Natural Gas Services Group Inc (NGS) 2011 Q3 法說會逐字稿

Good morning ladies and gentlemen, and welcome to the Natural Gas Services Group announces its third quarter 2011 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 like to turn the call over to Ms.

Idiaquez.

You may begin.

Thank you Ross.

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 on 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 Natural Gas Services Group.

Steve?

Thanks Modesta, and thanks Ross.

Good morning.

And thank you everyone else for joining me for Natural Gas Services Group's third quarter 2011 earnings review.

We are encouraged by our third quarter results.

Our revenues are higher in all product lines, and are generally supportive of future growth.

I am pleasantly surprised at the amount of activity we are seeing in what is in many respects a mediocre market.

Gas prices continue to be weak and the economy can't seem to get going, but our rental and flare systems growth has been vigorous.

For all comparative periods revenues have increased by at least 20%.

Total revenue increased 24% in the third quarter of 2011 compared to the third quarter of 2010.

Growing from $14.2 million to $17.7 million.

Sequentially revenue increased from $13.8 million to $17.7 million or 29%.

On a nine month year-to-date basis total revenue grew by $8.8 million or 23%.

Total gross margin increased 14% from $7.7 million in the third quarter of last year to $8.8 million in this current quarter.

Sequentially, gross margin increased from $8.1 million in the second quarter of this year to $8.8 million in the third quarter of 2011.

On a nine month basis, year-to-date gross margin grew by $3.7 million or 18%.

Looking at SG&A comparing the three month year-over-year periods, it increased from $1.4 million to $1.6 million in the third quarter of 2011.

Sequentially, SG&A increased from $1.5 million to $1.6 million in the third quarter of 2011, with the majority of this increase being a one-time vesting of restricted stock for a retiring Director.

For a comparative nine month period as a percentage of revenue, we are currently holding SG&A in the 9% average range which is down from the 12% level of last year.

We experienced an 8% increase in operating income for the three months of 2011 when compared to $3.4 million level of the third quarter of 2010.

Operating income was impacted relative to revenue growth in this year-over-year period due to a mix shift towards relatively lower margin compressor sales, and higher make ready and installation expenses for real compressors going on new contracts.

Sequentially, operating income up 13% to $3.6 million inthe third quarter of this year.

In the comparative nine month year-to-date periods, operating income grew by 28% to $10.2 million and increased from 21% to 22% of revenue.

Net income after tax increased to $2.2 million during the three months of the Q3 2011 as compared to the three months of last year, same three months.

Again, net income lagged revenue growth due to the factors just mentioned plus the higher tax rate this year of 38% versus 36% last year.

Net income sequentially increased 11%.

On the nine month year-to-date basis, net income of $6.7 million was up 33% when compared to last year.

EBITDA for the third quarter of this year was $7.2 million, a 12% increase from Q3 2010.

EBITDA increased 7% sequentially from $6.7 million inthe second quarter of this year to $7.2 million currently.

EBITDA increased to $21.2 million for the first nine months of this year, a 26% increase compared to last year's equivalent period.

Fully diluted earnings per share for the third quarter this year was $0.18 per common share up from $0.16 last quarter, and 34% higher than the comparative nine month period last year.

Total sales revenues were $4.8 million an increase of 30% in the third quarter of 2011 when compared to the year-ago quarter.

And were up 53% to $10.6 million for the nine month year-to-date 2011 period.

Sequentially, total sales revenues in the third quarter of this year more than doubled from $1.9 million to $4.8 million.

Compressor sales drove this big increase in the year-over-year and sequential quarters.

I will remind you this was because we completed the units originally scheduled for the second quarter, but that were delayed and pushed into this current quarter instead.

In the nine month year-to-date period compressor, flare and parts sales contributed evenly to the total sales revenue gains.

We are happy with our sales growth, although we think compressor sales will continue to be volatile in this recovery.

Total sales gross margins in the sequential quarters increased 25%.

The year-over-year quarter increased 6%, and the nine month year-to-date period showed a 60% gain.

I would like to remind everyone that our compressor sales gross margin in the third quarter of 2010 was an extraordinarily high 41%.

So while 18% margin is very good in this market, when compared to the year earlier quarter it appears skewed.

I hasten to add that 18% margin is still twice as high as the largest competitor in our industry.

Compressor sales backlog as of September 30th of this year was a bit over $8 million.

For the three months ended 2011 compared to 2010, rental revenue increased 23% from $10.3 million to $12.7 million.

A sequential increase in rental revenues were 9% with year-to-date increases of 17%.

Rental gross margins in the sequential quarters increased 5%, 15% in the year-over-year quarters, and 11% when comparing the year-to-date nine month periods.

Gross margins as a percent of revenues were 56% in the current quarter, compared to 59% last year, and 58% last quarter.

As I mentioned last quarter, our rental margins are impacted by the make ready expenses we incur when we prepare and install idle equipment for a new rental contract, and is a combination of higher shop overhaul and field labor expenses.

This is an inherent advance cost as our utilization grows, and essentially all of the increased expenses the last three quarters have been due to this.

However, as you can see these expenses are followed by offsetting revenue.

I will add that in spite of this our rental margins continue to be some of the highest in the industry.

We ended the second quarter with a rental fleet utilization rate of 74% on a fleet size of 2,076 units.

Although our fleet is larger this quarter we have a record number of active compressor units earning revenue,higher than our prior record quarter at the end of 2008.

Quarterly rental revenues are within $100,000 of the record rental revenues we posted in the first quarter of 2009.

Average rental price in this quarter was $2,734 per unit per month, the highest since the first quarter of 2010.

With the interesting and encouraging trends we are seeing is our participation in the oil shale activity.

Many of these wells produced associated gas with them, and they typically need compression the first day of production.

Not only is this providing a majority of our growth, but we now have 15% of our fleet in active oil areas, thereby providing us with some diversification in oil exposure.

Capital expenditures of which 95-plus percent go to growing the rental fleet were $7 million in this third quarter.

Compared to $9 million the second quarter, and $10 million in the first quarter of this year.

This year's $26 million in capital has all been self-funded.

These capital expenses provide some indication of future rental revenues since 95% of our build is already contracted in advance.

We think that rental growth rates we are experiencing are exceptional in this market, and exceed the growth rates of major competitors.

Looking at the balance sheet, our total short term and long-term debt was $1.9 million as of September 30, 2011 and cash on hand was $16.5 million.

Our operating cash flow for the first nine months of this year was $24 million, compared to $22.2 million in the first nine months of last year.

Summarizing, we are pleased with our performance this quarter.

Our rental revenue is showing solid growth, and has increased 17% year-to-date.

We have seen some impact to our current rental margins, but this is primarily due to the make ready expenses inherent in new rental contracts.

Flare system sales have doubled year-to-date and carry exceptionally high margins.

Although still not out of the woods, our compressor sales are up over 50% when year-to-date periods are compared.

We think these results attest to the favorable market position we occupy and the exceptional execution demonstrated by our employees.

From a market perspective, there is really not much new that is actually encouraging.

What I mean is thatall primary natural gas indicators are not significantly deteriorating, and some in fact hold a little encouragement.

Henry Hub pricing is within 2% to 3% of last year at this time, and in many regions pricing is higher than last year.

Storage is flat year-over-year and natural gas drilling is down 5% year-over-year, which will have some impact on supply going forward.

To touch on a couple of the encouraging items.

EIA predicts a 4% higher average price from natural gas in 2012.

That is good but the interesting part is that pricing is projected to bottom during this shoulder season, and start a slow upward trend.

If that is true and allowing for seasonal variations, the price of natural gas could be $4.75 to $5.00 next winter.

Another point of interest is that over the past 2.5 years from January 2009 through July of 2011 supply increased 9.4%, but demand kept pace at 9.2% growth.

I think it is this supply demand balance and a pricing floor from a co-equivalent price has kept pricing from dropping lower.

Another factor helping to temper the supply side is that we are backing out imports.

Canadian and LNG imports have declined significantly due to our growth in supply.

I am too smart to predict natural gas prices, but I do think there is an upward bias.

Now I would like to comment on the contrived controversy surrounding the Keystone XL pipeline that is being proposed to deliver oil from Canadian oil sands to the Gulf Coast of the US.

I equate the current protests with those surrounding fracking.

All of a sudden hydraulic fracturing is the bane of the Western world, a corrupt symbol of a world gone mad, an environmental disaster waiting to happen.

All told an evil tool.

How in the world can we live with something like this.

Wait a minute, it has been around sense the early 1950s.

How does this equate to the Keystone pipeline?This pipeline has been under US government scrutiny for over five years.

It has passed all of the environmental reviews from the EPA.

The pipeline has its Material Safety Administration has no problem with it, and the State Department has implied its acceptance of the plan.

All of a sudden we have protesters saying that it as bad thing after five years.

The apparent argument is that we will disrupt the environmental balance.

The only balance we are really threatening is the negative balance of trade payments that we send to the Middle East every day.

Why do I call this a contrived controversy.

Because the stated reasons for opposition do not stand up to even minor scrutiny.

The primary issue being raised is that extracting oil from tar sands is an environmental damaging method of obtaining oil, that the CO2 emissions from the process are much higher than other methods of extracting oil.

First, it does release more CO2 but only 15% more than equivalent methods, and greater strides in controlling CO2 over the last and next five years, will more than offset by cumulative impact.

If you really want to impact CO2 emissions import this oil and replace the coal we are burning.

Now that is stuff is dirty.

Second, this administration is doing just about everything it can to discourage the exploration for oil on our own soil.

So now apparently we don't like it here, we now want other countries to not produce their own natural resources.

If this pipeline is not laid to the US that won't stop the CO2 emissions.

The Canadians have already said that they will be extracting and importing this oil whether we like it or not, and the next likely customer will be China.

I would also ask the additional question of who do we think is a more environmental attuned country Canada or the countries we now import from, Saudi Arabia, Venezuela, et cetera?

Given the facts of the matter if we are serious about controlling emissions I would hook up with countries that hold the same values.

The second contrived issue is that it may create jobs, but they will be short term.

We are talking about a peak workforce of 20,000 people in very high paid work.

And short-term is the three to four years of construction will take.

Inthis economy, any job especially high paying ones should be pursued vigorously.

But do we not have a litmus test for jobs that they now have to be a certain duration and greener than other jobs?

I will take these short-term jobs over any of the shovel ready jobs we were promised in exchange for $1 trillion dollars TARP bill.

Wait, those weren't short term.

They just didn't exist.

One argument that doesn't seem to be rising to the surface is the economic and national security that comes from importing oil from a friendly country.

For the past 40 years we have talked about energy security and how to achieve it, but our own industry has been hamstrung all along the way.

Our imports have grown larger and our importers more radical.

We are buying oil from countries that tell to us our face that they don't much care whether we exist or not.

We now have an opportunity to significantly change the balance of the world oil markets in our favor with a friendly country that has reserves approaching those of Saudi Arabia, and we dither.

I am all for a cleaner world but I am more worried about the energy and national security tightrope we continue to walk.

Has any one even noticed what is happening in the areas of the world that controls the world market, Iran, Iraq, Venezuela, Libya, Kuwait, Saudi.

It is a powder keg.

We know it, and when we get an excellent chance to diminish our reliance on it we back up.

It makes no sense.

In spite of what was said before that the White House would not intervene, and this would be an independent assessment, we now have President Obama saying that he will make the final decision.

Unfortunately, this will now be a political decision, and based on this Administration's attitude towards the oil and gas industry I am not encouraged.

Let's see if National Security, Energy Security, and the promise of significant employment trump political interest.

Speaking of jobs, the Administration submitted their Jobs Bill recently.

Although it is actually a tax measure that again, after at least three defeats attempts to raise taxes on oil and gas industry.

I am not quite sure how higher taxes and increasing jobs comingle, so I will leave that to others to ponder.

Lest you forget this is the same Jobs Bill that didn't even pass the Democratically controlled Senate.

This Bill contains 14 different tax increases, with nine of them directly exclusively and punitively targeting the oil and gas industry.

Not only that, these taxes are discriminatory because other industries will be allowed to continue to take advantage of the same tax allowances.

It is one thing to repeal tax preferences altogether, but to single out one industry and characterize them as a ruthless competitor for taxpayer handouts is unfair and wrong.

Like I say, it is not paranoia if they actually are after you.

The oil and gas industry is presently taxed at an effective rate of 41%.

For comparison the average tax bracket for industrial companies is 26%.

This industry pays more than its fair share.

If you want a real Jobs Bill, domestic producers should be able to responsibly develop and produce abundant energy in our offshore and onshore deposits.

According to a recent Wood Mackenzie Study, this loan would create more than 1 million jobs nationwide, create an estimated $800 billion in additional government revenues, and contribute 10 million barrels more of oil and natural gas per day by 2030.

It is the premise that the playing field needs to be balanced is a falsehood, as this Administration is instead trying to pick winners and losers.

They wouldn't do that.

Oh wait, Solyndra.

Although there are plenty of things to talk about, to this point I have lived with my contemporaneous comments to those affecting the oil and gas industry, and unfortunately there are enough issues there to comment on.

However, a few weeks ago our President made a comment that I take personally, and I quote, the United States have gotten a little soft in the years before he took office, and needs to regain its competitive edge in the global economy.

We now have a President inthis time of economic difficulty stating that Americans have lost our competitive edge, and that we as individual workers and companies are soft, and that we are retarding our recovery.

The problem is the economy is not that Americans are less than competitive or lazy, it is that this country presently has no leadership direction or certainty.

That was in my opinion an insulting comment to all workers in this country employed or not, and the real tragedy is that it has been the actions of this Administration that have in my opinion exacerbated and lengthened our economic malaise.

It is not the quality of our work force or lack of motivation of our citizens, it is record debt levels, the interference beyond reason of governmental agencies and private enterprise, and the constant threat and uncertainty of higher taxes.

That Mr.

President is a problem, so don't insult me and other workers when looking for a scapegoat.

I appreciate your listening to me and Ross, if you will now align the questions.

Thank you.

(Operator Instructions).

Our first question comes from Joe Gibney from Capital One.

Joe, please go ahead.

Thanks.

Good morning, Steve.

Hi, Joe.

Just a question a little clarity on the compressor sales in the quarter.

You referenced sales up 50% year-to-date over the comparable three quarter period.

What were compressor sales dollar number in the quarter?I know you gave the 18% margin, just curious what the dollar number was?

Compressor sales.

In third quarter?

Yes.

Right around, a little less than $2.7 million.

Okay.

And out of your $8.8 million backlog, how much do you expect to kind of burn through here in the fourth quarter?

Let's see.

There is about $5 million of that I think is through, hold on one sec.

A little over $8 million backlog, and roughly about $5 million to $5.5 million throughthe end of the year.

Alright.

Helpful.

And then you reference the liquids driven rental fleet growth is 15% of your fleet now, stepped up on a nominal base on a year-over-year basis.

The relative driver of your rental fleet here near term.

Help us with fleet addition expectations here in the fourth quarter into next year, just given what you are seeing on all of that liquids driven growth for now?I know we have been kind inform the 35 per quarter run rate expectation for the back half of the year.

Looked like it stepped up a little bit here in the third quarter?

We built the thing around 45 in Q3.

It is going to come off a little bit in Q4, just because there are some budgets that are being not cut but just they have run out of budget money towards the end of the year, and this has been anticipated and I think maybe I even referenced that before.

I don't think it is going be, it might be back in the 30 range or so from a build of Q4.

And then we anticipate probably getting back into 2012 maybe just having about the same sort of I guess sequence of builds we saw this year, starting back up first quarter, peak in mid-year and tail off towards the end of the year.

I think we are around about 200 builds this year.

I would say we would see the same, maybe 10% or 15% higher.

Okay.

That is helpful, and one last one for me and I will turn it back.

Just general outlook and color on compressor sales, margin and pricing, any more signs of life?I know you have had some success with some international contracts that have come through, but just curious on the pulse of how things are going from a pricing and margin standpoint on the compressor sales front?

Well as I mentioned, our margins have held up very well in this market compared to the industry.

It is just the volatility of this business is still out there.

The backlog is encouraging, but the backlog is only out about two to probably just a couple of quarters, and back when things were really growing we saw backlogs out a year.

We could see what was happening out that far.

So it is still kind of a treadmill to keep that backlog up.

And I expect it to be up and down.

It is still a volatile piece of it as we are going through what we are hoping is a recovery from the sales side.

Certainly rental we think is well on its way, but the sales is still kind of an up and down thing.

We are still I think as I mentioned before an example, orders coming in that are nine months old that we had already expected not be awarded.

Some coming in and people changed their mind.

There is still just a lot of cloudiness out there as far as what we see.

But we will take what it is, the backlogs have held steady for a couple of quarters now, but it is just running to keep up with it.

Understood.

I appreciate it.

Thank you.

I will turn it back.

Okay, thanks.

The next question comes from Matt Beeby from Global Hunter Securities.

Matt, please go ahead.

Thanks, good morning, Steve.

Hello, Matt.

Steve, can you talk about maybe quantify a little bit of the costs that were for the reactivations in the quarter, the component there?And then expectations for that piece also Q4 are we kind of through most of that work, and we should see an immediate pop in the margin on the fourth quarter call?

Well, we will still have some of that going forward.

It is hard to predict sometimes because that stuff happens within a quarter.

You don't get a whole lot of if you have somebody come up and take X number of units, typically that stuff is delivered within 30 days, so a lot of this stuff happens in the quarter, so we might see here and I mean I would expect those make ready expenses to come off just a little bit in Q4, but in one sense I kind of hope they don't, because it just precludes some further rental growth out there.

So it is up about a third Q3 versus Q2.

And of course, you see it on the margin but I think we will see in future revenues going forward, too.

I expect to come off a little Q4, and I think once we, this is just a function of coming out of the downturn, and still kind of ramping up, and the first part of us coming out last year was we were building a lot of new equipment and putting it out there, because we are sold out of those models, and now what we are getting into is really what we have been waiting for, is some of the idle equipment going out.

That is driving the utilization, and of course, driving the revenues but driving the expenses to that point.

But it is all good that is what we want out of there, is the stuff sitting in the yard.

So I don't want to venture a guess as to what it might or might not be, but I think going into next year I think we will probably see some moderating of that, and those margins will get back up towards the 60% range.

That is helpful, Steve, thanks.

Also maybe remind us about how many idle smaller units have been reactivated in the last couple of quarters, and where the distribution by region where those have mostly been sent?

Are there any new bases that you are looking at?

Probably out of the total number we have put out in the yard, I would guess the smaller units, say being 80 to 125 horse is probably two-thirds of them would be of that size right there.

And we are really seeing them go all over.

We have had some going to San Juan Basin.

Some being placed up in the Granite Wash, some in the Barnett.

It has been pretty evenly scattered, some even up in the Utica Shale.

It has been a little evenly scattered like that and then those two areas are a couple of new areas we are seeing equipment go into, the Utica Shale and then the Granite Wash for us, and again those are somewhat encouraging because they are the liquids oriented plays up there.

I mentioned in the past we have got some equipment going to the Eagle Ford, it is not a big amount yet.

And the Utica Shale isn't a big amount yet either.

We know they will be.

We really don't know if this equipment going in right now is the start of the decline in those wells to need well head compression, or if it is just we found some anomalous needs in there on weaker wells, or what it is.

We will know a little more as quarters is go by as to whether growth continues in those areas.

Great.

Thanks.

And one real quick one if I can.

Can you talk about pricing?You mentioned that you expect margins to maybe get back to that 60% level.

Any kind of pricing power, or are you seeing just enough to cover your costs at this point?

I don't think there is any real pricing power in the market.

There is just too much equipment still out there now.

And I have always kind of used the 80% utilization or higher as a benchmark for pricing power to start to come back to the providers like us.

But we are getting some price increases.

They are not going to be, they are going to cover costs, some increased costs we have got, but I think they will marginally help margins somewhat, too.

But we are continuing to talk to customers on that, and I think they are seeing the, one, the value of our service and equipment,and then the reasonableness of some increased pricing.

Alright.

That is helpful.

Thanks, Steve.

Thanks, Matt.

The next question comes from Gary Farber from C.L.

King.

Good morning.

Hi, Gary.

You alluded to it a couple of different ways, you talked about pricing, and things like that.

Can you if possible shed more color on the competitive environment?Has anything changed in the last quarter?

How do you see it, and how do you see it to the end of the year?

It seems to have gotten I guess relatively benign compared to prior quarters, the key word being relatively.

I think there are still people that have more equipment in the yards than they want, and they are more willing than we are to sacrifice margins to get it out.

We don't think we need to do that.

We are holding price and trying to shrink it just a little bit.

But there is still some of that out there.

Again, I think it has probably tamped down a little bit here recently.

But it is like the flu, it can flare up any time, and we keep a pretty close eye on it.

Right now it is probably a little better than what it has been.

Great.

In prior calls you talked about international opportunities.

Any update there?

No, I mean we have got some of those that are being built out in the backlog right now.

There is, we put out some new bids on some of that stuff.

We think that is going to be a growing business in the future.

The problem with it is such a long sales and decision cycle, it can take a long time for foreign entities and/or companies based overseas to make those decisions, and there is a lot of iteration to it.

We think it is a longer term business for us, and I think it will grow.

We don't have any more percentage of the backlog in it now than we did before.

And just the last one.

You talked at the beginning of the call being pleasantly surprised by your demand.

When you look out over the next three to six months, what is going to cause that commentary to sort of continue or strengthen?

Is it the strength of the economy?Decline rates on wells?

How do you see it?

Well, I think if we see some of the same kind of growth rates in the same kind of areas, what the surprise has been the growth we are experiencing in still a $4 gas market.

I think gas is going to get a little stronger as I mentioned.

I think that will help somewhat.

Most of it is again we are holding our own in the dry gas areas, and we are growing in the liquids oriented plays, and that has been, those have both been gratifying from a point of holding in, and then growing in these new places.

We are being able to get into those, establish ourselves, get a share of those markets.

So if that continues number one from a revenue and unit utilization perspective, and then a little bit of pricing will help.

Gas pricing.

And putting aside just the price of gas, what would prevent that from continuing?

Oh, putting aside the gas of price, probably nothing.

That means the trend should sort of continue then, no?

If gas price goes down of course things will slow a bit.

If it goes up things will speed up a little bit.

What I have always said, I mean the gas price is important certainly, but I think where the market is and where we are in it, the gas price is just going to determine our rate of growth, not whether we grow or not just how fast we grow, and what the rate might be.

But I think we have shown and we have had a $4 market essentially for three years, it seems like 30.

But we have done pretty well in it margin-wise and revenue-wise.

So we think we know how to handle this market.

We think we know better than most of our competing companies, and as long as something crazy doesn't happen, I think we will be okay.

Alright.

Okay.

Thanks.

Thanks.

(Operator Instructions).

At this time, there appears to be no further questions.

Okay.

Ross, I appreciate your effort for joining us, and we look forward to talking to you on next quarter's call.

Thanks.

This concludes today's conference call.

Thank you for attending.