Natural Gas Services Group Inc (NGS) 2006 Q3 法說會逐字稿

Good morning, ladies and gentlemen and welcome to the Natural Gas Services Group's Third Quarter and Nine Months 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.

Good morning, ladies and gentlemen.

It is my pleasure to read the forward-looking statement.

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 risk 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 statements included in this conference call are only made as of this date of the call and Natural Gas Services undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances.

Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include, but are not limited to, factors described in our November 8, 2006 press release and under the caption "Risk Factors" in the Company's end report on Form 10-K filed with the Securities and Exchange Commission.

With that completed, I would now like to turn this call over to Steve Taylor, President and CEO.

Steve?

Thanks, Jim.

Good morning and thank everyone for joining me for Natural Gas Services Group's Third Quarter and Nine Month 2006 Earnings Review.

If you read our earnings announcement yesterday you saw we had a very strong quarter, the strongest of this year, in fact.

And this is in spite of the relatively weak natural gas pricing environment and natural gas storage level we saw throughout the year.

We experienced double-digit growth in all material financial metrics.

For the comparative quarters we had a 37% increase in total revenue, a 117% increase in net income and a 37% in diluted earnings per share.

Those are the highlights but I'll start with a general overview of the quarter and year-to-date results and then go into some segment details.

Looking at our total revenue and comparing the third quarter of '05 to the third quarter of '06, total revenues were up 37% from $12.5 million to $17.1 million.

On the comparative nine month periods, total revenues rose 30% from $35.5 million in the first nine months of '05 to $46.2 million in the first nine months of this year.

Sequentially, our second quarter '06 total revenue was $15.5 million.

It went up to $17.1 million in this current quarter, a 10% quarterly increase.

Our nine month 2006 revenue is already at 94% of our full year 2005 total revenue so it's apparent we're still experiencing the continuation of a very strong market and, of course, supply and demand for our services.

Our total gross margins grew 37% when we look at third quarter of '06 versus the third quarter of '05.

They grew from $4.6 million to $6.3 million.

Looking at the comparative nine month periods, we went from $12.9 million in the first nine months of 2005 to $16.6 million in the first nine months of this year which was a year-over-year 29% increase.

Our total gross margin as a percent of revenue for the Company was consistent for both quarterly and nine month comparative periods at 37%.

Last year, we had a strong margin quarter in our service and maintenance business.

This year our core rental business has provided that lift.

Our sales, general and administrative expenses are well under control; the third quarter of '05 they were $1.3 million, they actually decreased the third quarter of '06 to $1.2 million, a 7% decrease.

For the nine month periods they rose from $3.6 million to $3.8 million, a 6% increase.

Now as a percent of revenue and look at the nine month periods, SG&A was running 10% of revenue in 2005 and declined to 8% of revenue the first nine months of this year.

We're in the final quarter of estimating our stocks requirements and our costs in the current third quarter of '06 were a little over $60,000.

We anticipate those to triple in the fourth quarter of this year as we head towards an end of the year deadline to be about $180,000 as anticipated in this fourth quarter.

So totally we're looking at about a $0.02 hit this year just for initial compliance from the SOX regulations.

Looking at our net income after tax, it would be third quarter of '05 is $1.1 million; third quarter of '06, $2.4 million for a 117% increase.

For the comparative nine month periods net income after tax rose from $3.1 million up to $5.3 million, a 72% increase.

In a sequential quarterly basis, net income after tax doubled from $1.2 million to $2.4 million this quarter.

Our net income for the nine months of '06 are already 119% higher than the full year of 2005.

Now looking at EBITDA measures which is earnings before interest, taxes, depreciation and amortization, it rose from $3.4 million in the third quarter of '05 to $5.6 million in the third quarter of '06, a 66% increase.

And for the comparative nine month periods, rose from $9.4 million to $13.8 million, a 47% increase.

EBITDA as a percent of revenue in the first nine months of '05 was running about 26%; the first nine months of this year is running 30% and we hit a record 33% of revenue in this current quarter.

Looking at fully diluted earnings per share, they were $0.20 this quarter compared to $0.12 in the third quarter of '05 or a 67% increase.

And this is despite a 37% increase in the number of diluted shares outstanding.

For the nine month periods we are running at $0.47 this year compared to the nine months of 2005 which was $0.37, so a 27% increase, again against the 37% increase in diluted shares.

Our earnings for the nine months in 2006 reflect a year-to-date expense of over $200,000 of stock options expense that wasn't in last year's number so, again, another $0.02 per diluted share that we have experienced from expense for stock options this year.

Our balance sheet continues to be very strong.

We put out an announcement a couple weeks ago and just -- renegotiate our bank lines.

We combined three term loans into one.

We went from a variable prime rate to a fixed 7-1/2% interest rate.

We re-amortized all over 60 months and we increased our line of credit from $2 million/1 year term to $40 million/2 year term at a 7-1/2% fixed rate.

Our cash flow from these bank renegotiations -- our cash flow gain in the first year exceeds $0.5 million and we will save a total of $300,000 interest over the amortized period.

Now looking at our segments which break down to three major areas - sales, compressor sales, compressor rentals and our service and maintenance business.

We'll start with compressor sales or total sales first - our total sales revenue which includes compressor sales, flare sales, parts sales, rebuilds and CiP compressors, grew from $7.5 million in the third quarter of '05 to $10.9 million in this current quarter for a 45% increase.

For the comparable nine month periods it grew from $22.1 million to $28.5 million or a 29% increase.

Now breaking that down a little further into compressor sales alone, not including the revenue from the sale of 20 rental units, revenue increased from $5.7 million in the third quarter of '05 to $7.5 million in the third quarter of '06, a 31% increase.

If we include the $1.5 million revenue from those 20 sold rental units which was the last part of the 50 unit sale I discussed in the last call, compressor sales rose to approximately $9 million which is a 58% increase over comparative third quarters of 2005 versus 2006.

For the comparable nine month periods compressor sales, not including those 20 units increased 17% from $16.8 million in '05 to $19.6 million in '06.

Including those units, our nine month compressor sales for 2006 grew to $23.8 million, a 42% increase.

Now the balance of our sales revenue which are flares, parts, rebuilds and CiP frames fluctuates quarter-to-quarter.

It was $1.8 million in the third quarter of last year; it was $2 million the third quarter of this year.

But on a nine month basis it was $5.4 million last year, $4.7 million this year.

Gross margins in this component runs between 30% to 60% depending on the particular product line we're talking about.

I continue to remind everyone, and I will again, that the sales component of our business is variable on a quarterly basis.

We have different product mixes going through, associated margins, customer dictated schedules and fabricate time all combined to cause some of that unpredictability and, again, our sales component should be looked on a trim basis as opposed to a quarter-to-quarter basis more so.

The backlog on our SCS subsidiary in Tulsa totals approximately $17 million and is booked into May of 2007.

We're making progress in getting our backlog down.

It's currently about 6 months out and I anticipate it ultimately getting to a three to four month time frame.

Customers aren't as "panicked" as they were about ordering equipment, supplier deliveries have improved and the supply chain is in better shape than it was last year.

So the backlog should get to a more manageable load for us.

So in compressor rentals rental revenue continues to grow at a strong rate.

Third quarter this year our rental revenue was $6 million.

Third quarter of last year was $4.4 million for a 27% increase quarter-over-quarter.

For the nine month periods, we went from $11.7 million in 2005 to $16.9 million for the nine months this year, a 44% increase.

Our rental revenue for the nine months of '06 which was $16.9 million already exceeds our full year 2005 rental revenue which was $16.6 million.

Rental gross margins as a percent of revenue in the current quarter grew to 63%.

That's the same level as a year ago but our highest this year where we've been running 61% average first and second quarters.

Our core rental business is still growing at a past pace despite the fact that we didn't totally escape all the effects of lower gas prices.

The San Juan Basin which is a Farmington, New Mexico area historically has the lowest [weighted] gas prices in the nation.

This is primarily due to pop on differentials and the pace of additional rentals did decelerate there especially in our smallest horsepower model but we were able to mitigate that in other geographic areas and just from some generally higher horsepower rentals.

We've already seen the higher level of rentals or the level of rentals in Farmington in the fourth quarter pick up and we certainly expect to finish the year strong overall rental-wise which, again, we show a constant growth through every quarter.

I think this is our 14th straight day -- quarter of growth in rental revenue.

We added 62 compressor units to our rental fleet in the third quarter of this year and have a net addition of 187 to the fleet year-to-date.

Fleet size at the end of September was 1,052 after deducting the sale of the 50 rental units announced last quarter.

And we expect the end of the year within the growth range predicted.

Our average utilization for the year is down a bit to the 89% to 90% range.

This is less than we typically run due to two primary reasons.

One, as I mentioned, we saw some softness in the smaller horsepower units mid-year when gas prices hit their low primarily in the San Juan Basin.

But just as much and maybe even a little more of an influence was the batch manufacturing process I mentioned we went to last call in the second quarter.

We went to that to improve our fabrication through-put and control the unit costs and instead of pulling back from what we thought was a temporary stall in some of the smaller horsepower units, we held steady confident that that demand would resume.

It has and we expect average utilization to be back above 90% by year-end.

Our service and maintenance business, as I stated before, this is being deemphasized.

This is where we perform maintenance of customers' owned equipment.

We won't get completely out of it but we will maintain existing contracts and proactively chase it only when we need revenue support and, say, particularly new areas or where a good customer needs some of our help.

This year this business is running 1% to 2% of revenue at average gross margins of 24%.

From a price increase standpoint we had two increases this year.

We had a rate sheet increase on January 1 of '06 which averaged 6.1% and this is where all of the units built in the rental fleet showed going out on new contracts so that sort of increased and August 1 we implemented an out-of-term contract rate increase of 7% for all existing units in the field.

Our average monthly rental for contracted units has increased 11.3% over the past 12 months.

Our average rental expense per unit has decreased 5% over the same period.

These combined to deliver a 26% increase in gross margin for the average rental unit.

You can see we're able to take a fair amount of these increases to our bottom line.

From a market share perspective, the latest share data available through the gas compressor association is through the second quarter of '06 but we continue to increase our share of installed 0-to-500 horsepower, wellhead rental compression.

As of June '06, we had 11% share compared to 8.6% in June of last year.

This is a 26% market share growth and we have increased our share amount every quarter since the fourth quarter of 2004.

Now just summarizing, our quarterly and year-to-date results are certainly gratifying and we are very pleased with them.

We weathered the high storage and low-price environment and our customers continue to drill and produce natural gas.

And our primary markets, and again, our primary markets are the small to medium horsepower, unconventional wellhead compressor group.

And all market indicators continue to be positive.

I've talked about various indicators in the past primarily related to supply and demand which, by the way, do still hold but I think there's another set we need to look at and relate it to storage levels and its effect on natural gas pricing.

Let me give you a couple things to think about.

Natural gas storage capacity has not grown except for very, very small incremental pieces over the past 20 years.

Conversely, natural gas demand has grown 1% to 2% per annum over the last 20 years.

There was a net storage draw-down in July of this year - the first summer time draw in 12 years.

If you remember we had some warm weather, about 10 days in July, where the air-conditioning load jumped quite dramatically.

And I think the telling statistic is not storage as a level of five year averages but storage as a percentage of consumption.

It was -- storage was running 31% as a percentage of consumption in 2005; it was 40% in 1986.

So historically we're at a fairly low and conservative level in storage.

So I don't think we've been looking at the right statistics related to storage.

I wouldn't pay as much attention to the five year average although I think you have to consider it, but it's natural that we're going to run a higher level when consumption is increased but storage capacity hasn't.

I think, actually, natural gas in the U.S. is experiencing the same phenomena that crude has in the past five years when supply and demand started running a little closer, OPEC was able to be a swing producer, provide the cushion necessary and any market occurrences can spike crude one way or the other as we've seen.

I think we're essentially in the same situation in the U.S. with natural gas; natural gas being a localized commodity, not a global one at this point.

Any movement in storage tends to move these prices.

And I think we're starting to see that going into this winter.

I don't think we're going to have to have an extreme winter to get some good prices this year.

And I think if we do have an extreme one, I think we'll see some price hikes like we saw last year.

Now if you want to look at the five year averages, it's currently only about 10% above the five year average right now but it was 60% above the average about six months ago.

We had a relatively mild summer; the storage still moved back closer to the average over that time.

So short-term storage levels in my opinion don't change underlying facts.

Demand exceeds and will continue to exceed supply and we can't find gas fast enough here in the U.S.

I think there's always going to be some periodic choppiness in some of our markets but our particular business at NGS is dependent upon producing, rather than drilling for natural gas.

As long as producers move gas, and based on what we've seen this year they will, we will continue to provide services in demand.

I think we've seen and demonstrated the momentum and resilience of our particular piece of the business.

Our top line growth is solid, our rental and sales margins are steady and our earnings are showing dramatic growth so we're confident in delivering another record year through the fourth quarter.

Before I close I want to say two more things.

First, for the second year in a row NGS was named to the Forbes list of "200 Best Managed Small Companies in the United States."

We were in the top 100 each year and we're proud of that recognition.

Secondly, but most important, I want to make sure that I recognize all of our employees.

I get to talk about our results but they are the ones that make it happen and I sincerely appreciate everyone's efforts.

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

Let's take some questions.

[OPERATOR INSTRUCTIONS] Our first question comes from Neil [Dingman] from Pritchard Capital.

Please state your question.

Good morning, Steve.

Outstanding quarter.

Thanks, Neil.

Give me an idea as far as capacity.

You touched on this a little bit.

Just sort of wondering, '07 capacity versus '06, incrementally what you think you all can do?

As far as rental fleet?

Probably a little bit of both but mostly, obviously, primarily on the rental side.

Okay.

Well, generally I think I've stated in the past from the sales side we're really looking at -- we're trying to manage that growth at about a 5% or so increase.

We didn't do a very good job of doing that because we're running about 15% to 20% above last year.

So that's sort of a good problem to have and we're not trying to manage that "down" just for arbitrary reasons; we're actually trying to move some other types of equipment through that shop etc., etc.; but, again, a good problem to have.

So I think we'll see probably a 5% growth in that business next year is what we're aiming for.

From the rental side, we outsourced some units this year.

Going, again referring to our batch manufacturing process, that's really been a great thing that our guys have come up with and executed on.

We've really seen some good cost savings there and then some good solid through-put increases.

So I think nominally we can run 300 to 350 rental units through our own facilities before we might have to go to some outsourcer.

I'm not going to -- we're still in kind of the process of looking at what next year looks like so I'm not going to hazard a guess as to how many we might actually projecting to build next year but I don't think it will -- I think whatever we -- we've got that sort of capacity internally.

If there is anything over that we can go to an outsourcer.

If there's anything under that, of course, we can handle it ourselves.

Okay.

And then as far as regionally or more specifically have you added some new customers to the mix?

Is there one region that really appears healthier than others or is it still a pretty diversified mix that you're seeing the growth around?

Well, I think our mix is diversified.

We're continually adding newer people, especially in say the Barnett Shale areas and some of the more existing areas, San Juan and Barnett Shale.

I think we'll -- and that's one of our sales strategies is to diversify that a bit because you typically go into an area with a primary customer, get that built up and then bring in others around that.

So we're making some progress in that.

I don't have the latest numbers on that but I know about six months ago we had actually increased - as revenues were going up, as you know, in the rentals our top 10 customers were growing themselves - but they were also changing in who they are.

So we were getting the growth out of our existing customers plus bringing in other good customers at the same time.

So I think we're going to see continued diversification but then also continued growth from our existing guys.

Okay.

Good.

And then one last question just on the sales margin, obviously you had a nice rebound there and I think the type of orders maybe had something to do, obviously, like you were talking.

Any ideas on kind of going forward what sort of expectations that may be [inaudible] a wide range on sort of, marginally speaking, what you would expect?

Well, I hate to be a broken record but that is such a lumpy business; it gets hard to predict as you've seen in just three quarters this year - an up, a down, an up.

The best we see in this is we run about historically 20% margins.

We were up on that first quarter, down on it second quarter and right around that right now.

So that's what we're going to anticipate going forward and I think we can maintain that a bit.

So I'm going stay with the margins around the 20% range on the sales side and around 60% range on the rental side and if we get a good bumps like we got this quarter that's just so much the better.

Okay.

Perfect.

Thanks a lot.

Keep up the good work.

Okay, Neil.

Thanks.

[OPERATOR INSTRUCTIONS] Our next question comes from Sean Boyd from Westcliffe Capital Management.

Please state your question.

Hi Steve.

How are you?

Good Sean, and you?

Very good.

Nice quarter.

Thanks.

Just a couple things.

You mentioned your guidance for the full year on the fleet still holds, I think -- in the past you talked about up 30% to 40%.

Correct.

So if I kind of work backwards it implies you're bringing on about 116 units net in the fourth quarter.

Is my math in the right zone here?

Well, if you go -- look at the 30% number I think that equates to about I think about 250 or 60 units.

We've -- I think we've added about 180 maybe year-to-date so I think the number is closer to 60 or 70 is what Q4 has got to look like to get to the low end of that range.

Okay.

So at this point it's more likely to see that low end?

What?

At this point it's more likely to see that low end for the year?

Well, we'll make the low end and, yes, I think it's going to trend towards a 30 to 35 probably, primarily because we're not counting the 50 units that we built to replace that sale so if you count those we're probably already there as far as a net build or gross build but just looking at what's net in the fleet, we're going to be close to the low end.

Okay.

And then going on into next year, the question kind of came up already, but you've got capacity for 300 to 350 in-house?

Right.

Okay.

And any new or - not new - but any big sales that we should be thinking about whether it's Q4 or first half of '07 or --?

You mean like the rental --?

Having to sell units out of the rental so --?

No.

And that was an unusual occurrence and I'm not going to say it was a one-time occurrence but it was a big chunk.

We've always sold units here and there to good customers.

We've resisted it more so this year because the rental business was so strong, but what we are going to try to do going forward is this capacity - I mentioned the 300 to 350 - if we get in a situation where maybe we're only building 250 to 300 for the rental fleet but we - just in these just example numbers - maybe have another extra 50 unit capacity we might actually go ahead and project and build that and go ahead and sell those just as -- have it as a sale product, a standard rental unit, versus selling out of the fleet or versus building custom units like we do up in Tulsa.

So we're trying to go from the extreme of not selling any rental units or only doing it on a very rare basis to maybe making that have enough capacity and enough out there that if a customer wants to do that we've got the ability to do it a little better.

Got it.

Understood.

Now the other question is on batch manufacturing processes and we've been over that.

The primary benefit there is really just getting more units out the door as opposed to a kind of additional margin improvement?

Yes.

We're not going to see any margin improvement necessarily from the income statement perspective but where we see the cost improvement is just in the cost of that equipment going out.

What we're able to do is if we build 5 or 10 units of one side at one time, put those crews on there and they really whip those things out and we're trying to get more so into doing that versus crews moving back and forth and -- you learn one thing in fabricating compressor units, the longer they sit on the floor they are cost magnets.

The more costs get tacked onto those things just by the inefficiency of going back and forth so we're getting a couple things.

The through-put goes up and then our average unit cost tends to come down.

Got it.

Okay.

And just the last thing, can you clarify a little bit on the optioned expense?

If you don't mind just run me through those numbers one more time in terms of what you had in the quarter, what you've got coming in Q4?

Okay.

It was 212,000 for the first nine months so - what's that run - 7, 71 or something per quarter?

I think it was -- we've got to expense that this year versus last year.

Going Q4 I expect it to be about the same, maybe a little higher.

I don't think it can be over $80,000 and that's hazarding a real guess because if you've ever looked at those calculations it's --

Right.

-- high depending on the volatility, etc.

So I think we intend to -- we got approval from the shareholders at the annual meeting this year to increase the numbers as often as we have to award to employees and we intend to do that.

So we will see a climbing stock option expense on that, nothing dramatic, but it will be a good steady climb.

Okay.

And to just be clear, like in the third quarter you put out $0.20 in earnings, that includes that 200, roughly -- well, no, not 200.

It would have been --

It would have been 70.

That includes [inaudible].

Yes.

But the full year is 200,000 which - right - that's expense so that our year-to-date numbers are net of that expense which, of course, we didn't have last year.

Understood.

Okay.

Thanks, Steve.

Okay.

[OPERATOR INSTRUCTIONS].

At this time there are no further questions.

Steve, do you want to close it off?

Sure.

Well I appreciate everybody joining us.

Hopefully the numbers look good to everyone as good as they look to us and we look forward to an active and successful fourth quarter.

Thanks.

Thank you very much.