins continue to be some of the highest in the industry and they quote-on-quote normal quotas for industry are in the 10 to 12% range.

Going forward we have seen margins improve in July and as we've examined the second quarter we have decided to challenge typical assumptions on margins where small horsepower is typically lower margins, large horsepower is typically more.

We've already started to analyze and go back to customers in our backlog for some price increases to try and reduce the margin differential between smaller units and larger units and try to get away from the variability -- try to reduce some the variability we see in this business.

As I've mentioned in the past and I'll [insize] again because we have seen the exaggerated effect this quarter, this is a business that fluctuates quarter to quarter, due to the mix and the equipment going through the shop, the different sizes, the margins and the time it takes to build the individual equipment.

This is not a business that can be evaluated on quarter-to-quarter basis but more so on yearly trends.

The backlog at our NGS subsidiary in Tulsa where the majority of our third party sales take place continues strong and totals over $24 million booked out until May of next year.

On the compressor rental side, rentals continue to grow at a very aggressive rate.

The second quarter of 2006, our rental revenue is $5.6 million compared to the second quarter of 2005 of $3.9 million, a 44% increase.

The first six months of 2006, revenues were $10.9 million compared to $7.3 million in the first six months of 2005, which is a 49% increase.

The second quarter of 2006 had 5.6 million, as I mentioned, compared to the first quarter of 2006 of 5.3 million, this is a 7% quarter to quarter increase.

But the adjusted monthly rental revenue for the aforementioned sale of rental equipment we would have shown about a 9% quarter to quarter increase, right on track with our announced goal of 30 to 40% annual growth in rentals.

Our rental gross margin stayed solid at 61% for the quarter, compared to 60% in the year ago quarter and 61% for the last quarter.

We added 55 compressor units to our rental fleet in the first quarter this year and 101 units in the second quarter this year.

We have built 156 units for the rental fleet through June of 2006 with a net addition after accounting for the sale I mentioned, with 126 units.

This puts us solidly in the range of our predicted 30 to 40% annual rental growth.

And as you can see from the aggressive schedule in Q2 this continued to build through the year.

In fact, we celebrated the addition of our 1000 rental fleet unit this quarter.

We have previously stated that one of strategies is to increase our high margin rental revenue to a larger percentage component of our total revenue and we continue to see progress in that respect.

The second quarter of 2005 rental revenue was 32% of total, second quarter of 2006 adjusted for the sold rental units was roughly 42% of revenue, so good progress in that respect.

As I mentioned in prior calls, our service and maintenance business, where we perform maintenance on customers owned equipment is intentionally being de-emphasized.

This business is only about 2% of our total revenue this year versus about 5% last year and we are de-prioritizing it for three primary reasons.

We want to use our skilled people to support our rental growth versus work on non-owned equipment.

This business carries a lower margin then rentals and there's very little opportunity to differentiate in this business, which is essentially a [time] and mallets based business line.

We continue to see increasing costs, mainly related to labor, fuel and lubricants in our operations and goods and materials cost in our products.

We mitigated those increases in our sales product or pricing them into each job.

And as I mentioned we're doing an additional review on this with the smaller units.

For our compressor rentals, we have implemented two price increases this year.

We had a rate sheet increase effective January 1, 2006, which averaged a little over 6%, and this is for all new rental units going out on a contract.

We also implemented operating expense contract rate increase of 7%, which is effective August 1 of this year.

This will cover our operating expense increases we see through the year.

So throughout the year, we essentially did a vast majority of our fleet covered with rate increases.

The second quarter of 2006 was a successful quarter and summarizing a top line growth is vigorous, our rental margins are strong, our sales margins are averaging 20% year to date, our backlog is steady and our fleet growth continues at a pace with expectations.

Overall, our year to date results are right on target.

As you know we moved into the Rocky Mountain area last year and I am in Denver this week attending a Rocky Mountain Natural Gas Strategy conference to meet with numerous institutional investors and customers.

The general level of confidence from producers, our customers continues and we at NGS still see the market staying active and NGS participating and competing vigorously.

In fact it was predicted that producers will drill about 43,000 new wells over the next five years here in the Rocky Mountains, led by drilling in the [Uiant] and Permiam Basins which are the exact areas we moved into last year.

I've been pleasantly surprised that our top line growth has weathered the uneven price environment we have seen this year and I'm confident that we will continue to see good growth the rest of the year.

We are, after all, now headed into fall and winter.

Before I close, I want to make that I acknowledge all of our employees.

Good times are nice but there's a lot of hard work and time away from home when it's this busy.

I sincerely appreciate everyone's efforts.

That's the end of my prepared remarks and I will now open the lines for anyone that might have any questions.

Thank you.

Nate, you can go ahead and open them up.

[OPERATORS INSTRUCTIONS].

We are now ready to begin.

Our first question comes from Neil Daneman with Pritchard Capital, please state your question.

Morning Steve.

Say, maybe just look at each of the segments separately.

First, on the rental side and you spelled this out pretty well as far as what is again the total compressors that you're at right now?

At the end of the second quarter, I think the fleet count was officially 990 and that's due to the -- we sold those 30 units during the quarter.

Okay.

What was the rest -- and did that make more sense to sell those at the time versus continue to lease or that was already agreed?

Well our preference is to rent, but this is a very good customer.

They have some specific requirements that they wanted us to address and you get some competitive situations on this so we chose to go ahead and do that.

We thought it's, overall it was the best for route to take.

Okay, then as far as you had mentioned short of going forward for the rest of this year, you're still on track at 30 to 40 %.

I mean are you still contracting for the third party out or do you have enough at SCI in Tulsa to get to that level or what is your thought there?

We've outsourced some of the stuff up to this point in the year, we've still got some going like that, but it looks like we've changed some of our manufacturing to a batch-type manufacturing of which if you saw the growth and just how many compressor units we've put out Q2 versus Q1.

You can obviously see that that was the move we planned and a good move to make because we had a lot of questions the first quarter, "well of 55 units how do you get to that 30 to 40% growth" and we were looking at changing this method, so we obviously went from I think 55, 57 units in Q1 to 101 units in Q2.

So, that would get those out pretty quick some of that was that outsourcing, but not the vast majority.

Yes, we are very confident that we are going to be right there in what we predicted.

And could that growth even pick up more now that you've changed the fab process and some of this other.

I mean is that going to add to, I mean, can we look for even higher growth next year or what is that new process going to do?

I think that the rest of the year, Q3 is going to be a very active quarter.

We are actually trailing off a bit in Q4 from a count standpoint and some of that gets involved into the normal yearend stuff, the holidays and everything else.

We've got the ability to, with our outsources, to go up and down to some degree and that's been the intent of trying to outsource some of this to get some peak shaving and peak loading.

From a next year perspective, I feel like the 30 to 40% growth equates to about 250 to 350 units.

I feel like that's a good solid range we'll probably be looking at going forward.

If the market picks up even more, we've always got outsources to add to it or some other things we might be able to do.

But, I think we're probably about in the sweet spot of the unit count additions we'll see in the near future.

Okay.

Then sticking with that same segment, the price increase seemed to be even higher than I was suspecting and especially when one of you competitors mentioned that they put a price increase in April and that would probably be their last.

What are you seeing as far as the acceptance of this latest and kind of what do you see for the rest of this year on pricing?

Well, the increase we had at the first of the year, no problem.

This one, we just put it in so there hadn't really been a full effect at this point.

I don't think, we haven't heard of a lot of push back from customers, but again, it's been fairly recent that it's happened.

Going forward, I think we're, it's going to depend pretty closely on what costs do.

I know operators seeing cost increases.

We are seeing cost increases from an operating perspective and a cost of goods perspective.

So, as long as we have those, we are going to have to try to get those in there.

I think if anything we might see, in the past we've been able to add some of that increase to some of our rental margins.

It is hard to say what'll go on in the future.

If anything that might, we might just be getting price increases just to fully cover our costs and just be happy with that.

Okay, and then lastly on the sales side, you mentioned obviously lumping this in the business and your expectations for margins to get back to that 20% range.

Is it, you'll designate a certain amount going forward, I mean as far as sort of to look at or sort of forecast a top line rate?

Is there something that you are comfortable with as far as the amount of compressors coming out of that shop that you'll just continue to gear toward sales?

Well, let's see, our year-to-date sales are running around, what are we, about $17 to17.6 million we that that about the$3 million that we sold.

We are running 14,15 million half-year.

I think that we know what the backlog looks like.

I think you can pretty well just double that and we'll be in that 30 to 32 million range something like that on our total sales revenue piece.

Our strategy on the sales is to just keep it growing but certainly at a more moderate rate than the rental business because that is where we are really trying to focus.

So, I think we'll be -- we'll see a general trend up, but nothing in the double digits like we're seeing with the rental, I should say the 30,40% rates.

I think we are getting into the double digits on the sales growth certainly.

It's a balance we're trying to do.

We've tried to get some rental units through Tulsa and that business [expands] so vigorous that we're shifting them more to an outsourcing situation.

I think the top line -- the business looks good going forward, we're still getting orders and producers are confident.

So, I don't really see any deterioration in that respect.

And you are confident in the margins returning just based on the mix of those sales going forward?

We, this has been a very unusual situation these first two quarters.

As you know the 28% in Q1 was just stratospheric in this business and then we've made up for it this quarter due to a pretty wild shift in mix.

That's why I mentioned we're really going back and looking at these smaller units from the accepted wisdom, I guess, of those being lower margin.

We need to try to get those margins up on those.

In the past, we've had a good mix going through the shop.

We don't control that mixture it is dictated solely by the customer and what they're trying to do and the units they want out.

So, and that made sense in the first quarter trying to get bigger units out with bigger volumes.

So since we don't control that mix, what we're trying to do is work on something we can control.

And as I mentioned we've already gone back to some customers in the backlog to get some price increases on some of these smaller units to get these margins up.

But, we've mentioned the lumpiness in this business we've seen it very vividly in both quarters this year and we are just trying going back and do what we can to control the piece that we can from the margin standpoint.

And then we will still be at the whim of the customer, but I'm -- I think we'll be in the same historical range we've always been, which is the low 20% margin for that business this year.

Okay, keep up the good work, Steve.

Our next question comes from Sean Voight with Westcliff Capital Management.

Please state your question.

Just a couple of clarifications here, it showed the number of compressors at the end of the quarter was 990?

Right.

Okay, and that's because you sold 31 units to a particular customer?

Yes, 30 in that quarter.

Okay, and I know you said it was a difficult customer.

Could you just give me a little bit more color on that and how those situations come about?

I said what, difficult?

I didn't hear what you said.

I'm just curious -- I understand you have a difficult customer but given the economics are so much better for you on the rental side, can you just tell me a little bit how that comes about?

Okay.

Well, it wasn't a difficult customer.

It was -- our preference obviously is to rent, which again, these situations where some customers getting into some areas where their economics dictate less rental and more of a purchase.

You might get into some areas where they've proven up and they see a long term need there.

So, the choice we have is either, the customer's going to buy and we insist on renting that equipment, we'll get that equipment back and we could potentially do something else with it or we can go ahead and price that to go ahead and put that in place.

We decided to go ahead and sell it.

Number one's to get a customer who wants to stay in there from a market share standpoint with them.

Number two, the other thing we looked at was will we be able to replace those sold units as we're building up the rental fleet because that is our primary goal, and as you can see on the built schedule in Q2, we more than replaced those on there.

So, again, we don't -- we -- our customers know we like to rent and that's our preferred method, but again we have to have some serious discussions with them on some of their situations that don't quite match ours and it's a decision that I think in the longer term is best for us to stand there with a very good customer in that respect, but it does have a little effect on us.

But it's a short term, like I say, we've built up around it and we'll be okay with it.

And do you see any more of these coming on the radar screen for the back half of the year right now?

Or do these just pop up pretty quick?

No, no, no.

Like I said, they're our friends and we have to do business.

Right.

So, we pushed back quite a bit but sometimes we --

And I assume so and I think as you referred there in terms of where your schedule was and you're constantly looking at what your saying 30% to 40% growth in the fleet and at the end of the day on this one, your viewpoint was, you don't like it but you can give it up and still hit your target on this full fleet growth.

Right.

Okay.

Moving on, you talked about a 9% quarter-to-quarter increase on the rental sides for the pro forma for the adjustment.

So, I didn't understand that that adjustment is that if these hadn't been sold?

Right.

If we just continue with the rental revenue?

Yes.

That's where the adjustment is.

Without the adjustments is a 7% --

Right.

-- so we'll gain a couple of points or lost a couple of points actually by selling.

Okay, I get it.

The gross margins on the -- just an over/under, I guess I was just amazed by the magnitude here of this swing so could you just tell us what these low horsepower units go for?

What kind of a gross margin you see on these things prior before you had the price increases and then maybe after the price increases as these go through?

Yes, what, again, and the swing was pretty wild again as we mentioned, 28% in the first quarter, 13% this quarter, and that's about where you ended up on some of these smaller units.

We can get up to, and these are the extremes, we can get up to a 2 to 1 difference in margin on these.

And that's primarily from a point of larger units when a producer's sitting there evaluating economics on this.

Large units put a lot more gas in the line and they're less price sensitive in that area.

Smaller units are a little more competitive.

You get into areas where a lot of little guys are putting stuff out and it's just a smaller unit carries typically a smaller margin.

So, we're into a margin and the smaller units of -- it can vary from say 10% to 15% and the larger units go onto a 20% to 30% and some of them might even be higher.

So, and that's a typical thing and in the past, the mix has taken care of itself.

My concern now is the mix didn't take care of itself, obviously.

Now year-to-date it did.

Right.

But we get these, as I mentioned many times, we get a very lumpy -- this is a very lumpy business.

Right.

And that's exactly what we're seeing.

So, what we are trying to do is go back and really -- we're going to try and change our paradigm and maybe our customer's paradigm a bit on how these margins ought to go and really try to get these small ones up.

Alright.

As you were -- your thought process here in just a little bit longer term just to cap the question off that if you can kind of -- the gross margins were as high as 29% on sales in 2004 and they've come down 33% in 2005 and then now 20% at this point.

Are we just trying to maintain this low gross margin, excuse me, low 20s gross margin on this side of the business or do you see it actually turning at all and giving us a little more, maybe out in 2007?

I think we're going to -- we're not really trying to maintain a low margin.

If we get 30% margins, we'll probably do that or would do that.

I'm sure.

But before, where we get is, again as I've mentioned, we're at about twice industry margins right now.

We're pretty fully priced on this and as we really saw a ramp up on backlog last year, that was with everybody.

I think we had some -- a little more pricing power last year.

Backlogs have not declined but they've gotten to a static point so we're staying static on these backlogs.

So, it's become just a, probably, a little less hectic from a sales backlog standpoint.

And that has a little marginal effect on the margins you can go in there and get.

So, and I think it's probably been a little, the gas price environment first half always has everybody watching, so I think we've done a very good job in maintaining quite high margins relative to where we've been the last year or two.

They are down some but I think that's a function of just the fringe in the market has subsided at some point.

It's still a good market but I would call it a little less of a rabbit now.

Okay.

And just last thing on the rental side of the business.

Those margins are solid at 61% and not at all trying to split hairs, but is that, again, you were at low 70s and two years back and you can't start to see that creep up here or is that pretty much going to be--

I think we're pretty well going to do that.

The reason we were the low 70s and that's been over a year ago, a year or two ago.

Number one, the fleet was very young then, it's probably average age of the fleet and we got probably the youngest fleet in the industry.

Average age back then was probably less then three years, just about.

Now what happens at three years is you start getting into overhauls, maintenance starts climbing and things like this.

These are normal and expected but what it does is put pressure on those margins from your repair and maintenance.

Your first three years, you have very little trouble, it's almost like your car warranty sort of thing.

The equipments new, overhauls aren't hitting you, things like this.

So now we're into the more of the normal repair and maintenance cycle to where we're going to see those margins, I think pretty well stay in there.

And they've been solid in that low 60% range for, well we averaged 61% last year and that's about where we are this year, so a year and half we've been there.

So we expect those to stay right in there, I think.

We've also had, we've been doing expansion in Appalachian/Rocky Mountains those we don't have a fully recovered effect from a revenue base in those areas too.

So those are the mains things that we didn't have a couple of years ago when you saw those high margins there that we're seeing now.

And these are, really what you see now is more of a normal business versus what you saw as a say some new business working prior.

Got it, okay.

I appreciate that color.

Just one other thing, we're kind of half way through the quarter at this point, any chance that you can tell us what that number is of compression from the rental fleet is?

Oh shoot, that's probably the number I don't have.

I think I was reviewing that last night.

I'm going to tell you all not hold this to me and of course I'm going to tell everybody.

I think our Q3 -- we built a 101 in Q2, I think our Q3 is slated to be just a tad bit higher than that.

So I'll let you pro rate that a bit.

Okay, good enough.

Thank you Steve.

[OPERATORS INSTRUCTIONS] Our next question comes from Mike Drickamer from Morgan Keegan, please state your question.

Hey good morning Steve.

My question has been asked at this point, I think.

Let me follow-up on a couple of things though.

Trying to get to what your average number of compressors were in the second quarter in the rental fleet, what was the timing of those sales of those 30 compressors?

Was it early in the quarter or later in the quarter?

No it was ten a month.

Ten a month.

Yes, again we talked about not wanting to do it, so we stretched in out so we'd have less of a monthly impact.

Would it be fair to assume that since you didn't want to do it, you charged a pretty good price and therefore had a pretty good hefty profit on those?

Yes we didn't give them away.

And also we've got, let's see, I think, July and August, we'll have ten more and that's it.

Ten more each month, it's another 20 in this third quarter.

All right so when looking at the third quarter, I need to add slightly more then 101 and 990 at the end of the quarter but then subtract out 20 sales, correct?

Right, the upper net.

I apologize if I missed this, but where on the P&L statements did the sale of those compressors flow through.

Did the what?

Where in the P&L did the sale of those compressors flow through.

It's with the total sales number.

Okay, so total proceeds went into the sales number then I guess in the cost number was perhaps your book value on those compressors?

Right.

If it's in total sales and it's 2.7 million and it's a pretty sizeable chunk of the total sales revenues, roughly 1/3 or so.

I imagine it could have had a pretty hefty impact on the margin that we saw that, do you know what the impact on the margins for the sales business was?

Especially if you didn't give them away but we saw a big decrease in the sales margin anyway.

Right.

No I don't have that number right here on what we made on that.

It was about 1/3 of that total sales going through there.

I apologize I'm not sure what that bottom line effect was.

Well do you believe that you've had greater then a 10% margin on the sales or 12% margin on the sales of those compressors then?

What we would have done was sold those at a current market value.

Those units weren't that old so there wasn't a whole lot of -- we didn't have a very low book value on it.

I think those units were probably one or two years old on a 15-year life.

So there wasn't a whole lot of depreciation applied against it.

So we might have just been into the 10 to 15% range on those actually when we sit back there and look at it based on the book value.

Okay so that's in addition to maybe some of the smaller horsepower compressors that may have been another issue that negatively impacted the margin in the second quarter?

Right.

Yes it would have reinforced the low margin.

All right so if I look at the third quarter then, and you've got another 20, then the third quarters margins probably going to be something on this lower end also, correct?

Well I'm hoping we can counteract any effect from that with some of this price and review we're doing on these small units try to get some of that margin up.

So I really expect us in the year from the sales business in that low 20% margin area still.

Again even with this variable second quarter, we're right there year to date and I think we'll see 20 more units, which is less then the 30 we saw this quarter but also we're seeing a continual ramp up in the rental side.

And I think we'll have a little better margin just overall on the sales side.

So we'll have some of the effect in there but I'm expecting to mitigate that with some price increases on the sales area.

Okay, so maybe in the third quarter it will be something less then 20%, the fourth quarter maybe something slightly above 20%, averaging out around 20% for the back half of the year?

That's fair enough because I think again we're 20% half way through.

I'd expect in about that same point so, again I can't guarantee against variability in that business and we'll have some variability starting from our revenue standpoint and the mix standpoint and the margin standpoint.

But again our efforts going forward the last half of this year are to get those margins up on the small units we do have going through.

So I think we will be low 20s on the sell business that we have been and we're just going to have to use this 20 sell situation that we know is happening and balance that with some higher marginally smaller units.

Okay.

Steve I think that's all I got.

Thanks a lot.

Our next question comes from Zane Gurley a private investor, please state your question.

Okay, Steve I came a little bit late.

I hope that I don't ask a question that's already been asked, so just tell me.

I think all of your questions have been answered, Zane.

But go ahead.

Okay I got two questions.

Can you give me an idea how much horsepower is in the yard right now versus where it was in the first quarter or last year, just sort of --and what your utilization rate is on your lease fleet right now?

Yes our utilization historically has run 93, 94, 95% but we're in the second quarter this year we averaged 91%.

It's down 2 or 3 points overall.

And that's a function of what I mentioned before, the change in manufacturing process we've put into place second quarter.

So with this what we did was go to a batch type process versus more of a sequential or varied mix process.

And what that means is we started building batches of certain size units so we might build 10 of a GS10 model and then ten of a GS24 model.

What that does is enables us to get a crew on those, build the same ones in a cookie cutter approach, you can see the effect was we were able to get many more units out.

We expect also to get some cost efficiencies in those units.

But what we do suffer with is a little more -- a little loss utilization initially because what happens is as ten come out of that certain size, ten don't go out right away.

And where you had a variable mix you had a more of a likelihood of those going out to various places, various sizes in those areas.

We think that once we get this batch going and we have a good mix out there that utilization will start to average back up a bit.

But I tell you what, a low 90% utilization is not a bad area because we haven't had any work inventory in the past.

Okay, so if I was to drive by the yard, which I haven't for a long time, I'd see more units out there then I would have a year ago?

Well and also that's a function of just more units in the fleet.

Yes, okay.

Well thank you.

Okay, appreciate it.

Our next question comes from Daniel [Pelicano] with ItradeDirect, please state your question.

It was already answered guys, but one quick question.

Can you comment on your cash position right now and if you any plan of any sort of buy back?

That's all I have left.

Okay, thanks Daniel.

Of course cash position is very high and very strong now due to the offering in March.

We don't have any plans of a buy back and I get asked that question fairly often.

Primarily because we've got what we think is a lot better opportunity to invest that cash directly into rental and compression equipment.

We're drawing down that cash at about $1.5 million a month, so we're using it, we think that will help fund in addition to our internally generated cash flow, our capital partners for a couple of years.

My concern would be, and certainly buy-backs make sense in some respect, but the way our business is growing at the vigorous rate it's growing, we could go spend that cash on buying back some stock and then at some point sooner down the road, we'd need that cash back so we're either in the position of well, what are we to do, go sell some more stock and just trade back and forth or go borrow from the bank or whatever.

So, we're going to be -- we're burning through that cash at a pretty good rate and it just doesn't seem to be worth the exercise and maybe the market noise to buy back, sell back, re-borrow, things like that on cash that we know we're going to need fairly quickly in the short term and that we can -- that we are putting to good use in rental fleet.

[OPERATOR INSTRUCTIONS] Our next question comes from William Hughes with Natural Gas Services.

Please state your question.

There was an article in the Wall Street Journal yesterday about natural gas and one of the points that it makes is that a lot of companies like some of our customers, Devon and XTO, are undervalued, their stock prices are undervalued, but that a case for sustainable, natural gas prices is getting stronger and that it bodes well for the future for companies that are either looking for gas or somehow or another involved in the gas business.

I was wondering if you could take a minute or two and talk to -- put Natural Gas Services, put our company in the context of that for the long term?

Yes, good question.

And I'll introduce Frank to everybody in the audience.

Frank is one of our directors.

He's been a director for quite a while and so he's not a planted shield.

It's a valid question.

And that's a good point.

It's been a very interesting first half of the year from a gas pricing standpoint and the gas storage standpoint.

We saw starting the year end up with peaks of $14.00 in MCS and I stress peaks, because we hit that for one day but that seems to stick in everybody's mind and then we see the reports that gas price is down, CP 70%, and everything's going to hell.

And that's actually not the case and you can see that from our activity.

We saw gas storage at higher than historical levels, 50% above 5 year averages, I think we printed down now to about 30% to 35% of the 5 year averages, but what we're looking at really is a change in the structural use of gas in this country.

Storage is an important thing.

We have to watch that but it doesn't have near the effect it did years ago and where we were and I'm talking about years ago when actually supply exceeded demand.

We don't have that anymore.

We are burning more than we're finding.

We're importing the balance and those imports are going down from Canada, etcetera.

I think we saw, it was very interesting to me, in the first half of the year, as the gas price started going down and down and down, and I'm talking about an NYMEX price, and we got down to about $5.50 or so, right in that range, and even those stored reports stayed fairly bearish.

We kind of settled in at that price and we started getting a little bump and I looked this morning -- when you look at those slot prices and NYMAX prices, they're -- get pretty frustrating.

It's all over the board but we're $7.00 or $8.00 now depending on what time of day you're talking about yesterday.

And I think we have hit a point to where, due to the supply/demand situation, due to the growth that we're seeing, due to the infrastructural requirements of power generating plants being fired by gas, there's just a much higher base level need for natural gas in this country.

And that's not going to get any lower and you can see this and -- as gas prices going up the first half of the year, gas recount kept going up.

That would normally, you'd think that's an anomaly but I think it's just like we've seen a lot of our producers say.

We see the price going down.

This is a long term capital business.

We're going to drill right through this.

We think it's a temporary aberration and I think that's been proven out.

You can see it in our numbers.

Our top line growth is very good.

We've had this variation, in sales business on the margins but it's not an unexpected variation.

It's one that I predicted all along.

So, the main thing I would stress here is exactly like you're alluding to, Frank, that the price and environment has changed over the past decade.

The producers see that, we're seeing it from our business and I've talked to customers and again, up here at this conference, the presentations I've seen.

I mentioned the 44,000 more wells in the next 5 years.

That's a lot -- and those are gas wells.

A lot of gas coming on and the Rockies are getting the forefront of it.

So, we're just not seeing any let up in it.

Our backlog's still good.

Now, that's not say I've been in this business long enough, that's not to say that it's forever rosy.

I think the long term trend is up but those trends have jagged points to them and we'll see those, but again, I want to stress to everybody that this is a long term capital business.

You look at our business on a year-to-year basis and it's doing very good.

So, I think you're right and I think it's proven by our numbers and just general industry numbers and producers numbers that it's a good business to be in.

It's been very good the last two or three years.

I think it's going to be good going forward.

Part two of this question, there was another reference to a new shale area called the Big Empty in West Texas.

Do you know anything about that?

The Big Empty, huh?

That's what they called it.

The wildcatters are in a land grab out there.

I actually haven't heard that name, although there is more gas activity out there and it's kind of surprising because the Permiam's been known for decades as a big oil field.

And it is, but there's also been recent announcements of pipelines being built out of the Permiam going over to -- interconnections and other populated areas.

So, that's actually been kind of surprising.

We've seen some pick up in our business in the Permiam Basin.

We probably, just roughly, I don't have those numbers right here, probably doubled the number of compressors we've put out around Midland just on a year-to-year basis.

So, again, I haven't heard that number that's, or that name, I don't know if that's a good name or not but we are seeing good activity there.

There's -- NGS is not limited by opportunity.

We are limited by how we prioritize and get us some of those opportunities.

As I mentioned, theirs have moved into Appalachian and the Rockies.

Those are looking good.

There's many other areas, the Fayetteville Shale is a big area.

People are talking about coming on.

We're still busy in the Barnett.

The Barnett's getting even bigger, it seems like.

So, still a lot of things out there and you're right, and it's pretty interesting because it's been an oil producer.

Thank you, Steve.

At this time we have no further audio questions.

Steve, you want to wrap it up?

Yes.

Why, I certainly appreciate everybody calling in today.

I thank -- I appreciate your continued interest in the Company and I think we've had a good half a year.

We look forward to an even better second half.

So, thank you.

This concludes today's conference call.

Thank you for attending.