Natural Gas Services Group Inc (NGS) 2011 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group's second-quarter earnings 2011 conference call.

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

(Operator Instructions).

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

I will now hand the call over to Ms.

Idiaquez.

You may begin.

Thank you, Erika, and good morning, listeners.

Please allow me to take a moment to read the following 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 and Erika, and good morning and thank you for joining me for Natural Gas Services Group's second-quarter 2011 earnings review.

Our second quarter has been a successful one, although there have been some quarterly revenue variations in it that skew some of the comparisons, but I will point those out as we go through the call.

We continue to compete in a low-gas-price environment, and the competition remains very aggressive.

We were making progress despite the headwinds.

Our rental business has grown vigorously, with utilization increasing.

And we're seeing some signs of progress on the sales side, with continued gains in our backlog.

Total revenue increased 16% in the second quarter of 2011 compared to the second quarter 2010, growing from $11.9 million to $13.8 million.

For the comparative year-to-date six-month periods, revenues grew 23%.

Sequential quarters were, however, somewhat noisy from a revenue perspective due to two extraordinary items.

First, we had a very large parts sale in the first quarter of this year that I had mentioned on the last call as a one-time occurrence.

Parts sales that quarter were about three times higher than in a normal quarter, and nonrecurring.

Second, we had a negative sales revenue adjustment in the second quarter.

This had to do with how some progress payments on a couple of sold compressors were received and recognized between quarters.

Due to these items, we had sequential declined revenue of 9%.

As a rough approximation, without the nonrecurring events, our sales would've increased roughly 3% to 4% between quarters, which in essence would track the year-over-year double-digit revenue increases we were seeing overall.

Total gross margin increased 19%, from $6.8 million in the second quarter of last year to $8.1 million in the second quarter of this year.

Sequentially, gross margin increased from $8 million in the first quarter of 2011 to $8.1 million in the second quarter of this year.

On a six-month year-to-date basis, gross margin grew by $2.7 million, or 20%.

Comparing the three-month year-over-year periods for SG&A, it declined 4% to $1.46 million in the second quarter of this year.

Sequentially, SG&A increased 6%, but declined 6% in the year-to-date six-month comparative periods.

As a percentage of revenue, we currently are holding SG&A in the 10% average range.

We experienced a 35% increase in operating income for the three months of 2011 when compared to the $2.4 million level of the second quarter of 2010.

Sequentially, operating income was down $100,000, to $3.2 million, in the second quarter this year.

Part of this is from impacts from a 4% rise in our rental fleet depreciation due to our continued fleet growth.

However, as a percentage of revenue, operating income grew from 22% to 23% sequentially.

In the comparative six-month year-to-date periods, operating income grew about 42% to over $6.5 million, and increased from 19% to 23% of revenue.

Net income after tax increased 30% to $2 million for the three months ending June 30, 2011, and increased 55% to $4.5 million in the comparative six-month year-to-date period of this year.

Both of these periods increased even with the higher 38% tax rate this year, compared to 36% last year.

Sequentially, net income of $2 million in this quarter was off compared to Q1 2011, due to a $640,000 gain on the sale of our old headquarters facility in the first quarter.

That one-time sale last quarter contributed about 25% of our net income.

EBITDA for the second quarter this year was $6.7 million, a 25% increase from the second quarter of 2010, and grew from 45% to 49% of revenue.

EBITDA increased to a bit over $14 million for the first six months of this year, or a 34% increase compared to last year's equivalent period.

EBITDA decreased sequentially, from $7.3 million in Q1 '11 to $6.7 million in Q2 '11, but held at 49% of revenue.

Fully diluted earnings per share for the second quarter this year was $0.16 per common share, as compared to $0.13 in last year's comparative quarter and $0.20 last quarter.

Total sales revenues increased 6% in the second quarter of 2011 when compared to the year-ago quarter, and were up 44% to $5.8 million for the six-month year-to-date 2011 period.

Sequentially, due to the compressor sales revenue adjustment and the large parts sale in Q1 '11, total sales revenues in Q2 '11 were about half of what they were in Q1 '11.

Interestingly, and offsetting some of that, were our flare sales almost doubling quarter to quarter.

Gross margins in the year-over-year and sequential quarters increased dramatically, in the range of mid-30% up to mid-60%, but they were skewed by the items we've already discussed -- the best gross margin comparison of the six-month periods ending June 30 of each year -- and increased from 34% to 45% of revenue.

Again, noting that flares are having an increasing influence on those composite margins in the sales component.

Second-quarter 2011 compressor revenues were impacted by the adjustment and delays in the projected revenues from our backlog in the first quarter of this year.

If you recall, our backlog at the end of Q1 2011 was about $7 million, and that has now grown to the $8.5 million to $9 million range.

However, we did not have any of those projected sales materialize in the second quarter, due to extensive customer design changes on a proprietary compressor project we are contracted on.

I noted in my last call that part of that backlog was supposed to ship in Q2, but that didn't happen due to the design delays.

The work is still there.

The scope has, in fact, expanded.

We are getting paid for the added design work, and, [yes, we're] starting to ship.

But it'll be Q3 revenue instead of Q2.

Geographically, we are seeing an increase in international inquiries, and some of our backlog is for overseas projects.

For the three months ending 2011 -- well, the current three months -- compared to 2010, rental revenues increased 17% to $11.6 million.

Gross margins in the current quarter were 58%, compared to 62% last year and 60% last quarter.

Again, recall that I noted that rental margins could slip, in the last call, due to some higher comparative overhaul cost -- we anticipated to overhaul idle rental equipment going out on contract -- and the associated [build installation] expenses.

These type of expenses always have an impact in advance of the rental revenue stream.

Sequentially, rental revenues were up 7% to $11.6 million in the current quarter.

We ended the second quarter with a rental fleet utilization rate of 72% on a fleet size of 2,031 compressors.

Rental CapEx for the second quarter 2011 was $9 million, compared to $10 million in the first quarter this year and $3.4 million in the second quarter 2010.

All of our capital expansion is currently being self-funded.

From a geographic perspective, we continue to place equipment at the Barnett Shale and San Juan Basin, our traditional areas.

But we've also seen some movement into the Marcellus, Eagle Ford, and other shale areas.

Oil-rich plays are actually working to our advantage, and providing growth and opportunity through low-pressure casinghead gas sales and gas-lift applications.

We think the 15% to 20% [real] growth rates we are experiencing in a low commodity price market are exceptional and, according to our market share information, exceed the growth rates of major competitors.

Our overall market share is back to our peak 2008 range.

And, in fact, we have the same number of active compressors in the field now as we did during the peak in the fourth quarter 2008, the difference today being, of course, that we have a larger fleet.

Turning to the balance sheet -- our total debt, short term and long term, was $2 million as of June 30 of 2011, and cash on hand was $17 million.

Our operating cash flow for the first six months of this year was $16 million.

Summarizing, we continue to make gains in the market, whether it is in existing areas, moving into new areas, or discovering new applications.

Activity in gas shale seems to have stabilized, with present growth coming from the liquid-rich, oil-oriented plays.

Our share penetration has grown, and we are maintaining our margins.

Our cash-generation ability continues unabated, and our liquidity enables us to make our own opportunities.

We think the worst in the market is behind us, but it is still very competitive.

Rentals continue to perform, and sales are increasing.

But as we have seen again this quarter, the sales business still carries that quarterly variability that makes forward visibility very difficult.

We are, however, optimistic going forward, and are confident that we can continue to grow our business in a profitable manner.

From an industry production and consumption perspective, it looks like the natural gas supply-and-demand gap is closing, albeit slowly.

Production is up year over year, but according to EIA, it is expected to slow in the fourth quarter this year.

Consumption is expected to grow 2% this year, but [in adding that], we'll still have more gas in the market than is needed.

But a positive development has been the lower imports from Canada and overseas LNG, and higher exports to Mexico and Canada.

Storage levels are, in fact, lower now than last year.

EIA gas pricing predictions are $4.40 average in 2011 and $4.54 average for 2012.

Not much of an increase, but the first time in two to three years that it's increasing year over year.

I personally think pricing will be better than this in 2012.

I'm not going to predict, but I will say that EIA was 8% low on their price forecast for June 2011.

If they're off that much on their 2012 prediction, that puts the average price close to $5.

There are also some longer-term interesting things happening in the coal markets pertaining to coal-gas switching.

We're seeing market share loss for coal due to the comparable BTU pricing with gas now.

Will that disappear if gas price rises?

Some will, but the switching is going on in electrical generation, which tends to be a more structural change, and the trend is definitely with natural gas.

I'd like higher gas prices, but our revenue growth is running at 15% to 20% annually in a $4 gas market.

That is good growth in this kind of market, and proves that we can grow in this environment and maintain margins.

From our view, higher gas prices don't determine our growth, only the speed and slope of it.

As for my contemporary comments, there were quite a few topics to choose from this quarter, and it's hard to decide, so I'll address three of them, albeit briefly.

I'll start with the latest investigative reporting on the fallacy of shale gas and how it is supposedly illusory, a sham, and even a Ponzi-type scheme.

This line of debate has been created by the New York Times in a series of articles filled with pseudo-revelatory and sensational quotes from industry experts.

Only problem with these industry experts is that they are all anonymous.

Not one source is named or identified.

So we are supposed to believe that a reporter in New York City has broken a secret code perpetuated by the SEC, independent reservoir engineers, auditors, and millions of investors and analysts that shale gas isn't sustainable or economic.

I'll be the first to say that I don't know the detailed economics of any particular operator.

But I do know that NGS has set over 1,500 compressors in the shale gas plays over the last decade, with a vast majority of them still pumping gas.

Have the wells declined?

Yes; all wells do.

Have they declined at higher rates than conventional wells?

Absolutely, and that is a well-purported and documented phenomenon.

Actually, that fact is what drives the higher density of compression.

All I can relate is the anecdotal evidence that we, and many others, have built a successful company on.

For example, we have more compressors running in the Barnett Shale today than we had in our peak quarter of 2008, and at a much lower natural gas price margin.

In fact, Exxon Mobil said their net development cost in the Barnett are $1 per Mcf, and that is an improvement of 50% over the last five years.

Our third-largest area remains the Antrim Shale in Michigan.

It's not a hot spot, but the Antrim was developed in the '70s, and there's still drilling and production going on.

I personally prefer the economics I measure with real dollars over those of a cub reporter in New York City.

The article was roundly criticized by many.

I can tell you more than a few without any industry affiliation -- John Hanger, former head of the Pennsylvania State Department of Natural Resources; Melanie Kenderdine, executive director of MIT's Energy Initiative; Christopher Helman of Forbes; and various analysts from large banks, including JPMorgan and UBS.

But you can't always bet 1,000, and there was, however, one publication that agreed with Mr.

Urbina, the author.

And they said -- and I quote in their broken English -- even though the shale gas story was very successful in the United States, it has no big future in that particular moment, because the shale gas production involves physic and ecological risks.

And the second issue is that the production itself is very expensive at the moment compared to the production of natural gas.

You have to drill a lot of wells to produce a lot of gas, and, again, every single well costs a lot -- unquote.

The publication agreed with him, the Voice of Russia.

Let's see.

Next I'll talk about one of my favorite subjects, wind energy.

Not from the perspective that you might think -- that is, the fallacy of those economics, although it's well known that wind energy wouldn't exist without federal subsidies.

Let's hope those, too, go the way of the ethanol handouts.

No, this is going to be more fun and not bothered by that inconvenient hurdle of integrity.

It's Robert Kennedy's support for wind energy unless it spoils his view at Hyannis Port, Massachusetts.

The great thing about this is that, try as I might, I couldn't have dreamed it up.

Have you ever seen his many objections thrown out about how bad it is to build wind farms where he can see them?

They have tried to appeal to the Indians' need to see the sunset unobstructed, the need to protect birds from flying into them, interference with ships -- schooners, I assume -- and even that they will disrupt radar signals, with dire consequences for our military preparedness.

Hyannis must be more important defensively than we've ever been led to believe.

Every one of these objections over the last few years has been litigated, and he has lost every time.

So his last resort is the ultimate one.

He's objecting because the power from this wind farm would be too expensive.

What?

He's falling back to an economic argument against wind power?

I'm impressed; he's a wily sort.

Those arguments are typically emotionally based.

I would never have prepared myself to fight him on the economics of it all.

Mr.

Kennedy invoking the high costs of green power to show its folly is totally out of character, and he may actually be able to confuse his opponents into submission.

But it seems to me that he's painted himself into a nice, neat little box.

I can't wait to see how this one comes out.

Okay, last one.

Don't let the order fool you.

The Strategic Petroleum Reserve -- you know, the large reservoirs of oil meant to be used in the event of a 1975-type oil embargo, for events where the supply of oil is suddenly and dramatically disrupted through nefarious actions of our enemies.

Now, don't misunderstand this.

The purported reason for the release of oil from the SPR was the Libyan uprising and the concurrent rise in gasoline prices.

That's all well and good.

The uprising had been going on for three months by that time, and prices were already on their way back down.

Additionally, this was all orchestrated by the IEA, the International Energy Agency, based in and controlled by European countries, those great defenders of free markets, and we followed them.

There have only been two other times that oil was released from the SPR -- first in the Kuwaiti war, when there were real disruptions caused by a real war; and then again during Hurricane Katrina, where there were other supply disruptions.

This time, there was not a supply disruption.

There was not any national security issue.

There was only a price that the administration thought was too high.

What if I thought cars were too expensive?

Would I want them in the automobile business?

Oh, wait, bad example.

The point is that governments never, ever know how to positively intervene in markets; they only distort them.

Did prices go down?

Yes, for about two weeks.

And then they recovered, and now you can't even tell it happened unless you're listening to me.

There's only one way to get a lasting impact of oil or energy prices for anywhere longer than a week, and that is higher supply and lower demand.

The problem with all of this is that it was a purely political ploy.

There was no market reason for it, no strategic reason for it.

It was only to appease a particular political constituency; no other reason.

This was nothing but market manipulation for political points.

The corollary to this is, of course, the actions we should be taking to insulate ourselves from disruptions -- radical solutions like drilling, fracking, and producing our own oil resources, encouraging the greater use of abundant natural gas, nutty things like that.

But lest I run out of things to talk about in the future, I'll save this one for later.

Thanks for listening, and Erika will now open the lines to questions.

(Operator Instructions).

Our first question comes from Matt Beeby from Global Hunter Securities.

Please state your question.

Hi, Matt.

You talked about the impact of the overhauls on your reactivated units coming out of the idle fleet.

Can you quantify the number of units and then maybe speculate on when you see a more meaningful uptick back to kind of that historic 60% type gross margin run rate?

Can you give some expectations there?

Well, probably the -- just an easy way to quantify the number again.

We're 72% utilization now.

Probably will run around 68%, 69%, so 3% on a 2,000 fleet that was about a net of -- what was that, another 60%?

Yes, another 60% right there, but you're always getting turnover and churn in that, so you get some back and get some going out.

We probably, from a net standpoint, have used equipment going out.

It's probably in the 60% to 80% range of units coming out of the yard and going out.

And I missed this in the last call, and we anticipated this might impact us some, but weren't sure how or when because that stuff rolls out at different times.

But that's what we think impacted that margin somewhat.

-- ask if the bulk of that reactivation were largely complete in Q2, or is there some carrying over to third quarter as well?

Well, the stuff we're anticipating is largely done, but of course, we would like that to continue on, because the good thing about that is it's pulling the equipment out of the yard.

And so utilization starts to go up.

We get the good incremental margins on that stuff once you get the expenses behind you.

And plus, as long as you can keep rolling that along, you'll have the revenue start kicking in and starting to cover some of the other expenses that you're generating from all that equipment going out.

So it's a good thing if we can keep that going like that.

It'll just remain to be seen how that works.

Right now we're still building quite a few units, so we're getting a mix of both right now.

Okay, great.

Maybe I missed it.

Did you mention the number of new units added to the fleet in the second quarter, and then expectations for growth?

Are we still on track through 2011?

I didn't, Matt.

In fact, I was sitting here just thinking about that when you said that.

We had 2,031 at the end of Q2.

And I'm --

About 50?

-- shocked at myself that we didn't have that number.

And then, yes, probably about -- yes, it's going to be right around that 50 range, somewhere like that.

(Inaudible) quarter.

Okay, thanks.

Okay, thanks, Matt.

(Operator Instructions).

Matt, you had a follow-up question?

Yes.

Thank you, appreciate it.

Just wanted to talk maybe number of units added into the oil window, either the Barnett or the Eagle Ford.

Say it again?

The number of units going into the Barnett and the Eagle Ford?

Yes, with respect to maybe kind of more that the oil windows have applications that you'd referenced.

Okay.

All right.

Well, the majority of the growth in the Barnett is in that oil and gas play.

I'm hesitant to say exactly how many are going in there, because it's a little bit of a competitive situation in that market.

But yes, we've -- I'll say probably -- yes, and I'm going to mix it up here a little so you can't tell exactly.

But of -- I just looked it up.

At the end of the first quarter, our rental fleet was 1,978, so yes, right around -- yes, looks like around 50, 52 units.

Yes, so probably of that, we're getting I'll say maybe half into the north and northeast Texas area, which is going to include the Barnett gas and the Barnett oil plays, and then the balance going to some other areas.

Now, actually, most of the stuff we're seeing in the Eagle Ford is just coming out of the yard.

So part of those overhaul expenses, we're sending some stuff to the Eagle Ford.

And there's a couple other shales that I didn't mention just because I want to go and get into them yet, because we're just starting to move into them.

People are familiar with the shales, but they're pretty new shales, and we're starting to see some equipment move into those, which actually we're a little -- surprised us.

But next quarter or two, we'll have more information on that and maybe be able to tell what we're doing there.

The main thing is it looks like these liquids made in shales are really providing the growth right now, and that's no surprise.

That's where the activity is, and that's where the economics are.

It's just -- in fact, it surprised some people.

And we figured we'd get some growth out of that.

We didn't know how much.

But I think what surprised some people was that there was any growth for compression in an oil-oriented play, but it's because a lot of this stuff is producing low-pressure gas along with it.

Okay, great, and I'll leave it with one more maybe.

You had mentioned other shales.

Obviously, you did presumably mention the Marcellus.

Any comments on the Haynesville?

Is that one that we'll have to wait a couple quarters to find out about?

No, the Haynesville's still -- those wells are still producing pretty good pressure.

So you're seeing some big centralized horsepower going in, which is always the first phase of that.

But those are still pretty good wells in there, and they're not -- they're declining, but they've still got pretty good pressure and pretty good volume.

So yes, we're still looking for that to be 12, 18 months down the road.

But the only horsepower we see going in there is just large central stations right now.

So the ones I was -- that's not the one I was -- there's a couple others that we're going into that we haven't mentioned.

All right.

Thanks, Steve.

Appreciate it.

Okay, thanks, Matt.

Our next question comes from Randy Bhatia from Capital One.

Please state your question.

Hey, I was just hoping you could give some color on where you see margin trends heading in the third quarter and the rest of the year, and then maybe even into '12.

Well, from the rental side, we're always aiming for around the 60% range.

And over the past year, it's varied from 58% to 62%, so the 60% range is a good one to aim for there.

The problem on the sales side is, if you look back on it, it's just all over the place, and not because necessarily a certain piece of the sales changes that much, but we get a lot of mixed shift in there.

For example, right now those margins are running up real high, but we had a small sales component, a large flare component, rebuilds, parts, etc., that tend to carry higher margins, and pure sales are becoming -- are a bigger piece of the pie right now.

Now, as things continue to grow and this backlog continues to build out and get recognized, that's going to tamp down because sales are more of a 20%, 25% margin business.

So as I mentioned, Randy, in the call, the margins -- I think we had margin differences from other periods.

You have sequentially and then year over year of 35% to 65%, and that's just because of shifting we're seeing in all this stuff.

And the flares are having a pretty big impact on that, because that's always been a business that's been nice and steady, but nothing to write home about.

And it's gotten pretty busy because there's a lot of flare business going on in these plays that there's no gas infrastructure in.

So it's real hard to put a handle on margin trends in that business unless you know exactly how those three or four components can play out, and there's very little visibility in that right now.

And if I could, just kind of a quick modeling question, and I apologize if you covered it already.

Just the dollar amount of the total sales segment backlog at quarter end?

About $8.5 million to $9 million.

Thanks very much.

Sure, thanks.

At the time, we have no further questions.

Okay.

Thanks, Erika, and thanks, everybody, for joining us, and we'll look forward to talking to you about three months from now.

Goodbye.

This concludes today's conference call.

Thank you for attending.