Natural Gas Services Group Inc (NGS) 2013 Q3 法說會逐字稿

Good morning ladies, and gentlemen, and welcome to the Natural Gas Services Group third-quarter earnings conference call.

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

Operator assistance is available anytime during this conference (Operator Instructions).

The call leaders for today's call are Lindsay Naylor, IR coordinator; Steve Taylor, Chairman, President, and CEO.

I will now turn the call over to Ms. Naylor.

You may begin.

Thank you, Erica, and good morning, listeners.

Please allow me to take a moment to read the following forward-looking statements 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 of the Safe Harbor provision 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; and 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 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 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 said, I will turn the call over to Steve Taylor, who is our President, Chairman, and CEO of Natural Gas Services Group.

Steve?

Okay.

Thanks, Lindsay, and thanks, Erica.

And good morning, and thank everyone for joining me for Natural Gas Services Group's third-quarter 2013 earnings review.

To summarize a bit before we get into the details, NGS performed well this quarter, led by significant growth and progress in our core oil and gas compression business.

Rental revenues grew at a high rate with year-over-year revenue gains of 26%, along with 7% revenue growth on a quarterly basis.

We continue to anticipate further gains in this part of our business and, as a result, have ramped up our fabrication throughput by approximately 20% this year when compared to 2012.

Our compressor sales business rebounded from last quarter's revenue levels, is on pace with the rate of growth we have forecast.

After last quarter's exceptionally high levels, rental and sales margins return to their typical range.

We anticipate them continuing at that pace, which are among the highest if not the highest margins in the industry.

Now, let's move on to the details and I'll expound more.

Total revenue -- looking at total revenue in the year-over-year quarters, third-quarter 2013 revenues increased 13% to $21.9 million from $19.3 million in the third quarter of 2012, with rental revenue showing a year-over-year increase of $3.7 million, or 26%.

The sequential quarters of -- the second quarter of 2013 compared to the third quarter of this year, total revenues increased $1.6 million, or 8%, and rental revenue increased 7%.

Comparing gross margins of the third quarter this year to the third quarter of 2012, total gross margin increased 17% from $10.2 million to $11.9 million.

Sequentially, gross margin decreased approximately $400,000 to $11.9 million, or 54% of revenue.

This decline was due to a combination of a mix shift towards lower-margin compressor sales and more normalized sales and rental margins.

SG&A increased a little over $180,000 in the year-over-year quarters and approximately $100,000 sequentially.

SG&A is running at 10% of revenue for all comparative periods.

Comparative year-over-year quarters for operating income reflected 20% increase from $4.2 million in the third quarter of 2012 to $5.1 million this current quarter.

Sequentially, operating income decreased approximately $750,000 from $5.8 million to $5.1 million due to the mix in margin differences I just mentioned.

Approximately one-third of the decrease was attributable to higher rental depreciation from rental fleet expansion.

The comparative year-over-year third quarter's net income increased 30% from $2.6 million last year to $3.4 million this year.

Sequentially, net income decreased by $450,000 to $3.4 million, around 16% of revenue.

Interestingly, looking at the comparative year-to-date nine-month periods of 2012 and 2013, and recalling that we had approximately $11 million extraordinary sales last year, our revenues were off only 6% but our operating income was up 16% and net income has grown 23%.

Despite the revenue differences, we're delivering appreciable bottom-line growth.

EBITDA increased 21% from $8.2 million, or 42% of revenue in the third quarter of 2012 to $9.9 million, or 45% in the current quarter.

Sequentially, EBITDA in the third quarter of this year was up $347,000 compared to the second quarter of 2013.

But at 45% of revenue, we continue to experience very strong cash generation.

On a fully diluted basis, EPS this quarter was $0.27 per common share compared to $0.21 in the second quarter of 2013 and $0.31 last quarter.

This quarter marks our strongest 12-month trailing earnings per share since 2009.

Now reviewing the business segments.

In year-over-year quarters, total sales revenues, which include compressors, flares, and parts, decreased from $4.9 million in the third quarter of 2012 to $3.9 million in the third quarter this year, primarily due to lower compressor and flare sales.

However, gross margins in both quarters were a steady 37%.

Sequentially, total sales revenues increased 17% to $3.9 million this quarter from $3.3 million in the prior quarter, primarily due to higher compressor sales.

Gross margin decreased from 52% last quarter, which was a record high, to a more typical 37% in the sequential quarters, primarily due to a more normalized mix in margins.

Looking at compressor sales alone, in the current quarter, they were $2.2 million with a gross margin of 23% compared to $2.8 million, or 24%, in the third quarter of 2012.

Our compressor sales are running at lower levels than last year because, as I have mentioned in prior calls, we have dedicated more shop floor space to building rental units.

But we are at the $1.5 to $2 million per quarter levels we projected in our first-quarter call.

Our compressor sales backlog at the end of the third quarter was a little more than $4 million.

Compressor rental revenue had a year-over-year increase of $3.7 million, or 26%, from $14.1 million in the third quarter of 2012 to $17.8 million for this current quarter, with gross margins consistent at 58% of revenue for both periods.

Sequentially, rental revenues gained 7% with an increase of $1.1 million to $17.8 million this quarter, while margins decreased from 63% to 58%.

Comparatively, last quarter's margin was the highest we had experienced in almost four years; and as I mentioned, we have one of the highest margin profiles in the industry, so a retreat wasn't unusual.

That quarter was also helped by one less pay period.

For the year-to-date nine-month periods, rental revenues were up 22%, with the gross margins up from 58% last year to 59% this year.

Rental fleet utilization has also shown excellent progress over the year.

We ended the third quarter at 80% on a unit basis, which is up from 79% last quarter and 75% at the end of the third quarter of 2013.

An interesting number we watch periodically is the fleet churn, defined as number of units installed divided by the number of units terminated.

Churn is a normal function of the rental business and can give us an idea of the strength of the market.

For example, a churn of one indicates no growth, while a higher number is good and lower is bad.

For the nine months year to date this year, our churn is at 2.1, so we are setting more than two compressors for every one returned.

This compares to full-year churns of 1.6 last year in 2012, a strong year; 2.1 in 2011; and 1.4 in 2010.

Looking even closer at the individual number of new installations and terminations and annualized in 2013, the number of units installed in 2012 and 2013 will be within a close range of each other.

But the unit terminations were down over 20% this year.

This is contrary to what others in the industry are experiencing, so we are not only growing absolutely but picking up share.

Fleet size at the end of September was 2466 compressors.

This is a net addition of 74 compressors this quarter compared to 65 in the second quarter and 49 in the first.

These 188 new fleet compressors added this year are already 90% at the level we added in the full-year of 2012.

This is an approximate 20% increase in throughput.

So, as we laid out to you previously, we have made appreciable progress ramping up our rental throughput without added roof line.

Approximately 40% of our active rental fleet is in oil and liquids plays.

However, we have also added about 5% more dry gas units to active status this quarter to where we have seen some oil and gas growth.

That's not necessarily a trend, and I think it's predominantly attributable to our share gains, but it is interesting when it seems few others are seeing any activity in dry gas markets.

We spent $10.8 million for capital expenditures in this third quarter compared to $10.7 million in the second quarter.

This is a total of $29.2 million for the year to date, with 97% of this going for rental fleet additions.

On last quarter's call, I raised our capital budget estimate for 2013 from $30 million to $35 million to $35 million to $40 million, and we are tracking on the upper end of that higher range.

Going to the balance sheet, our total long-term and short-term debt was approximately $750,000 for the September 30, 2013, and cash in the bank was almost $28 million.

Our cash flow from operations through the first nine months of the year was $28.4 million.

I have mentioned in the past that I don't try to predict commodity prices anymore and that I'll just reflect consensus opinion.

But even that can be tough.

So repeating what EIA thinks, the Energy Information Administration, natural gas prices predicted to average $4.00 per Mcf in 2014, up from $3.71 average this year and $2.75 in 2012.

Well, this price level is not enough to drive much added drilling.

We think it will give added support for at least keeping existing dry gas compression in the field.

Brent crude oil is projected to be $102 per barrel in 2014, with the discount for WTI decreasing down to $6.

We think a $96 average oil price will continue to drive good levels of activity for our equipment services in all the oil shale areas we operate.

We continue to anticipate a good and growing year in 2014.

Preliminary indications are that our customers are planning for additional growth in 2014, and we are confident we'll remain a significant supplier of their wellhead compression needs.

We are well-positioned in many growing areas, our fabrication capacity is increasing, and our service response is second to none.

Erica, that's the end of my prepared remarks, and I'll turn it back to you for any questions anyone might have.

(Operator Instructions) Gary Farber, CL King.

Yes, just a couple of questions.

One, just on the CapEx.

It sounded like you are saying possibly $40 million this year.

Can you sort of give some thoughts to us regarding next year preliminarily and then also talk about the pricing environment and what you're seeing?

And you mentioned also taking share.

Can you talk about -- do you think it's service that's driving your share gains, or is it something else?

Good morning, Gary.

Let's see, from a CapEx -- yes, right now, we haven't got full [scall] on 2014 yet from all the activity in all the areas.

We're just starting on the process here the last couple or three weeks.

Everything is looking positive.

I'll say I think we'll at least be $40 million range, and I'll put a plus or minus on that, just depending on how that number is probably coming in.

You know the year is looking to be a growing year next year.

As I mentioned, we're just not exactly sure how much, but we think it's -- that's going to equate into the [220] to maybe up to [240], maybe a little more, compressors.

So we think we'll be on track to put more out than we put out this year, and the capital budget will commensurately reflect that.

Pricing wise, it seems to be generally okay.

We still see spots that don't make some sense in some respect.

It seems like maybe -- I think we pick up share just from a service standpoint.

A lot of others try to pick up share through pricing.

Of course, that tends to be what we see I think sometimes.

So it's not fully rational yet, but maybe I could say semi-rational at this point; much better than we have seen in the last year or two.

And, again, from a share perspective, just like I mentioned, primarily our service capability, we've got an excellent reputation in the field.

I've always mentioned that to everybody.

And we see that certainly in just some of our numbers but also anecdotally.

And we know of -- we've seen a couple of specific areas where we have overtly gone in and picked up some comparative share there.

So we think that will -- it's hard to predict that, when that will happen.

Certainly that's not just up to us but also to the customer and the existing providers.

So, hard to say, but we've had pretty good luck with it this year.

And one last one.

Would you say it's accelerating the share gains?

It's higher this year than I think what we're seeing the last couple of years.

But, again, I can't say it's a trend or if it will continue or anything else.

It's just we've had pretty good luck this year.

Okay.

Thank you.

(Operator Instructions) Jason Wangler, Wunderlich Securities.

Just on the churn thing -- and thank you for that; it's very interesting.

Is there any way to maybe just add a little color as far as you're adding two, are you seeing those basically two going to oil markets and the one coming back from an oil market?

Is it two in the oil and one from gas?

Is there anything -- is there a generalization you can make on that, or is it really case-by-case?

Yes, we didn't break it down.

I imagine we could, we just haven't got into that much detail.

You're being dangerous by giving us some detail, I understand.

Well, my feel is certainly the last two to three years it's primarily been oil gone out and gas coming back.

But I think this year, certainly, the oil growth has continued.

But this quarter, again, adding 5% more active units on the gas side, we've seen oil going out and gas going out.

And I think primarily still the returns we get are primarily to drive gas, but we have been able to offset those pretty well this quarter.

In the past, and you've seen the numbers, we've stayed pretty constant.

X gas going out and X gas coming in, so it stayed pretty flat; but now we've got 105X going out and X coming back.

So both of them -- oil is still the grower, but just a little (multiple speakers) --

Gas is kind of being a little -- behaving little better, I guess I could say, is maybe --

Yes.

And, again, I think it's primarily from our share gains.

Sure.

Okay, and then just on the utilization -- or not the utilization, but the compressors getting the throughput up, the 20%.

I know you've talked about it in the past and that you are pretty darn close to putting out as much out of there as you can.

I mean, do you see much more?

Are you kind of at that level where, look we're about as good as we can get and anything else we're going to need to look to outsource or go somewhere else?

Yes, we are still looking at expanding capacity and how we might want to do that.

And, again, there is a couple of ways we can either build on to our existing facilities or outsource.

And we're still looking at both of those to see which might be a little better.

Of course, the advantage when you do it yourself is you control it a little more and have a little more check on your supply chain, whereas if when you outsource you've got to -- sometimes you're in line behind some other people at times.

But we're looking at both just to see where the dollars look best and balancing that against our ability to control the supply chain a little better.

Okay, that's helpful.

Thanks Steve.

Okay, thanks.

Jeffrey Kerr, Kerr Financial.

Oil, I missed the percentage of the fleet in oil plays.

It's right around 40%.

40%.

Yes.

And I guess the other question kind of follow-up what you said about building or outsourcing like that, do you think about that using the capital -- you've talked in the past about maybe doing acquisitions or whatever.

And is it -- would it be correct to think about maybe doing an add-on to the current footprint as replacing the acquisition strategy, and would that be kind of the use of capital now?

Yes, I mean, it's -- I think they fit together from a perspective of how we go about growing.

As I mentioned in the past, we've looked at a lot of cash the past, but there's always been one issue or the other, either the price or the quality of the fleet, that has kept us from doing anything there.

And, again, it's not just us.

You look over the past four or five years, there's not been a whole lot of acquisitions in this business (inaudible) presumably doing the same thing.

So, yes, when you look at our rental fleet growth particularly, it's been a 20% grower over the last three years.

So from a -- if you're looking at -- it's not that we're saying, okay organic is the only way to go and I won't look at anything else.

We still look at stuff.

But if you look at the organic growth being in that kind of range, we're growing fairly quickly that way, not having to have any M&A although we don't discount it.

So when you look at that, and just looking at the ways to increase that capacity, yes -- as I mentioned, adding on to existing facilities is one way to do it.

And the advantage to that, of course, is, as I mentioned, control over some of that.

Now, control -- if it doesn't come to high a price.

But the good thing about it out here in West Texas where, although it's busy and things are a little higher price than what they have been, it's not an extraordinary expense to add roof vinyl onto some of our facilities depending on what we're doing and how much we do.

So, right now, frankly that probably looks attractive.

But we are going out to get some market indications of what other fabricators may be able to do it for us, too.

And we'll just make the financial decision, number one; the control decision from supply chain, number two.

And also, outsourcing certainly gives you more of a swing capacity if things do tail off at some point.

It's much easier to get rid of than the brick-and-mortar you've now got.

How fast do you kind of think about being able to add on that bricks and mortar if you choose to go that strategy?

We've got a couple of bids on that.

I think it could be a 90-day sort of situation, so it's not extremely long.

And, again, we may -- as we're looking at this, there could potentially be a combination of a process where maybe we outsource a little while this place is getting built too, if we decide to go that way.

So there's a little flexibility in what we -- how we could go forward.

How about workforce?

Would there be any issue in growing the workforce, finding the capable people to put in the new building?

Well, it's gotten better here in Midland.

A year ago, that's when we really started looking at outsourcing because -- and we weren't going to outsource here in Midland necessarily because there weren't any people anywhere.

Right.

We were looking within a 100-mile radius, at least keep it close to the house.

But now, about 12 months later, the market is loosened up a bit, so we're now able to staff up to where we want based on -- that's how we got some of the throughput now.

And then we think we could -- if we do decide to build it ourselves, we think we could staff it.

Okay, very good.

Appreciate it.

Thank you.

Good quarter.

Okay.

Thanks.

Peter Van Ruden, Spitfire Capital.

Just wanted to talk a little bit about gross margins.

I know that you said that this is going to be kind of a new normal going forward, but was there any sort of increase in maintenance activity in the quarter?

And if you do kind of pick between 62 and 58, are we going to end up in the middle for the year and going forward?

Just a little color there would be great.

Well, as I mentioned, right now year to date nine months, we're 59% gross margin on rentals and last year at 58%.

So we've actually made some progress there.

You know, the contrast -- the big contrast we have between Q2 and currently of course between [63%] and [58%] was part of it was that extra pay period, which was actually about 3 points.

So that was more than half of the difference, and we added about -- relatively added another $400,000 in payroll costs this quarter.

So you saw a little of that.

But there wasn't any more maintenance activity in Q3 versus what we had in Q2.

So really if you get down, throwing out that pay period fluctuation, we've got a 1 or 2 percentage point swing in the margin, which is really going to be kind of your normal quarterly variation.

It's just -- it's exacerbated by the number one, [63%] being very high; and number two, that payroll.

So on a relative basis, it makes it a little tougher comparison.

But yes, I think we're -- again, we're 59% running now.

We want to get up into that 60% range pretty consistently.

And we have kind of averaged that 58%, 62% depending on what the quarter is.

You know, next year, we want to aim for having that a pretty good, solid consistent [60%].

Okay, that's helpful.

And then just a quick update on what is my favorite topic, the VRU rollout.

Okay, all right.

You know, that's a -- for everybody that haven't followed it, you know, there's an EPA regulation that has come out called Regulation 0000, which is [quad 0], and it's actually starting to take effect now.

And there's a lot of pushback on the regulation from the industry mainly because it's not a very economic sort of exercise but it's intended control methane emissions -- or really just natural gas emissions off of locations.

And a couple of ways you can control emissions; one is with flares, and one with VRUs.

They're cover units, which are small gas compressors.

So both those fit right into our present business lines in [Bailiwick].

And we had seen some VRU activity last year; I announced that a couple of contracts we had gotten.

One of them has been in full swing, and then one of them probably won't start up much until next year.

But beyond that, we haven't seen a whole lot of additional movement out of that market yet.

Now, we think either -- and we're talking to a lot of customers out there on what they're seeing, what they're planning, what they're doing.

There seems to be a general feel that maybe this thing gets pushed off again; it's been pushed off a couple times.

I don't know if that general feel is based on fact or just hope; I think maybe more of the latter.

So, we're still -- April 2014 is when this regulation is supposed to take full effect.

So as we get closer to it, I expect to see a little more activity than we're seeing now.

But really we haven't seen as much as I would have thought, and of course we haven't anticipated anything from any comments we've made from the point of business or anything else.

But just seeing that is icing that may come on top of the growth cake we've got anyway.

But we're not seeing any more than what has been happening in the last few quarters.

So we're still waiting to either see EPA actually push it back a little, or there should be some movement coming in the next couple of quarters, I would think.

And then one last question on the -- I guess, a little bit more macro, is that I saw that a couple of more shales are going to push to outlaw flaring.

I think it's the Utica is about to do that.

Are you starting to look at ramping up activity in those areas?

Yes, well, we are in the Utica.

This flaring issue, that's kind of the funny thing about it; the EPA is all for it and nobody else is now.

So figure that one out.

And of course we are in the flare business and compressor business.

But we've always said the flare business, really our ramp-up in that is about triple the last three years -- is just an opening window, and that window will be closing at some point.

It's not closing yet, but I think certainly the pushback is coming.

It doesn't go to zero, but it does throttle down.

But whether it's the Utica or the Bakken, I think the pushback is interestingly not coming from Washington or ilk of that sort, but really more from a local and state pushback.

State politicians and the local populace.

So we've already started seeing that in the Bakken pretty heavy.

And you've seen large operators up there announce that in X number of years, they won't be flaring anymore.

Now, part of that is, okay we'll get out of flaring.

But part of it is, because we've always talked about it, there just hadn't been the infrastructure up there anyway.

So it didn't matter whether you want to flare or not; you didn't have any choice if you are going to produce oil but to flare.

But that's getting alleviated on its own, too, because there's pipelines, gas lines going in.

So part of this, I think is, yes, we're not going to flare.

But ultimately, they weren't going to flare anyway because that gas can go into a pipeline.

I actually meant it more as a positive in terms of not flaring the gas.

They might actually want to use a compressor.

Yes, and I should've followed up with that.

The logical extension for us is when you don't have flares out there and you have a pipeline, you can put a compressor in there.

So, yes, we think that's certainly a future growth area, and -- I mean, that's what we've been looking at in the Bakken for a bit.

We were up there with a little compressor but really not a whole lot, and we think the big push will come when those pipelines get in and that flaring does go away.

So I appreciate you finishing my sentence, though, Peter.

(laughter) Okay, thanks Steve.

Good quarter.

(Operator Instructions) Steve, at this time I have no further questions.

Okay, Erica, thanks.

And thank everyone for joining me on the call.

I appreciate your time this morning and look forward to visiting you again next quarter.

Thank you.

This concludes today's conference call.

Thank you for attending.