Natural Gas Services Group Inc (NGS) 2010 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group's Third Quarter 2010 conference call.

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

(Operator Instructions).

Your call leaders for today's call are Modesta Idiaquez, IR Coordinator, and Steve Taylor, Chairman, President, and CEO.

I would now like to turn the call over to Ms.

Idiaquez.

You may begin.

Thank you, Erica, and good morning, listeners.

If you would, allow me to read the forward-looking statement prior to commencing our earnings call.

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

Forward-looking statements, as you may know, 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, or environmental regulations, which could require Natural Gas Services Group to make significant capital expenditures.

The forward-looking statements included in this conference call are made as of the date of this 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 they are not limited to, factors described in our recent press release and also under the caption "Risk Factors" in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission.

Having all that stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group.

Steve.

Okay.

Thanks, Modesta, great job and thanks, Erica.

Good morning and welcome to Natural Gas Services Group's third quarter 2010 earnings review.

As I mentioned before, 2010 continues to be a transition year, but we are seeing some positive signs I'll talk about.

You've heard me say this before, that as I review the numbers with you, the year-over-year comparisons are going to be less representative of our current business performance than the sequential quarterly comparisons, which moreso reflect today's market conditions.

The latest total revenue for the sequential quarters of -- the second quarter of this year compared to the third quarter of this year, total revenues rose $2.3 million, or 20%, primarily due to increased compressor sales.

However, we also saw real revenues increase for the fourth quarter in a row.

In the year-over-year quarters, third quarter of 2010 revenues declined to $14.2 million from $16.4 million in the comparative quarter last year.

Sequentially, gross margin increased 13% from $6.8 million in the second quarter of this year, to $7.7 million in this current quarter with overall margins at 54% compared to 57% last quarter.

Comparing the third quarter of this year to the third quarter of last year, total gross margin was down $1 million to $7.7 million.

But the gross margin ratio rose slightly from 53% of revenue to 54%.

SG&A expense was down in sequential quarters 11% on a dollar basis and moved from 13% of revenue down to 10% of revenue.

SG&A dropped 14% in the comparable year-over-year quarters or remaining flat at 10% of revenue.

Sequentially, operating income increased almost $1 million, or 40% to $3.4 million and moved from a margin of 20% up to 24% of revenue this quarter.

Comparative year-over-year quarters reflect a decrease of just over $800,000 from $4.2 million in the third quarter of '09.

Looking at net income and comparing the second quarter of this year to third quarter of this year, net income rose $600,000, or 39% to $2.2 million and grew from 13% of revenue to 15%.

In the comparative year-over-year third quarters, net income declined from $2.6 million last year to $2.2 million this year.

EBITDA grew from $5.4 million in the second quarter of 2010 to $6.4 million in the current quarter, a 19% increase and remained at a 45% margin.

EBITDA fell from $7.1 million in the third quarter of '09 to $6.4 million in the current quarter, or 10%.

But the margin improved from 43% to 45% of revenue.

Fully diluted earnings per share this quarter was $0.18 per common share compared to $0.13 last quarter and $0.22 last year.

I want to point out that gross margin, operating income, net income, and EBITDA were all at their highest levels this quarter than any of the past four quarters and have grown in each consecutive quarter this past year.

Now looking at the different segments and comparing them, sequential quarterly total sales revenues improved from $1.8 million to $3.7 million.

And margins moved up from 36% to 40%.

This doubling of revenues is due to the backlog we started building last quarter.

In year-over-year quarters, total sales revenues declined to $3.7 million in the third quarter of this year as compared to revenues of $5.3 million in the comparative quarter in 2009.

Compressor sales in the current quarter were $1.4 million with a gross margin of just over 41%.

This compares to last quarter when, if you recall, sales were essentially non-existent.

We continue to see a volatility in the compressor sales segment, especially with the continuing low gas price environment.

Our backlog at the end of Q3 '10, this current quarter, is approximately $4 million to $4.5 million, and this reflects a couple of orders that have fallen off the tail of this past quarter.

Some customers are taking another look at their economics, and we have removed these from the backlog.

If they do materialize, they will be in 2011.

In compressor rentals, sequentially rental revenues were up from $9.9 million in the second quarter of this year to $10.3 million this quarter -- or almost 5%.

Gross margin moved from 62% to 59% of revenue.

Rental revenue had a year-over-year decline of only 5% from $10.8 million last year to $10.3 million for this current quarter.

Gross margins were 64% and 59%, respectively.

The last year's margin was a record so we continue to approximate our target margin range of 60% to 62%.

Average rental price in active units in the third quarter of this year were down 7% when compared to the same period last year.

But throughout this year, we've seen an increase of roughly 2% in pricing on an average unit.

We ended the third quarter with a rental fleet utilization of 69% on a fleet size of 1,849 compressors.

This was a slight increase in utilization from last quarter.

It was on top of 2% growth, or 43 compressors in fleet units.

It's interesting that our incremental utilization in the third quarter was actually 111%.

We added 43 units to the fleet but ran it down an additional 48.

Our horsepower utilization is running a couple of points higher at 71%.

With the rental fleet currently at 1,849 compressors, we have already built more rental units year-to-date, 73, than all of last year.

In fact, the 43 we've built in the current third quarter almost equals all of last year's production of 46 compressors.

At last quarter's call I projected that we could add up to 100 units of the rental fleet this year, and we are on track to do that.

We are also seeing a slightly positive trend in the average size of our units climbing in horsepower this year.

This generally equates to a lower cost per horsepower to build but a higher average rental rate per unit.

Our average horsepower per unit has climbed from 128 horsepower to 133 horsepower this year.

Rental CapEx year-to-date through September 2010 has been $12.9 million, but we project CapEx this year in accordance with what I just mentioned our second half fabrication output will be in the $16 million to $18 million range.

This compares to 2009 when we spent $7.7 million through the third quarter and $9 million full year.

You can see the appreciable amount of cash we continue to generate even in sideways markets.

We spent $12.6 million in CapEx this year, to date.

Almost $5 million more than last year at the same time, and our cash balance is low at $2 million less than last year.

Now, looking at our balance sheet -- our total debt, short term and long term, was $3.7 million as of September 30, 2010, and cash in the bank was $22.9 million.

Our cash flow from operations through three quarters of this year was $22 million compared to $24 million for the same period in 2009.

In spite of the year with depressed revenues, this is only an 8% decline in operational cash generation.

We are happy with our performance this quarter, but I will repeat some of the comments I made last quarter.

Our rental activity is showing signs of life and growth but it is not broad-based.

It is spotty by geography and by customer and some areas are essentially treading water.

We are not losing ground and still renting but it's slower-than-anticipated growth.

Sales activity is, as always, very volatile and a quarter-to-quarter fight.

Still not much visibility in the business, and I don't think we're out of the woods there yet.

We have been fortunate enough to win some work from some good customers including a very large major.

That, of course, certainly helps from a revenue perspective, and it also adds an additional positive edge for our engineering reputation -- that we can compete on the same technical and engineering level as much larger companies.

We will start seeing some cost pressures.

We lifted our wage freeze, and there will be increasing fuel costs.

Some competitors continue to try and grow by cutting price, which is, of course, in our opinion, a short-term folly.

But we see pricing pressure in some areas.

We will compete in the areas we choose and at the prices we set.

And I think our pricing performance this year shows the strength and wisdom of that strategy.

Now looking at the current market, it's just tough going right now.

It seems like everyone is lowering the price tags and expectations for natural gas, and I feel like the Maytag repairman sometimes -- pretty lonely.

But I think we'll see some resurgence next year.

I'm not going to predict the magnitude, but it will be better than this year.

Operators are moving to oilier and more liquids laid in place, and that will naturally move rigs off natural gas.

The economy will strengthen as we move forward, so I think the supply/demand and balance will tighten.

In the past year, all players in the industry have reduced their operating cost, and today's $5 to $6 gas price level is yesterday's $7 to $8.

We have grown a bit in a $3.50 to $4.00 market, and an increase in gas price will only add to our efforts.

Although lower gas prices certainly caused some short-term dislocation in markets, we are positive in the longer-term advantages to it.

Coal is presently an effective competitor with natural gas, but it will be come more expensive as environmental regulations become stricter.

In many cases, it will be more economic to switch to gas for fuel as opposed to cleaning up a coal plant.

Most plan for wind farms and nuclear plants were made under the assumptions that gas would be $8 to $9 far into the future.

These projects now look too expensive.

On the nuclear front, plans for three dozen plants were drawn up four to five years ago with the availability of governmental loan guarantees.

Almost all those plans have been shelved today.

Constellation Energy and NRG, just to mention a couple, both of who made a splash last year with Obama's nuclear loan guarantees, now say that they probably will not go forward with their plans.

The wind industry is suffering, too.

The third-largest wind power producer in the world, Portuguese Utility EDP, which also invested heavily in the US, reduced their investments here by 75% over the next two years.

Wind turbine construction will probably fall 40% this year and half again as much next in spite of federal subsidies of 30% for wind projects.

Does this sound like any other government-sponsored market manipulation?

Say ethanol?

If (inaudible) of natural gas has become the preferred fuel for many good reasons, and it should be accelerated to its proper place in the energy spectrum.

Let's hope that yesterday's election results brings some common sense to a body whose decision-making capability has been about as dim as the likelihood of economic renewable sources of energy.

Despite the physical and financial advantage of natural gas over oil and coal, and the financial and market improbability that wind or solar will be feasible for decades, Mr.

Ashok Gupta, Senior Economist at the Natural Resources Defense Council, rejects a move to natural gas, because he says, "We don't want natural gas to become our next big climate problem." So -- according to Mr.

Gupta, it is better to continue with the dirtier hydrocarbons in the intervening decades while renewables are developed.

It's too bad scientists aren't made to run for reelection.

I point this out only because it took me a while to understand this totally foreign type of thinking, and it's real (audio break) in the environmental community.

They would rather continue to burn coal than transition with gas to renewable future.

It sounds more political than environmental to me.

I often wondered why this administration hadn't pushed the Natural Gas Act to kickstart the substitution of natural gas for dirty fuels, and that is it.

What these people don't understand is that the market, if allowed to work, even sometimes when not, usually delivers the right answer.

And it doesn't matter if I wish real hard that wind and solar become viable.

I'm not denigrating wind and solar because we will need sources like that in the future, but we can't step directly into them.

It's a transition, and therein lays my frustration.

Now, I usually close the call with remarks about the value of our employees, but I want to brag on them now.

We don't dictate what the market does and can only work with what is given us -- a consistently and in spite of declining revenues and pricing cost pressures, NGS and our employees have maintained enviable margins, high utilization, consistent pricing, and superlative cash generation.

I want to thank our employees and also make the point that we've set the right strategy in the past, we have executed on it, and we continue to do so no matter what the market does.

This company, in spite of a sour natural gas market, continues to counter the odds and deliver the goods.

We may make it look easy, but it is not, and credit goes to our employees.

That's the end of my prepared remarks.

I'll turn the call back to Erica for questions that anyone might have.

(Operator Instructions) Steve Ferazani, Sidoti & Company.

Given the low natural gas prices, have you been seeing an increase in shut-ins?

Are you seeing any impact on your compression activity?

No.

No increase.

There's still some stuff shut in.

Some came off the first part of the year when we hit some $4.50 to $5.00 gas.

Of course, that was short-lived, but some of the stuff has turned back on.

But really haven't seen more go to shut-ins.

Just whatever has been there throughout the year seems to have stayed.

Even probably expectations for lower natural gas prices and keeping bring them down, would you still expect to see some seasonal pickup as we get into winter heating season?

Or is that not necessarily the case given the pricing environment?

Well, you always expect that.

Of course, what I think the latest prognostication I saw from the weatherman, which is, of course, 100% accurate, is a 3% warmer winter -- 3%, that doesn't usually -- it's usually a routing area anywhere else but the natural gas market, it might make a difference.

I think winter is always a seasonal effect and a better situation for us.

We've seen the last couple of days gas prices increase just a little bit.

So I think it's going to be a help.

I think we'll go through that.

I think we'l have a -- it's not going to be an opening of the floodgates or anything like that.

But I think it will hold.

As I mentioned, we've been able to grow, however slightly, in a pretty depressed market, and I think that will just maintain that and get us into '11.

And I think '11 is going to be a better year.

Nothing to write home to mom about necessarily, but I think things continue to get better as each day goes by.

Really strong margin on the sales in the quarter.

Was there anything particular in terms of what you've built out there, and I'm assuming that was at least some degree one-off?

We wouldn't expect that type of margin from --

Yes, yes.

I'm glad you bring that up because -- don't start figuring in 40% margin on that stuff.

No, it's a combination of things.

We had some good jobs come in.

And we get a lot of cost-cutting and finding efficiencies and the fabrication piece at the beginning of the year and the end of last year when things were so rough.

So -- we've just been able to carry that on and apply it to the margins.

Last one for me -- just for developing shales -- when do you think they become material?

And are you starting to see any hints of demand on some of the earlier wells drilled in some of those markets?

Well, we're starting -- the drilling is going on, of course.

We're starting to get some feelers.

It's not a rush again.

I think the big ones, of course, are going to be Eagle Ford, Haynesville, and Marcellus.

And I think, as I mentioned before, Eagle Ford will probably, for our business, leap the others a bit because there are more liquids associated there, and a lot of infrastructure.

The Marcellus is probably going to be dragging a little bit just because of lack of infrastructure and then some political considerations out there from fracturing concerns, et cetera.

We're still on the same time schedule.

We'll start seeing stuff the next 12 to 18 months from a wellhead compression standpoint.

There's big compression going in.

That's always a first step.

So no change in the time on that, I don't think.

If anything, it could be retarded some if the gas price stays lower longer, but it's inevitable.

The declines on those wells is tremendous.

And even -- there's always a lot of consternation and talk and guessing about what's this drilled?

And not completed well count, and things like that.

And everybody's got a different number.

But even with that, that doesn't really -- that's not going to hurt our business when those things start to be put off.

As long as gas -- I mean, the gas price is always the determinant, but the wells drilled not complete -- when they start completing those things, there's still going to be compression at some point in those lives.

So that's really just, in some respect, a backlog for us as prices increase and those things probably get put on just a little quicker.

So, timeline, I think we're still looking at the same thing -- probably 12 to 18 months before we start seeing some stuff go in there, although we are getting some inquiries and some feelers now.

Jack Gibney, Capital One.

I wanted to follow up a little bit more on the sales side.

It looks like -- correct me if I'm wrong on my math, it looks like you had a big boost in your other sales -- flares, parts, rebuilds -- in the quarter north of $2 million.

Just curious what happened there in the quarter?

Some one-time noise?

Well, all those seemed to pick up a bit, and it's not unusual in a slower market -- usually a little more parts and rebuilds going on than you have in new sales.

So you get a little shift in that, and that's normal and natural.

But we've really had a pretty good influx of flares.

That business has picked up, and I think a lot of it is environmentally driven, and you're seeing -- I think it goes along with some of these older are replaced, too, where you get people drilling for oil and maybe don't have the outlets on the gas.

And they've got to do something from the standpoint of producing that oil.

So we get some of that.

Not that these flares are going constantly, but they've got to have those on locations in case they are needed.

So we've seen a pretty good push in that stuff.

And that's going to be the majority of what you're seeing.

That's probably 75% of it.

Okay, that's helpful.

In terms of what came out of backlog, as you referenced a couple of orders that have fallen off the table.

The guys get a little more hesitancy on their plans.

What was the aggregate amount that came out of backlog quarter-over-quarter that something shifting out if they come back into '11?

It's a couple million dollars.

A couple million, okay.

Well, I guess, if you could just help us a little bit -- previously, you talked about the possibility of [borrowing] through, roughly, 80% of that backlog in the back half.

So what's your expectation now for the fourth quarter given that slippage?

Well, we've got 4 to 4.5 so probably one to -- let's see, let me think through this -- probably a couple of million of that.

$1 million to $2 million of that is going to go into '11.

Okay, into '11, all right, that's helpful.

We'll get, roughly, 40% to 50% this year and the balance next year.

Okay, and on this last one, the slight downtick in G&A -- just curious what sort of a reasonable run rate, going forward, holding here.

Do you think it picks up a little bit?

Just curious, it came off a little bit this quarter?

Yes, right now that's just strictly a function of what those revenues are doing.

With the sales revenues going up, the percentage comes down.

So it's going to be -- we're used to, when we're running 7 and 8, we're down to 7% and very efficient there.

We're still as efficient because the dollar amounts are coming off.

It's just the calculation of the revenue base is making a fluctuation.

So -- most of this fluctuation is in the sales piece.

The rentals are, as they normally do on a growth curve, they climb pretty steady quarter-by-quarter.

So it's going to all depend on just that fluctuation on the sales piece of it.

Matt Beeby, Global Hunter.

Maybe go back to when you look at the shale plays and the things that are emerging in that 12 to 18 months.

Can you talk about the competitive landscape?

If you look, there's going to be an awful lot of work out there, it's just a matter of timing.

How do you all look at that?

Well, competitively, we've got the largest fleet that concentrates on the wellhead portion of the business exclusively.

And, of course, we're focused on the shale.

So we're very well positioned from the competitive standpoint.

And I think you can also see that same number as I mentioned in the call from the point that our pricing is -- even in a $3.50, $4.00 market, our price is up 2% over the year.

Our horsepower is climbing.

So those things are going in the right direction.

Competitively, in the areas we're in, we tend to have majority share of the wellhead markets.

And as we look at these new areas, we certainly think, as we move into -- as -- as we're needed and start moving into these other plays, that we'll be the dominant player in those.

Now, whether it's dominant moving in or dominant a year or two down the road depends on who might already be there and what's going on in those markets.

But we always do a real good job going into an area.

The good thing about a lot of these plays is we're already working with those customers in different areas.

So they know our equipment, know our service capability, and we've got a good reputation in both those areas.

So we're able to go in just as we have done in the past, and continue to compete very effectively in those areas that we choose to move into.

Competition -- that's going to be the mom and pops mostly?

Yes.

Again, I was talking about four.

When you get -- it fully depends on the market and what some of the competitors are doing.

The mom and pops tend to be the ones that we compete directly against.

But when you get down markets like we've been through and still in to a degree, even some of the guys that say they don't like wellhead.

Well, try to get back into it because they've got some equipment sitting around and try to put pricing to it, and it's good try, it's not working because I think people know where you concentrate and what your strategies are and what you're good at.

And we're consistent in our approach and our strategy and what we build and how we service it.

So we're a known commodity in that wellhead market, and that's what helps us compete against the local guys and/or anybody bigger trying to move in.

Okay.

Also, too, you mentioned the number 100 for 2010 as far as additions to the rental fleet.

That kind of implies a pretty big dropoff in the fourth quarter.

Is that 100 kind of a minimum number?

Or is it a more likely target and how do you look at 2011?

You said that in 2011 you expect to be better -- considerably better than 2010.

Can you maybe just address that?

Well, we -- yes, we expect '11 to be better than '10.

I didn't mean the 100 to imply a tremendous dropoff in Q4.

Moreso that we're getting into holidays and things like that, and you get a little -- probably while you're busy, you get a little less output, throughput through those periods.

So we think we're still -- we're going to maintain our workforce the same level through it.

We've got orders coming in on the rental side that we need to build.

So it could be 110, 115 at the end.

But, again, let's prefer to under-promise and over-deliver.

I like that strategy.

One more, if I may, then, real quick.

We're through October.

What's the trend in utilization for the rental fleet, the end of September being 69%?

Have we seen any meaningful appreciation in the last month?

It's a real slow trend, and we went from 68 to 69 in one quarter.

Of course, that's pretty slow moving.

The thing that's retarding that a bit is we're adding equipment.

So -- if we weren't adding this equipment, we could be going up 2 or 3 points a quarter.

But building and adding is retarding that apparent utilization growth, although it's doing pretty well.

It just inches up, Matt.

It's just -- you'll get 30 to 50 basis points a month, and we're still seeing that.

(Operator Instructions) Gary Farber, C.L.

King.

I just had two questions.

I was just wondering, could you talk about market shares.

Do you see any shift in market shares out there?

It's a very slow environment and sort of a measured recovery next year.

Do you think there's opportunities to grab share?

Do you need to add salespeople or do you think about adding salespeople to do that?

And then just your input costs?

Is there anything that's going up measurably versus prior quarters?

Or is it pretty much status quo?

Okay, on the share -- over the past year, and I've mentioned this before.

We've lost a couple of points in share.

And that was essentially expected.

I'm not ever going to say it's a plan, but expected from the point of we were (inaudible) from the margin and not really going after share on that stuff.

I think I mentioned before, we look at our pricing very, very carefully and clearly and seriously.

And not only from the cost side but the revenue side -- what we're putting this stuff out for.

And we won't chase half-price deals or two-for-ones or red-light specials.

As I mentioned, we'll pick the areas and the customers we won't compete in, we'll pick a price we want to compete at.

So we're not going to save some market on that stuff.

We've got a pretty good way to price to the market, we think.

And I think the numbers show it's been very effective.

So -- we've lost a couple of points over the past year.

I think that's bottoming and it will probably stay at a level -- a little over [level rate] for a bit.

Going forward, yes, I think we will pick up share.

Again, it's not a primary driver of us.

It's nice when you do, but as long as we keep the margins, which we've done, and show some good growth, which I think we're showing a bit now, market share is just kind of a side calculation.

Going forward, sales, yes, we're always looking at different areas we want to put people into or shift around or do something different.

So that's always a driver for us.

Okay, and then the raw materials stuff?

We came off our wage freeze in June and phased that in in the third quarter.

So we've seen some of that.

And there's, again, some pressure out there mainly from capital goods.

You see engine manufacturers making noises, compressor manufacturers making noises and things like that.

So we haven't seen anything yet, but there's some on the horizon, we know.

And, again, that's from a capital standpoint, so there will be more -- we'll see that effect, of course, in CapEx not in OpEx.

From an operating standpoint, we're going to see increases in oils and lubricants and antifreeze and stuff like that, I think.

But just as we were able to manage through last year, we're keeping an eye on the rental margins, and we're going to get pressures.

But we're going to have to figure out the ways like we have in the past to maintain the margins we want.

(Operator Instructions) At this time we have no further questions.

Okay.

Thanks, Erica, and thanks, everybody, for calling in.

Happy with the quarter, look forward to a good end of the year, and look forward to talking to you at the next call.

So have a good day.

Thanks a lot.

This concludes today's conference call.

Thank you for participating.