Natural Gas Services Group Inc (NGS) 2008 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the National--the Natural Gas Services Group Third Quarter and Nine Months 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, Erica.

Good morning, everyone.

Please allow me to read the forward-looking statement.

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's 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 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 include, but are not limited to, factors described in our recent 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 now like to turn the call over to Steve Taylor.

Steve, it's all yours, sir.

Steve?

Hello?

It appears Mr.

Taylor has dropped off.

I'll let you know as soon as he's back on.

All right.

I apologize for this, ladies and gentlemen.

We'll get Steve back on the line here immediately.

Mr.

Taylor is now back on.

Steve, I have read the forward-looking statement and now it's your turn.

Okay.

All right.

Well, we got disconnected there for some reason.

I don't understand, but go ahead.

Thanks, Erica.

Thanks, Jim.

And good morning to everyone and welcome to Natural Gas Services Group Third Quarter and Nine Month 2008 Earnings Review.

If you saw our earnings release this morning, we're very pleased with our third quarter results, so I'll get right to them.

We again achieved double-digit growth in all of our material financial measures.

Looking at the third quarters of 2007 versus 2008, our diluted earnings per share were up 43%, net income was up 44%, EBITDA was up 34%, and our total revenue increased 34%.

For the nine month period ending September 2008, compared to last year, diluted earnings per share was up 33%, net income up 35%, EBITDA up 27%, and total revenue grew by 20%.

Looking at total revenue and comparing the comparative quarters of 2008 to Q3 of 2007, revenues were up 34% from $18.7 million to $24.9 million.

Sequentially, total revenues rose 28% from the second quarter of 2008 to the third quarter of 2008, from $19.5 million up to $24.9 million.

This significant quarter to quarter growth is primarily due to a relatively light quarter for sales in the second quarter of 2008.

If you recall, last quarter we had some compressor sales we couldn't recognize in the second quarter due to late customer inspections being delayed causing those sales to be booked in the first week of the third quarter.

We also used 13 sales [slots] to [build] rental equipment in the second quarter of this year.

Both of those drove Q2 sales revenues to a relatively lower level.

So the sales side's quarter to quarter growth will be apparent throughout our financial report today.

Nine months of 2008 versus nine months of 2007, total revenues increased 20% from $53 million up to $63.4 million.

Total gross margin, looking at the third quarter of 2008 versus the third quarter of 2007, grew to $11.6 million, or 46% of revenue, from $8.5 million or 45% of revenue, a 37% increase.

Sequentially, gross margin increased from $9 million to $11.6 million.

Comparing the nine months of '07 to the nine months of '08, gross margin increased from $22.8 million to $29.5 million, a 30% increase.

SG&A, our sales, general, and administrative expense, was $1.3 million in the third quarter of '07.

That was 7% of revenue.

And it was $1.5 million in the third quarter of '08, or 6% of revenue.

In the comparative year to date nine month periods, SG&A was even at 7% of revenue.

Our net income after tax for the third quarter of '07 versus the third quarter of '08 rose 44% from $3.3 million, or 18.1% of revenue, up to $4.8 million, or 19% of revenue.

For the sequential quarters, we went from $3.3 million in the second quarter of '08 and it grew 44% to $4.8 million in the third quarter of '08.

Looking at the comparative nine month year to date periods, net income rose from $8.7 million in nine months of '07 up to $11.7 million this year, a 35% increase.

EBITDA or earnings before interest, taxes, depreciation, and amortization in the third quarter of '08 was $10.1 million, compared to $7.5 million in the third quarter of '07.

That's a 34% increase.

And those both ran 40% of revenue.

Sequentially, EBITDA rose from $7.6 million in the second quarter of '08 to $10.1 million in the third quarter of '08, an increase of 32%.

The comparative nine month year-to-date periods in 2007 EBITDA was $20.1 million and it grew 27% to $25.5 million this year of '08.

As a percent of revenue, the third quarter of 2007 and 2008 were constant at 40% of revenue and it rose from 38% to 40% for the comparative nine month periods.

Fully diluted earnings per share for the third quarter of '08 was $0.40 per common share.

That compares to $0.28 for the third quarter of '07, a 43% increase.

We saw a 33% increase in the comparative nine month periods when diluted EPS grew from $0.72 to $0.96.

Now, looking at our different segments and comparing them, primarily sales and rentals, from the total sales perspective, which, again, includes compressor sales, flare sales, parts sales, rebuilds, and CiP compressor sales, it was $10.6 million in the third quarter of '07 and it grew to 13.2 million in the third quarter of '08 for a 25% increase.

The total sales gross margins moved from 35% in last year's quarter to 32% for this year's period, with the decline attributable to a reduction in compressor sales gross margin from 32% to 29% in the same periods.

Sequentially, total sales revenues increased from $9.2 million to $13.2 million with gross margins flat at 32% for both quarters.

Compressor sales alone, which is primarily our Tulsa fabrication facility, increased 27% between the third quarter of '07, when it was $8.9 million, to the third quarter of '08 when it grew to $11.2 million, and were up 45% sequentially from $7.8 million in the second of this year to $11.3 million in the third quarter of this year.

This quarter to quarter lumpiness is larger than what we normally experience.

It was primarily caused by a $2 million shift in third quarter compressor sales when some unit sales did not get recognized in the second quarter, as I mentioned before, and slid into the third quarter due to late customer inspections and equipment acceptance.

These contributed--these primarily contributed to the spike in revenues to a record level in the third quarter of this year.

Now, we normally don't provide a forward look at our revenues.

But for a bit of clarity and because of the aforementioned third quarter effect and some softness we are starting to see in that business due to capital constraints and certainly from our customers, we anticipate compressor sales revenue in the fourth quarter of this year to be between $6 million and $6.5 million.

Compressor sales margins were down in the comparative year quarters from 32% to 29%, but increased in the consecutive quarters from 28% to 29%.

The compressor sales backlog at our fabricating facility in Tulsa has typically run three to six months worth of production, but we are at the low end of that range at the end of Q3 '08.

Now, looking at compressor rentals, rental revenue continues to grow at a very, very strong rate.

The third quarter of '07 was $7.9 million revenue.

The third quarter of '08 was $11.4 million, or an increase of 45%.

Rental gross margin as a percent of revenue in the third quarter of '08 was 64% and that's up from 60% in the year ago quarter.

And 64% is one of the highest rental margins we've seen in the last two or three years.

Rental revenue increased sequentially from $10.1 million to $11.4 million for the current quarter, a 13% gain, with gross margin also increasing from 59% to 64%.

Now comparing the nine-month period of 2007 versus 2008, rental revenue increased from $22 million to $30.6 million, a 39% increase.

Year to date rental gross margin is 62% compared to 60% in the year ago equivalent period.

We added 116 new compressor units to our rental fleet in Q3.

That brings the total fleet to 1,662 units or over 200,000 horsepower for the first time in our fleet.

This is up from 1,352 units at year end 2007, an increase of 310 units year to date.

Our average fabricated rental horsepower per unit this quarter was 156, continuing the last few quarters' trend of billing higher horsepower than our fleet average of 125 to 130 horsepower.

We ended the third quarter at a rental fleet utilization rate of 85%.

This is a little lower--we were 89%--89, 90% last quarter and one primary factor has contributed to this five point drop since the last quarter.

We've seen some regulatory issues in Michigan that have dramatically stalled everyone's growth there.

The State Resource Board has issued negative rulings applying to the production of gas wells using compression on depleted wells.

And we had a number of rentals terminate there this quarter.

This accounted for about three points of the drop.

We think the ruling may be modified within the next quarter or two and we could then see these same compressors that came in go back out.

In the meantime, we are continuing to rent equipment into that market.

The remaining two point fluctuation wouldn't normally be a concern, but in this environment we are watching it very closely and taking action relative to it, and I'll go into that in a minute.

I do want to point out that we calculate utilization based on equipment that is drawing rental payments and don't count any rental units that may be committed to a customer and isn't being charged for yet.

As an immediate comparison, we have rental compression committed to customers that we're not getting revenue yet that account for an additional three points in utilization.

To provide another point of guidance, we estimate that our Q4 earnings per share will trend up from Q1 and Q2 this year, but a little bit higher and be in the low $0.30 range.

From a balance sheet perspective, which certainly has become more important to everybody in the last quarter or so, we continue in very strong shape.

Our total short term and long term debt is $17.4 million as of September 30, 2008 and we currently pay 3.5 interest rate on our term loan.

Our cash and cash equivalents were $6.7 million.

Our total debt to capitalization was 12% on September 30 with net debt to capitalization of about 7%.

We presently have $7 million drawn on our $40 million line of credit upon which we pay 3.75% and our borrowing base exceeds $9 million.

Looking at our last 12 month EBITDA to net debt, we could pay off our total debt load in about four months if that's what it came to.

We have always been pretty conservative and these statistics show that has paid off and I think it will pay off in the future.

They provide a pretty clear picture of the strength of our balance sheet.

Capital expenditures in the third quarter of this year were $14 million, and that was about flat with the second quarter and they have run $35.9 million year to date, compared to $15.7 million in the first nine months of 2007.

95 to 97% of our capital expenditures go directly to rental equipment to build up our rental fleet.

Year to date through September 2008 we have spent almost $36 million for capital expenditures and generated about $21 million cash from operations.

The difference there, of course, has come from the balance sheet cash and the pull on our line of credit.

Going forward, however, until we get a clear picture from our customers as to what they plan to do and most either haven't decided yet or aren't releasing that information, we plan to spend no more than our internal cash flow generating capacity and we have already set that in motion.

Based on our projections and not including any change in the working capital, which we think will be to a minimum or positive, we think we'll generate free cash in the fourth quarter of this year.

If we do spend up to the limit of our cash flow generation, less debt service, we can still build at a run rate of 70 to 75 compressors per quarter.

We will continue to spend capital on our emissions retrofits that I talked about last quarter that are required by law.

We do have the capacity operationally and financially to pursue and take advantage of any opportunities that may come up and we will continue to do that as we see them.

Now, to summarize, and I usually make a comment or two about the wisdom or questionable wisdom of some of our elected representatives in Washington, but I think right now discretion is the better part of valor.

The country's having a hard time now from a financial perspective and I only hope that our new leaders take the time to understand the energy issues and take the appropriate actions.

We're in a strange environment now.

And in this business that's due to two primary factors, of course - the macroeconomic environment and resulting cash and credit scarcity and simultaneous falling commodity prices.

It's really no surprise that everyone, including our customers and competitors, are hunkered down waiting to see where the chips may fall.

Customers are making plans, too, and like us, stay within their cash generating ability and not add debt now.

And their activity in cash flow is directly affected by the price they receive for natural gas.

It seems that $7 to $8 gas is the range that operators are looking at to keep some semblance of activity going.

And EIA projects an $8.17 average price in 2009.

If average prices stay in this range, I think we will see a satisfactory 2009.

But if they don't, there can be a drop in drilling and drilling activity.

Although at first blush this may seem bad, I think there can be a silver lining to it.

The tempering of activity may cool off some of the oil fuel inflation we have all experienced.

Labor and labor rates may get more realistic.

And on a bigger picture view, half the gas wells drilled in the U.S.

now are in (commissionable) wells, which have a very high decline rate - 30 to 50% annually or more.

If drilling recedes, it will not take long for the balance between production and consumption to restore itself.

And if we do get a cold winter, which is predicted, we may not even notice anything.

I think our rental business will grow and it's been very strong to this point, although certainly, depending on the activity driven by commodity prices.

The vulnerable piece of our business is the sales piece.

We've talked about this in the past - that being a capital driven part of the business, so as we--if we see additional capital constraints and credit scarcity, that could suffer more relative to the rental piece of the business.

I think we'll see a slow Q1 and Q4, although as I mentioned on Q4 I think we'll still show good progress and growth.

And we may actually get some shift in the buyers becoming renters in a capital constrained world.

We are adding rental units only to our cash availability and don't anticipate adding to our debt load.

We have added new sales representation recently in the Northern Rockies and the Permian Basin, so we intend to continue to gain market share.

We are moving up in our 50 to 500 horsepower range and should be able to capture new business from a product standpoint, too.

We are best positioned to weather any storm coming our way.

A couple other points I want to mention.

These are certainly bright points for us.

NGS started trading on the New York Stock Exchange last week on October 30.

This is a milestone for the Company and we are happy to be on the premier exchange in the world.

And for the fourth year in a row, we were named by Forbes as one of the 200 best small companies in the U.S.

We ranked number 38 this year and that's our highest ranking of all four years.

That's the end of my prepared remarks.

I'll now turn the call back over to Erica to open the lines for any of you that might have questions.

Thanks.

(OPERATOR INSTRUCTIONS.) Our first question comes from Mike Drickamer from Morgan Keegan.

Please state your question.

Hey, good morning, Steve.

Hi, Mike.

Steve, I apologize if I missed this.

Where did the rental fleet end the quarter at as far as sale size?

16--hold on here--1,662.

Okay.

Steve, you've been around.

You've seen a couple of these cycles before.

Kind of the actions you talked about on this call, is this an abundance of caution or are you seeing--is this what you're really seeing in the market out there?

Well, the problem is nobody's seeing anything.

Okay.

And so, I think it's probably an abundance of caution from the point of if we had customers saying, hey, here's what we're going to do and here's what we're not going to do, I'd be a lot more confident of what I'm telling you.

But we've been talking to our customers a lot and of course listening to some conference calls and the majority of them are saying, you know what, we'll let you know what our capital is going to do next quarter.

People just aren't sure what's going to go on.

And again, from the--just the general economic effect and then the commodity prices.

So it's--we're being cautious with it.

We want to pull back to make sure where things are and what's going on there, too.

We think--as I've always said, we think the rental business will be strong.

The vulnerability is the sales business, being capital driven.

But we're going to--we've--the good part about this business, especially on the rental side, is if you do get into some of these uncertain times and maybe some flat quarters, we'll tend to generate cash pretty well and build up some cash cushion.

So as we pull back on fabrication, as I mentioned we will, we don't intend to spend over our cash capacity right now.

We'll build cash on the balance sheet.

So we are prepared to chase anything that might up, any opportunities that might be there.

We'll be ready to go get them.

Or if the thing gets worse or is prolonged, we've got cash to get through it in good shape.

So again, we're not getting a real good feel from any customers of exactly what's going on, because I don't think they know yet.

But the pieces we see, I think there's still--I don't think it's a doom and gloom thing by any chance.

So I think we're just trying to be prudent right now until we get a little clearer idea.

Okay.

Now, are you actually going to take and reduce any headcount or do anything that restricts your current capacity or are you just not expanding your capacity as much as you previously expected to?

Yes, I think we're just going to pull back.

I mean, not from a reduction standpoint, but just not advancing as we said before.

If you remember we were projecting a 400 to 450 compressor add in '09, et cetera, and going on up.

I'm formally withdrawing that projection from the table.

We don't know exactly where we'll be, so we're just going to--we'll add to the high end of our range this year, which we said was 300 to 350.

We can do roughly 250 to 300 just based on cash we can generate.

So I don't think we have to cut back.

I think we just need to kind of stay steady here a little bit.

Okay.

You and I always discuss the gross margin on the sales side.

In light of what you are seeing in the sales and looks to be a drop in sales going into the fourth quarter, is something around the 30% range still achievable or are we going back to where you've been guiding us to I guess all this time, more in the mid-20 range?

Well, I guess my best answer to that is certainly we try for the higher ones, but plan for the lower ones.

So I think when you get into an environment like this that's--there's a lot of uncertainty in there from the customers' standpoint.

I would guide everybody towards the mid-20s in that respect.

And again, if we can maintain the excellent margins we've done, we'll be in that much better shape.

It's just real hard to get a feel for it right now.

Okay.

And then, where did the margin improvement on the rental side come from this quarter?

A couple things.

We had the price increase August 1.

And then, we have had some--we've aimed for a 62, 63% margin.

We've been 60 to 62 in the past.

So I think we got a little bump from the price increase and then our guys are continuing to watch the costs pretty well.

And then, still in our areas like the Barnett Shale, the Barnett's still busy.

So what we're able to do there is essentially we're just adding density in there so we don't get stretched out.

So once we start adding density to an area we're getting some economies of scale there, too.

Okay.

So then, do you believe this margin is sustainable with your outlook for a slowdown?

No, I'm still going to say we'll average in the low 60s.

I think we hit a homerun in all respects this quarter, some things we did and just how some things fell.

But, no, I think we'll need to--I'd still be more comfortable in the 60 to 62% going forward.

All right, Steve.

Thanks a lot.

That's all for me.

Okay.

Thanks, Mike.

Our next question comes from [Louisa Herman] from Dahlman Rose.

Please state your question.

Hi, Steve.

Good quarter.

Hi, Louisa.

Real quick.

I might have missed this, but what was the number of rentals to customers for the quarter?

Well, I don't think I said the number of rentals to customers.

What we did was we added another 116 new compressor units to the rental fleet.

And so, actually, with an average utilization of 85%--so 85% of that 116 actually went on earned revenue.

Okay, got you.

And then, how--can you just give us your view on with your clients reducing just their CapEx budgets, do you see the number of wells still increasing even though CapEx budgets are going to be decreasing?

No.

I think the well count will come off.

I mean, the rig count I think can start coming off.

I mean, it's come off some.

But just the budget cuts we've heard.

People can draw some rigs.

Now, I'll say that and I'll follow up here again.

And I know some of the customers are saying, well, even though the drop in rigs, well count may not decline because they've gotten much more efficient in their number of wells drilled per rig.

And I think generally it may come off a bit.

And I think where we're going to be able to come out okay on that is, again, just is we've have good luck over the past four or five years in getting market share gains, so I think we can still get some of those.

We're still in I think real good areas from [San Juan] Basin to the Barnett to being established there with the infrastructure that we can still add to that.

And I compare those against the Marcellus Shale, the Haynesville and things like that that are good areas, but they are still new areas going to have to have a lot of infrastructure in.

And if you're an operator, you're going to pull back into where you've already had a pretty big operation.

So I think the places we're in are the best places to be and we haven't moved into those new areas yet, so we won't get hurt by any slowdown there.

But, yes, I think generally you'll have some nominal reduction in well count.

I don't know what that might be and I don't think--from a rental perspective especially I don't think we'll--I don't anticipate us seeing a whole lot of negative effect from it.

Okay, thank you.

Okay, thanks.

Our next question comes from Steve Ferazani from Sedoti and Company.

Please state your question.

Good morning, Steve.

Hi, Steve.

Just want to ask a little bit about sort of you gave more of an outlook than you have in the past.

The 6.5 million on the sales side.

I mean, have you gotten any pushback from customers at this point?

Have you seen a change in backlog?

I mean, what--can you give some color there?

Well, we haven't seen pushback necessarily.

What we've seen is people are reluctant to commit to something.

So the six to 6.5 is the low end of our historical backlog, so that's where we're thinking we're seeing--well, what we're doing is again being pretty conservative and cautious like.

Well, if this is the low end, let's take it like that instead of thinking that maybe it will jump up to the high end at some point.

We're starting--that's why we're adding some of these sales guys.

We're certainly working to get that backlog back to where it was.

So it's one of these things we see a couple of data points here that look like a slowdown and some softening.

And they may be, and that's what we're planning for.

But if we can get it--if some of the customers start letting go of some projects and putting some stuff out there, we'll be in good shape to take advantage of that also.

Then you offered up sort of the 70 to 75 compressor additions per quarter.

And how flexible are you if one of your market softens, another one that you've just entered picked up, is your sales and your maintenance crew flexible enough that you're going to be able to move around and take advantage of any places that you see growth at this point?

Yes, that's no problem because we don't--internally, we don't market the compressors by area.

Each one of our sales guys gets a view of every compressor in the fleet.

So if the guy in Barnett needs a unit from Farmington, he knows it's there and we can get it moved out and things like that.

So we're able to move between the markets pretty well.

And then, should we think about--as you're probably moving into a more difficult period having to market more aggressively or sell more aggressively, should we look at SG&A ramping up a bit here or how would you think we should view that?

Well, I've always said except for the last year and a half, and we've done a real good job on keeping that overhead down.

We had typically run 8 to 8.5% as a percent of revenue SG&A.

We're running 6 or 7% now.

So we're--we've stayed pretty lean through all of this.

And so, I think the thing we've got is we've already got the discipline in the company to get through anything that might happen, whether it be moderate or severe.

We did not fatten up even when things were good.

So I anticipate us being able to keep the SG&A within that range, maybe plus or minus a percent.

And then, in general on the rental side, I mean you've been--what are the possibilities of winning over new customers?

Has the brand name recognition grown?

What do you think your ability to take share away is, if we see slower wellhead growth?

Yes.

Well, I think our abilities are--and capabilities are very good.

We've shown that in our market share numbers consistently increasing year over year.

We're the biggest player in our horsepower range of 50 to 500, so we've got some advantages there.

And again, one of them being this ability to have a nationwide footprint and move things around.

So I think we can do it.

We're adding customers that are very good customers, large independents, and that's our typical customer profile, too.

So I think our customer profile is very--I mean, is gold plated.

It's the guys that are doing all the work, it's the guys that pay you, it's the guys that like to rent and outsource and stuff.

So I think we're adding to that and we're not seeing a predominant rush of onesy-twosy guys or smaller operators.

We're going in and still getting some of these bigger operators to rent from us.

Okay, thanks a lot, Steve.

Okay, thanks, Steve.

We have another question from Mike Drickamer from Morgan Keegan.

Please state your question.

There's only one question per call.

Okay, well a quick follow-up then real quick.

We're wrestling here trying to get our arms around how bad this slowdown is going to be.

Is the sense you get, is this kind of like with the slowdown we saw in 2007 or is it much more worse, something like '98 or 2001?

Good question.

And the reason I hesitate is because, again, we can't get customers to even say.

And only because I don't think they really know.

My sense is that it's going to be more of an '07 thing than anything else.

The gas price is still in there at $6.50.

Storage is not way out of whack.

As long as we don't have a sudden deterioration in some of those base level fundamentals I think we can get through it okay.

If we--and especially if we get a cold winter.

If we get a warm winter, if gas prices start dropping down to $5 or less, things like that, it's--it could be a tougher environment.

But my general sense right now is that we can get through--get through in good shape.

Again, we may have a couple of slow or flat quarters, but then we'll be ready to get right back after it and get back on the growth curve we're used to.

And again, from the rentals side, I think particularly we can maintain some positive growth.

I don't think--my sense is that we won't maintain the 40, 45% we've done historically.

But, heck, if you cut that in half, 20% is not bad in a slow time.

And I'm--and that's not a prediction, that's just an example.

But my sense is that it won't get as bad as the earlier years in the decade.

But no matter what it does, I think NGS is positioned as well, if not better, than anybody to get through it in good shape.

Okay.

That's really it for me this time.

Okay, no problem.

Thanks.

At this time I have no further questions.

Okay.

Well, Erica, I appreciate your help and I appreciate everybody calling in.

We're very happy about this quarter.

We think we'll be okay in the quarters going forward.

We'll have more information certainly the next time around on the call and look forward to visiting with everybody then.

Thank you.

This concludes today's conference call.

Thank you for attending.