Natural Gas Services Group Inc (NGS) 2007 Q2 法說會逐字稿

Welcome to the Natural Gas Services Group conference call.

At this time, all participants are in a listen-only mode.

(OPERATOR INSTRUCTIONS).

Your 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 is my pleasure to read the forward-looking statement before we begin so except for historical information contained here in the statements in this conference call are forward-looking and made pursuant to the Safe Harbor provision as outlined by 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's actual results in future periods to differ materially from forecasted results.

Those risks include among other things 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's 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 expected are reflected in the forward-looking statements included but are not limited to factors described in our August 7, 2007, 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 I would like to turn the call over to Steve Taylor, Steve, it's all yours.

Okay.

Thanks, Jim.

Good morning and thanks everyone for joining me in Natural Gas Services Group's second quarter and six months 2007 earnings review.

As noted in our earnings release this morning we again reported excellent earnings this quarter and year-to-date and continue to experience double-digit growth in all materiality financial measures.

The highlights for the comparative second quarter of 2006 versus 2007 show that diluted earnings per share were up 120%.

Net income was up 119%.

EBITDA or earnings before interest, taxes, depreciation and amortization was up 70%.

On a total revenue gain of 14%.

For the six months year-to-date diluted earnings per share were up 65%.

Net income, up 83%.

EBITDA, 54%.

And total revenue, up 18%.

Now as I dissect these numbers a bit and look at total revenue first comparing the second quarter '07 to second quarter '06 total revenues were up 14% from $15.5 million to $17.6 million.

At first glance it appears to be a slower pace of year over year revenue growth but if you recall we had an extraordinary sale of rental equipment in the second quarter last year to a particular customer that totaled $2.7 million that wasn't repeated this quarter.

Taking that one time revenue gain out of the comparison results in a comparative quarterly revenue growth rate of 38%.

From $12.8 million to $17.6 million.

Sequentially total revenues rose 5.5% from the first quarter of this year to the second quarter from $16.7 million up to $17.6 million.

The first question half of the year total revenues were up 18% when you compare the six months of 2007 to the six months of 2006 which again would be a 30% increase in last year's rental equipment sales aren't included.

Total gross margins looking at them and comparing the second quarter of 2007 to the second quarter of 2006, gross margin grew to $7.2 million which is 41% of revenue.

Up from $4.7 million or 30% of revenue last year, a 55% increase in gross margin.

Sequentially gross margin increased from $7.1 million to $7.2 million.

This slight growth in gross margin dollars quarter to quarter is a result of a bit lower gross margin in the rental business during the quarter.

I will touch on that later but it is due to some higher repair and overhaul expenses we experienced as we got equipment ready to go out on rental contracts.

Comparing the first half of 2006 to the first half of 2007 gross margin increased from $10.2 million to $14.3 million, a 40% increase.

Our sales, general and administrative expenses continued to be well under control.

SG&A expense of $1.4 million in the second quarter of '06 which was 9 percent of revenue but decreased to $1.3 million in the second quarter of this year, or down to 7% of revenue.

In the comparative year-to-date periods SG&A is down 7% and running at 7% of revenue.

As I mentioned before we are adding staff as we prepare for more growth and this will rise back to traditional 8 to 8.5% levels for the year.

Looking at net income after tax the second quarter of last year versus second quarter of this year, net income rose 119% from $1.2 million or 8% of revenue up to $2.6 million or 15% of revenue.

For the sequential quarters we were essentially flat at $2.7 to $2.6 million.

Again, this is attributable to the higher overall expenses in the rental fleet we saw in the second quarter.

The increased rental expenses aren't necessarily bad as long as they are followed by revenue generating contracts as these are.

They are ongoing fill operating expenses but overall expenses to sends equipment back on to rental contracts.

This is in line with my prior comments made at the end of 2006 about our belief the year will be back end loaded.

This is exactly what we were seeing in the flat net quarters here will be eliminated as we head into Q3 and finish the rest of the year.

This is essentially a chance to get equipment repaired in preparation for higher levels of utilization in the second half of the year.

Looking at net income for the first half of 2006 compared to the first half of this year, it rose from $2.9 million to $5.3 million, an 83% increase.

EBITDA in the second quarter of this year was $6.3 million, up from $3.7 million or 70% versus the second quarter of last year.

Sequentially like net income and for the same reasons EBITDA was flat at $6.3 million, increased 54% in comparative to half years from $8.2 million up to $12.6 million.

EBITDA as a percent of revenues has been constantly rising over the past year.

The second quarter of 2006 it was 24% of revenue, second quarter of 2007, it was 36% of revenue.

And moved from 28%, 37% of revenue for the comparative six-month period.

Our fully diluted earning per share for the second quarter of 2007 was $0.22 per share, compared to $0.10 for the second quarter of last year, a 118% increase.

This is the same earnings per share time that record that were recorded in the first quarter this year.

Comparing the six-month period, diluted earnings per share grew from $0.27 to $0.44 this year, a 65% increase on top of an 11% growth in the diluted shares.

Breaking down the segment comparisons and looking at sales revenue, to remind you our total sales revenue includes compressor sales which is 85 to 90% of the total sales, flare sales, parts sales, rebuilds and sit compressor sales.

Total sales revenue in the second quarter of 2006 was $9.6 million, it grew to $10.2 million in the second quarter of this year, up 6%.

But that would have been a 52% increase without the previously mentioned rental unit sales we had in last year's second quarter.

Gross margin improved from 13% in last year's quarter to 28% for this year's period.

Sequentially total sales revenues increased 7% from $9.5 million to $10.2 million this quarter with a gross margin moving from 30% to 28%; primarily as a result of our parts sales and rebuild margins being a bit lower.

Compressor sales alone increased from $8.4 million in the second quarter of '06 to $8.7 million in the second quarter of '07, a 4% increase year over year, which would have been a 58% increase without the previously mentioned rental unit sales.

Gross margins in the same period increased from 25% to 26%.

Consecutive quarterly compressor sales revenue quarters grew from $7.5 million in the first quarter of this year to $8.7 million in the current second quarter of 2007 with gross margins staying constant at 26%.

Again, I sure don't want to forget to remind everyone that these are industry high margins.

The compressor sales backlog at our fabricating facility in Tulsa totaled approximately $17 million at the end of the second quarter of '07 as it booked into December, '07, to January, '08.

Effective June 30th of this year we merged our wholly own subsidiary suppressor systems into Natural Gas Services Group.

This will deliver some nominal tax savings and eliminate some internal accounting exercises and result in one corporate entity.

We will retain the associated names as brand names.

SCS engineered products representing our custom fabricated sales out of Tulsa and sit compressors, our proprietary small to medium small compressor frame.

Moving to the compressor rental business, rental revenue continues to grow at a strong rate.

The second quarter of '06 saw rental revenue of $5.6 million.

Moving up to $7.2 million in the second quarter of this year, a 29% increase.

Rental revenue increased sequentially from $6.9 million to $7.2 million, 4% gain.

This is in line with what we anticipated and I mentioned as we entered the year.

To remind everyone we anticipated a back end loaded year for rental.

We are already seeing our activity pick up into the third quarter.

Compared to the six-month period of 2006 versus 2007 rental revenue increased from $10.9 million to $14.1 million, a 30% increase.

Rental gross margin as a percent of revenue in the second quarter of '07 was 59%.

This is also been from the second quarter of '06 and the first quarter of 07 at 61%.

However as I mentioned and in line with the second half push we had higher level of maintenance in overall expenses getting equipment ready to go out on rental contracts.

We will see the benefit of this in revenue and margin the rest of the year.

Also point out that we don't capitalize any of these expenses.

However, overall expenses are expensed and fully absorbed and reflected in our rental gross margins.

We added 51 compressor units to our rental fleet this quarter, that brings total fleet to 1208 units, a bid over 140,000-horsepower and that's up from 1,111 units at year end, 2006.

Going forward we estimated that we would add 250 to 300 rental units at a fleet this year as we have in the past two years.

We are still at that range but as you can already calculate it's not going to be easy to add 60 to 70% more units in the second half of the year than we did in the first.

Like last year though we are going to outsource some of our production, probably about 10 to 15 %, and if everything goes according to plan we are confident we can hit those mark.

The critical eye for outsourcing over which we have limited control are the availability of skill contract labor and integrity of supplier lead time.

We are in the midst of working out those issues and beginning to start outsourcing within the next 30 to 45 days.

We ended the quarter at a rental fleet utilization rate of 88 %, up from 87% in the last quarter.

We measure rental market share by the number of units we have installed in the 50 to 500-horsepower range in the states that we operate in.

According to the gas compressor association and their data, our share has increased from 7.4% in December, 2004, to 10.3% in December, 2005, to 11.8% in December, 2006.

As of the latest data available we have 12.1% share at the end end of March, 2007.

The point here besides gaining share is that we continue to penetrate the market in a slower half through the year meaning of course that we grew faster than our competition.

Our service and maintenance business revenue was essentially flat to comparative year over year quarters and runs about 1% of total revenue with a margin of 43% in the current quarter.

Our balance sheet continues to be very strong.

Comparing June 30, 2006, against the same date in 2007, we have reduced our total debt by 29% from $20.2 million to $15.6 million.

Capital expenditures in the second quarter of this year were $5 million year-to-date are $9 million.

To just summarizing and looking back at the energy information administration data from the Department of Energy, and this is out of the their July report they are predict ago 4.3% rise in natural gas consumption in 2007 with natural gas production increasing only 0.3%.

2008 they are predicting a 1.1% consumption growth and a 2% production growth.

Average price predicted this year will be $7.91 in MCF, which is up from their prediction of $7.84 per MCF.

in the last call three months ago.

For 2008 their projecting a price per MCF, of $8.39, from $8.16 in the last call.

Now its interesting the price today is about 15% less than the same time last year meaning that we might see a pretty good increase in gas prices in the last half of this year to make those averages at the E.I.A.

is projecting.

Natural gas storage, is above the five year average but about on par with last year which I think is the more (inaudible) indicator.

We continue to stay very busy in the Barnett shale, our second largest market and are encouraged by that activity and new customers we're picking up.

Farmington our largest location also continues to grow very well.

We did have a price increase effective August 1,2007 for all compressors going out on contract after that date and it was about a 7 to 8% weighted-average increase.

Macro environmental scene looks good.

I expect NGS will continue to execute as we have in the past as we have in the past to take advantage of these robust market.

We are pleased with our results for the year and optimistic about the rest of the year.

I do want to make one final comment on a subject related to our industry with respect with to the U.S.

Congress.

The house recently passed a $16 billion tax bill, HR 6, aimed against oil and gas companies.

Whether you invest solely for return of equities of energy and industry service companies, or also have an interest in this vital industry you should be concerned.

At a time when energy prices are high and total energy consumption in the U.S.

out paces production by a large margin Congress is proposing to increase taxes on the industry as, in my opinion, punishment for (inaudible).

Instead of incentivising the industry to finds more information, they propose to impose more taxes while continuing to restrict responsible access to closed areas in the U.S.

and encouraging the domestic search for energy.

It is certain this country villafies the oil and gas industry but continues to feast upon its fruits.

More money to taxes will do nothing to lower prices or secure supplies.

Both of which we have been talking about for over 30 years.

I encourage everyone listening to make sure your congressman knows your views about this important issue before the Congress considers it.

Before I close I want to thank all of our employees for the continued work as through their efforts that Natural Gas Services Group has been able to grow and prosper as we have and I want to make sure they know it is very much appreciated.

That's the end of my prepared remarks.

I will now it were the call back over to Erica to open the lines for any of you that might have questions.

(OPERATOR INSTRUCTIONS).

You're first question comes from Shawn Boyd from Westcliff Capital Management, please state your question.

Hi, Steve, how you doing?

Hi Shawn, good, how are you?

Good.

A couple quick questions, if you don't mind.

I did not catch the number of compressors in the fleet at quarter end.

1208- Let me double-check.

Yes, 1208.

So that's where we are getting to the kind of the, that we get a back half loaded year overall and also had a back half loaded year in terms of the fleet additions at this point.

Right, these are just random numbers.

We had about 100 units the first half of the year.

So to get to 250, 300, let's just say, pick a number, 275, we had had need to increase that about 50, 60%.

So we are ramped up here in mid land and Michigan.

We are putting some units through Tulsa and again we are going two outsource probably 10 to 15% of that to get those numbers.

Got it.

Okay.

Gross margin on the rental fleet and leasing income, with that kicking in, in the back half of the year, do you think we will be kind of at or above where we were on a year over year basis?

So Q3 of last year we were about 60 -- well Q3 and Q4 right around 63%, would you anticipate that we would be back up at those levels for the back half of the year?

Well, I think we've got a lot better shot at hitting that Q4 versus Q3.

But I think we will either get back into the 61, 62, 63% would be a home run within six months.

But it will get back to our good solid 61, 62%, pretty quick, though.

Okay.

Last one for me and I am going to jump back in the queue.

(Inaudible) announced they were going to put their compressor assets in an MLP What do you think of that?

Is that something that you would ever consider?

What do you, just what's your view on that?

Well, it's a very popular thing to do nowadays in the compression and or pipeline industry.

Of course it's been a little (inaudible) here just this week on those evaluations there due to the course of the credit situations.

It's something we look at as we try to look at everything out there whether it's a state-of-the-art MLP.

It's nothing we are seriously considering.

Again as I think mentioned a couple of times, there are some advantages to it and some down side to it.

We continue to feel that based on our growth rates, top line and bottom line that our shareholders would still benefit to a greater degree just through long-term equity appreciation versus a income distribution model.

The common equity structure.

Yes.

And I lied, I do have one more.

You;ve been really good in the past about kind of giving us a little bit of a regional breakdown.

Would you mind walking through the regions real quick and kind of what's strong, what's not, what your outlook is?

Well, probably I will just look back the last six months where we had a little slower rate of accelerated growth than what we were used to me in the past our growth has been about 10% per quarter.

It went down to about 5% per quarter the first two quarters which we anticipated and announced a couple of quarters ago and I want to be sure everybody understands I don't usually prognosticate that well.

But we saw more of a slow down in the Farmington area than other areas but now, and Barnett shale will has, really just an amazing area, just continues to grow and stay busy.

So that's where we saw probably more of the slow down first of the year and again I want to say slow down, we still grew its just a less accelerated growth.

The last half of the year we are just seeing good growth everywhere and again we've already seen pretty good piece of that in July.

So the Barnett continues, Farmington has really picked back up.

We are starting to, I think I mentioned last time Michigan have been a surprise and still continues that way.

As a matter of fact I mentioned some market share numbers.

At the end end of March in our horsepower range in Michigan we have 45% are of that market and that's up from about 35% a year ago.

So not a big, big market as far as areas go but it's certainly growing pretty well for us.

So we are just seeing the ends of the year just everything getting back like we would like it and just busy in a lot of places.

Again that's where we are going to have to outsource more.

Michigan, is it just because you guys have really turned that on or is there a whole lot of new wells coming on line there?

There's not a whole lot of new wells coming on there's some drilling going on up there but I think we've had some real good luck in penetrating a bit more in the last year, year and a half up there.

It's not, we all know it's not a big market.

It's a good market for us but I think a lot of the bigger guys don't, to them it's even smaller in their area of influence so I don't think we see a whole lot of players in there a lot so we tend to be the bigger dominant force up there and have pretty good luck with it.

Great.

Thanks a lot and way to go, Steve.

Thanks, Shawn.

Our next question comes from Neal Dingmann from Dahlman Rose.

Please state your question.

Hey Steve, how you doing?

Hey, Neil.

Good.

What is it, on the short term investments that you have on the balance sheet right now,what is that?

Just some treasuries or something, I'm wondering if that's essentially cash out there.

Yes, it's short term investments in high-grade commercial paper.

So you could take that any time you wanted it.

Yes, well, the yield curve in the past has been pretty flat so we could keep it short term and just get it rates so that's what we've done.

With that type essentially I'd like at that plus your other cash, say we're talking around maybe $26 million, $27 million at the end of the quarter in cash.

What are your thoughts as far as you had a little bit of debt, does it make sense to pay that down?

I mean, are you seeing, I think myself and others continue to ask if you've looked at acquisitions now that the hand over to UCO has finished and given how segmented the rest of the market is out there just thinking the combinations of your financial situation plus opportunities, what are your thoughts around that?

Well, we are not, when we did the offering last year we paid a little down on the debt, the $5 million we've just been paying down just on amortization since than.

We are not looking at paying down debt other than just what's being amortized off of, as soon as I did that I know you guys would be saying, hey,man, you're under levered, what are you doing and all this other stuff.

So I think we are down to 16, 17% debt to total capital.

So we are at a very good place right there.

We are keeping the cash balance there for a couple of reasons.

Number one we are still capital intensive, still building a lot of equipment.

So we are still using that, although actually our cash position as I mentioned, our cash flow position as I mentioned last call has gotten better quicker than we projected so we are not pulling down as much.

And secondly it is something we can use for an acquisition if we find one.

We constantly look and really haven't found anything that's either number one that's attractive enough to do or number two been something that would be accretive based on some pricing.

So it's there, it's available to use on how we think we can use it but again I think the best use of that is going to be going into either equipment where we can get returns or if a good acquisition comes along we can do something with it there.

Okay, then a combination with SCI that you mention ready we going to see anything cost wise because of that combination, any small synergies, anything along that line.

There are some savings but I don't think you'll see them.

Nominally we are going to get about a 50, $60,000 tax savings with the combination.

Where we will see a lot internally when you have a sub like that and having to buy and sell between each other there's a lot of accounting and back and forth so we will see an elimination of that internally so we will get some savings that way but I don't think you will see it showing up in the numbers.

Your costs can continue to be quite excellent.

It looks like selling as well as the G&A costs continues to go down in the second quarter, can they go down even more from where they are or do you think that we're at a pretty good run rate?

No, I anticipate them coming up just a bit.

Probably '05, first part of '06 we were running about 9% of revenue with SG&A.

We have it down to about 7%.

I think we even dropped to maybe under a quarter.

And run about 7% now.

But we are staffing it up in certain positions because of the growth I guess we continue to see in the business.

So I anticipate that arriving back up probably to about an 8, maybe a little over 8% level.

So maybe about a point higher than what's running now but a point less than what we've traditionally run.

Okay.

Perfect.

Keep up the good work.

Thanks, Neal.

Our next question comes from [Donald Burke from LTL].

Hi, one of the things I'm always concerned about is a, one large customer.

Could you give us a little contingency plan in case something would happen to XTO?.

Well, XTO is a big customer on our sales side, not a big customer on a rental site so there's a little mitigation right there.

We are in fact and have been for probably a year or two really trying to diversify customer basis on both sides, the rental and the sales side from the point of maintaining those good customers and catering to them of what they need and want.

But also growing others at the faster rate so we do get the revenue base spread out just a bit.

So we've done that very well in the rentals.

We are really embarking on that a bit more than Tulsa with XTO.

But we watch it too but it's a situation we've got a very good relationship with them.

I think they like our equipment.

We know how to build how they like it and in a very competitive manner.

So I think there's a good relationship there, a profitable one but we do watch that and try to keep them in the fold because they are the biggest one of and one we real dollar value but also bringing in other to say help dilute it a bit.

Thanks.

(OPERATOR INSTRUCTIONS).

You're next question comes from Mike Drickamer from Morgan Keegan.

Please state your question.

Good morning, Steve, I'm obligated to ask about the sales margins.

You commented you were warned I should say that they are industry high margins.

You commented in the past you are not as comfortable with us projecting them to stay at these levels but do you currently see anything to suggest that they will fall from the current levels.

I didn't warn about them, I was actually bragging a little about them but I just want to remind everyone that they are industry high.

Boy, Mike, there's a second quarter, second, third quarter we've had good margins in that business and as I mentioned last year when we had a margin compression due to small units going through there we really made a decision to try to relive that business from the point of not in the conventional wisdom of small units, small margins so we've obviously done a pretty good job on that and I commend the guys in Tulsa for that exercise.

I guess I've been doing this over 30 years I guess it still spooks me since they are industry high to project industry high going forward until I end it.

I think last time you got me to in the past percent, 22%, I think you got me to move 22 to 23.

Yes.

And I think you are about the edge of my comfort level so I will stay in that range right now.

That's your comfort level but you don't see anything right now that suggest it will fall from the 28% had you in the second quarter?

How much visibility do you have into margins in the backlog?

Well, we know how we price them.

But some of the uncertainty you get is, how does, how do you, ours actually come in on to your labor costs, if there's any cost you didn't capture, anticipate or somewhat up.

So that's where the, if I can sit here and tell you with certainty exactly how we are pricing them easy enough but there's always, pricing is like a lot of things, the only thing fixed in the sales price and all the other stuff kind of floats around.

So I wanted to get a little hesitant on I can't predict those costs as well as I can predict selling price.

Have you looked at the pricing then, would the pricing infer the 28% margins?

The pricing would infer mid 20s margins.

And you guys have done a great job then in managing the cost?

Okay.

I will accept that.

All right.

Looking at the rental margins then you talked about the overhaul expense in the second quarter.

Is that expected to recur in the third quarter and that's why to Shawn's question you just responded more of a 61% type margin?

Well, I think we won't have as much of the level that we are going to have, some overall maintenance expense just as we continue to put equipment out.

But what we got kind of a double whammy here in the first half.

We have the especially in the second quarter have the expenses coming through but then we were having a less accelerated growth in the first half like we thought.

So we got squeezed a little in that respect in the second quarter and that's why I think going forward our revenues, just for a number, we, the units we rented, the compressors we rented in July equate to about 20% of the total compressors rented so far this year.

So you can see the acceleration we are already seeing.

So our revenue I think is going to accelerate in a quicker rate than obviously where the expenses are which is just a little opposite here in Q2.

If you remind me what's the initial contract term where you put these compressors out?

Typically six months.

Okay.

We will go longer that's the majority for standard rent equipment.

With the increase in the number of compressors being built in the back half of this year including the outsourcing do you have an update on Capex expectations for the second quarter.

Or for the second half of the year?

Well, we spent $9 million the first half so we just take that and ramp that up about 150%, what's that, 13, 14, so that gets you 22, 23 for the year and I think we have, anticipate 20 to 25 so I think we will be right in the middle of that range.

Okay.

And then one more, Steve, for you.

If you look at the public equity markets right now you've got economic concerns that relating to concerns about the cycle.

Are you seeing anything in the private market perhaps leading to more acquisition opportunities right now?

Well, as I mentioned we constantly look and we travel and talk to people and see things.

There is as I mentioned before the issue is not the people that are, the number of people that are out there but it's actually the quality of the assets and what that business is made of and if you think a lot of, it's a different contrast to move some of the bigger players in the industry where you are going after bigger players and maybe get a little higher quality asset base.

And down where we are and where our competition is being a little more localized it's more of a mom and pop situation, more regionalized company typically start up with used equipment, rebuilt equipment, thing like that so a lot of their fleet tends to be used and rebuild and has some age on it and they are also to assume some rebusinesses or services that we really are not interested in.

So it tends to complicate any -- acquisitions and, in the small to medium aren't as clean and pure as in the bigger sizes.

So it makes it a limit tougher and harder to find.

Thanks a lot, Steve.

Thanks.

(OPERATOR INSTRUCTIONS).

At this time I have no further questions.

Steve, why don't you wrap it up, then?

Thanks for your help, thanks for everybody joining us on the call and look forward to visiting with you again next quarter.

This concludes today's conference call.

Thank you for attending.