Natural Gas Services Group Inc (NGS) 2017 Q3 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Third Quarter Earnings Call. (Operator Instructions) Your call leaders for today's call are Alicia Dada, IR Coordinator; Steve Taylor, Chairman, President and CEO.

I'll now hand the call over to Ms. Dada. You may begin.

Thank you, Erica, and good morning, listeners. Please allow me 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 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 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 undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements, include, but are not limited to, factors described in our recent press release and 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?

Thank you, Alicia and Erica, and good morning, and welcome to NGSG's third quarter 2017 earnings review. Although our markets continue to be very competitive, NGS posted another quarter of positive growth. For the second quarter in a row, we delivered higher operating income and net income. Our rental gross margins remained among the highest in the industry, and our sales revenues and margins continued strong. Rental fleet utilization and churn are relatively positive, and due to high utilization rates, we are adding more large horsepower units to the rental fleet. Our sales backlog remains at a record-high level due to the large order we announced last quarter. However, we've been asked by one of those customers to convert a majority of their purchased units to long-term rentals. This is a unique opportunity for NGS, and we have agreed to do so. I will discuss this further in my latter remarks.

Generally, the activity trends in all segments appeared to be positive. This is not to say that there won't be some volatility, but it appears that we will be well positioned going into 2018. With that said, I'll comment in more details as I review the financials.

Starting with total revenue and looking at the year-over-year comparative quarters, our total revenues decreased a little over $250,000 from $16.2 million in the third quarter of '16 to $15.9 million in the third quarter of '17. Quarterly sales were up from $2.5 million in the third quarter of '16 to $4.3 million in the third quarter this year. Our rental revenues fell to $11.3 million.

For the sequential quarters of the second quarter of '17 compared to the third quarter of '17, total revenues were off a little over $300,000 from $16.2 million to $15.9 million. Reviewing the comparative 9-month year-to-date periods, total revenues were down 7% with rental revenues decreasing to $34.6 million. However, our compressor sales revenues are 53% or almost $5.6 million higher in the 9-month year-to-date period of 2017 compared to last year.

Looking at our gross margins and comparing the third quarter of 2016 to this current quarter, total gross margin declined from $9.4 million to $8.3 million. However, sequentially and significantly, total gross margin improved by another 2% from the previous quarter and grew from $8.1 million to nearly $8.3 million and improved from 50% to 52% of revenue in the third quarter '17. This is due to an appreciably higher sales gross margin and larger dollar contribution from our sales product line this quarter. In the 9-month year-to-date comparisons, gross margin -- gross margin dollars were down from $30.7 million to $25.1 million, but still came in at 49% of revenue.

Our sales, general and administrative expenses increased about $240,000 in the year-over-year quarters. They fell about $50,000 in the sequential quarters of Q2 '17 to Q3 '17. SG&A is up about $950,000 in the 9-month year-to-date comparisons over the prior year, primarily due to the accelerated noncash stock charge in the first quarter this year. In the comparative year-over-year quarters, operating income decreased from $1.8 million to nearly $600,000 in the third quarter of '17. Sequentially, we saw operating income increase nearly $200,000 from a little over $400,000 to nearly $600,000. When comparing year-to-date 2017 to 2016, operating income fell from $7.5 million to $1.4 million.

In the comparative year-over-year third quarters, net income dropped from $1.5 million to a little over $520,000 this year -- or this quarter. Sequentially, however, we saw net income increase in this third quarter from nearly $400,000 to a little over $520,000. In the 9-month year-to-date periods, net income decreased from $5.3 million to $1.1 million.

On a year-over-year basis, EBITDA decreased from $7.3 million in the third quarter of '16 to $5.9 million in this current quarter. Sequentially, however, EBITDA rose a little over 3% to $5.9 million. It was at 37% of revenue in this current quarter. On a 9-month year-to-date comparison, EBITDA was down from $23.9 million to $17.3 million.

On a fully diluted basis, earnings per share this quarter was $0.04 per common share compared to $0.03 last quarter and $0.12 a year ago.

Total sales revenues, which include compressors, flares and aftermarket activities, increased to $4.3 million from $2.5 million, when comparing the year-over-year quarters. For the sequential quarters, total sales revenues remained essentially flat with a slight softening from $4.4 million to nearly $4.3 million.

On a 9-month year-to-date comparison, total sales were up $5.6 million, or 57%, from $9.7 million to $15.3 million. Reviewing compressor sales alone in the current quarter, they were $2.7 million, up from the third quarter of 2016's $1.7 million, and down $300,000 from last quarter's $3 million. When comparing the 9-month comparative periods, year-to-date compressor sales were up 53% from $7.4 million to $11.3 million. I think this is a commendable performance considering the current environment.

Gross margins with the compressor packages we fabricated in the quarter averaged 17%, significantly up from 4% a year ago and 5% last quarter. On a year-to-date basis, we are averaging gross margins of 13%, up almost double from 7% in the prior year.

Our sales backlog as of September 30, 2017 was approximately $23 million compared to about $25 million in the last quarter and $6 million a year ago. We have, however, received additional orders totaling a little over $2 million at the quarter's end. So our backlog has remained at a stable level. We estimate that this present backlog will stretch into midyear 2018. The first units from the large order announced last quarter will start to roll out in the fourth quarter of this year. However, as I mentioned in my opening remarks, we have been asked by one of our customers to convert a majority of their purchased units in this backlog to long-term rentals, and we have agreed to do so. This will reduce our sales backlog to approximately $6 million, while simultaneously increasing our capital commitments by $17 million to $18 million.

Rental revenue had a year-over-year quarterly decrease of a little under $1.9 million from $13.2 million in the third quarter '16 to $11.3 million in the current quarter. Sequentially, rental revenues were down a little over 1% or less than $150,000 from $11.4 million in the second quarter of '17. The year-to-date review shows rental revenues down from $44.2 million to $34.6 million for the 9 months ending in September.

Our rental gross margins continued to be strong. We posted a 62% gross margin this quarter against 63% last quarter and 66% in the third quarter '16, which was a 10-year high. Year-to-date, we are averaging 62% compared to 65% last year. Average rental rates across the active fleet decreased a little over 4% in the 9-month period of this year versus last year.

Our second pricing indicator looks at the rental rates for units in a particular quarter. This gives a better indication of current pricing versus long-term averages. On a year-to-date 9-month basis, average new set prices were $3,092 per unit last year compared to $2,983 this year, a 3.5% decrease. With the current pricing decline being about the same as the long-term average decline, it appears that the pricing deterioration we have seen over the past couple of years has lightened up a bit. I'm not saying that pricing pressure is gone and pricing levels are certainly not where they should be, but in these comparative periods, NGS has been able to hold our rates to a large degree.

Fleet size at the end of September was 2,538 compressors, which reflects 7 new units for this quarter. These additions were all our new larger horsepower products. Fleet utilization continues to be in the 49% to 50% range where it has been since February this year. It appears that a bottom has formed.

Another activity metric we look at is our rental churn, which is number of units rented divided by the number terminated. Therefore, a positive number indicates growth. In the first quarter of this year, the churn was 0.47, the second quarter it was 0.73 and the third quarter turned positive at 1.05. So we are also seeing a positive trend here.

We continue to see bright spots on our new product launch. Of our 400-horsepower units, we've rented 12 of the 13 we had in the fleet as of July and have added 2 more to the fleet in the last couple of months of the quarter. Referencing our 600-horsepower line, we sold 7 of those earlier this year and have built 1 for the rental fleet. As of last week, we rented 2 of them, so we have another [build in] process. As for the smaller horsepower VRUs, or vapor recovery units, we have approximately 60 in the fleet now with utilization approaching 90%. Overall, among these 3 new products, our utilization is running in the 80% to 90% range, and we anticipate this market will continue to grow. It is apparent that we made the right decision 12 to 18 months ago to enter those markets.

Talking about large horsepower markets and, again, [we haven't seen] the conversion of a large part of our sales backlog to long-term rentals, we see this as an excellent and unique opportunity to enter the high-horsepower rental market in a robust manner. We will be able to rent a good number of 1,300 horsepower units on a multiyear agreement at above-market pricing. As you know, we had already made the decision to move into the medium-horsepower market with our new 400- to 600-horsepower products, and we have designs on even large horsepower over time. When we were approached to rent these large horsepower packages, it was an opportunity to accelerate our strategy and move into the bigger horsepower right away.

Our customer processed for this large project due to our past service, rental and fabrication relationship with them, and we were able to respond positively because of our ability to immediately commit the capital. Our competitors are not able to provide this service level or the capital required. The long-term economics of these rentals are compelling. Converting from a sale to rentals increases our total nondiscounted EBITDA from roughly $2 million to almost $14 million, granted there are different timetables associated with these. But the advantages of our rental business is apparent and this clearly aligns with our strategic direction towards larger horsepower. These rental units will be built and placed into service over the next 12 to -- 10 to 12 months.

Now looking at service and maintenance, it was a small part of our overall revenue. We have placed a little more emphasis on our service and maintenance business and it's being successfully realized. On an annualized basis, we have grown at a bit over 50% since 2015. And it actually delivers gross margins that exceed even our rental business.

I previously said that our capital expenditure this year would be in the $5 million to $10 million range. And through the third quarter, we have spent approximately $5 million, with $4 million of that in this current quarter as we added 7 larger horsepower units, totaling 3,000 horsepower to our fleet. By year-end, we anticipate allocating another $2 million to $3 million in capital for larger horsepower units.

Now with the sales to rental conversion we've discussed, we will add another $4 million to $5 million in CapEx in the fourth quarter of this year, with an additional $12 million to $13 million in 2018.

Going to the balance sheet, our total bank debt continues at $417,000 as of September 30, 2017, and cash in the bank was $73 million. Our cash flow from operations is almost $4 million this quarter and $14.2 million year-to-date.

From a macro perspective, the price of oil has generally held up pretty well, and it seems like we may get some stability. Crude inventories are down, the rig count has leveled to what is, hopefully, a sustainable level, and OPEC and Russia are cooperative from the supply side. We're cautiously optimistic that 2018 will bring additional activity to NGS.

As I just noted in my comments, we're seeing some positive indicators, and our move into the higher horsepower rental market is being welcomed by our customers, so much so that we are actually being invited in as alternate suppliers for bigger horsepower. We're very excited about the opportunity this large horsepower rental contract brings to NGS. Not only is it economically attractive, but it accelerates our strategic entry into the higher horsepower market. This is important. It represents a high level of confidence in NGS by our customers. NGS has positioned itself well for this downturn and it's [about the time our] operating results are enviable. Our margins continue to be among the highest in the business, our sales backlog is strong, we are seeing some traction with the new products. Our debt is negligible, our cash availability enables us to react to and capture opportunities we want, and our ability to generate cash is exceptional.

That's the end of my prepared remarks, and I'll turn the call back to Erica for questions anyone may have.

(Operator Instructions) Our first question comes from Mike Urban from Seaport Global.

Could you talk about -- I wanted to go into the -- this contract conversion here or probably, that's conversion to contract work here. Certainly, makes a lot of sense strategically. What is the -- given the additional capital required here, what is the comparative return profile of what you would have generated as a product sale versus a rental? Is it attractive? Is it better? Or is there also an element of just there's a strategic initiative here that's important and you kind of have to weigh all of those factors?

Well, it's really all that, Mike. Certainly, strategically, as we announced over the last year or 2, you always start putting up the 400- and 600-horsepower designs we come up with and so we're moving into that. This accelerates it into the large horsepower, the 400 to 600 being a more of a medium-horsepower range. So these are 1300-horsepower units. So strategically, it just moves us in and up much quicker than we were planning. So we think that's good from that standpoint. From a return standpoint, as I mentioned, just looking at EBITDA comparisons to kind of eliminate some of the other fluff around the number, EBITDA on the sales contract itself was around -- little over $2 million. Now over time, and again, this is longer-term contract, EBITDA will be about $14 million. Now -- 7x, that sounds great, and it is great. Certainly, there is a -- if you want start discounting, you start looking at depreciation, start bringing in some other factors there. But generally from an EBITDA standpoint, it's -- rental is very attractive compared to sales, and especially with this, we got a longer-term contract than what's normal. So overall, everything looks pretty good with it.

Okay. And what is the time frame for the contract?

I don't want to go into too much competitively. Well, let's say, it's longer than 3 years.

Okay. That's great. And you mentioned that this just kind of accelerates your entry into the -- into large-horsepower market. With that contract now in place, do you see others out there? Does that kind of push other customers over the edge, say, "Hey, these guys can do that?" Or -- and then also do you have the capacity to do additional work there? Or is this kind of a lot to bite off right now and you're focused on executing this particular contract?

That's a good question. I think it will bring to the forefront a little more that we've got these capabilities. As I'm mentioned last quarter, when we got the order as a sales order, I said that it would demonstrate the customers that we can build this big step. We had built it in the past, but this is a big build with a fair amount of volume. So it would demonstrate to maybe the industry and particular customers, that we can handle this sort of stuff. Now we take the next step, not only can we build it in volumes, but now we can put it out there and operate and maintain it. So we think it will be met with open arms by some customers now. And as I'm mentioned, we've actually been invited in by customers on big horsepower. The first 400-horsepower units we put out almost a couple of years ago were at the request of a customer move into that horsepower. Now this is at the request of another customer, we're into bigger horsepower. So I think the market, number one, we got -- yes, it's a little [tighter] market on the bigger horsepower than smaller horsepower, so we're able to take advantage of that. But then I think also our service reputation and then our fabrication ability, some of the players don't have fabrication ability anymore. We still do. So I think it enables us to react a little quicker. Then, of course, our availability of cash has helped in this, one of the competitors couldn't come up with the cash.

Our next question comes from Rob Brown from Lake Street Capital.

Just want to dive into trends in utilization a little bit. You've talked about it flattening for a few quarters. What's sort of your experience historically? And how that turns around after a flattening? And maybe your sense on the market stepping up the next few quarters.

Well, just looking back, again, the utilization has been up and down, measuring in basis points by the months of February. So for 8 months, it's been within a 1% range. So it looks like certainly that's a flattening now. The uptick -- we're hoping that the uptick starts fairly quickly. Now we did see -- I think the last month of the quarter was actually a positive month and the churn on the quarter was positive. So we're starting to see maybe just a little increase in that now. It's hard to say exactly how that will play out over time. I think, generally, if you look at, say, the next 12 months, we're going to see higher utilization. But on a quarterly or monthly basis, we're still going to see some basis point variation on that as we start to climb out of it. But I think, as I mentioned, the 400- and 600-horsepower units are moving pretty well, the VRUs are moving very well. So if we can kind of get the terminations slowdown a bit and operators, I think, will start doing that with the oil price, hopefully, holding up. Those factors ought to contribute to a little higher utilizations as we go forward.

Okay. That's good color. And then on the VRU market. I guess, what's the trend line there? Is there -- what's sort of driving that? Or is that just a kind of a steady-state improvement?

It's been pretty good. We're mainly seeing the SCOOP and the STACK being quite a bit [down] in South Texas, some in the Permian. And I was trying to, this morning, remember the number I have thrown out a couple of years ago as to what we're expecting. I think, I was saying we would expect a 5% to 10% of the fleet in VRUs over the next couple or 3 years. So we are at almost -- we're at a little over -- we're almost 5% now after, say, 12 to 18 months. So I think, we're pretty well on track, and that's a pretty good ramp up on that. So I think the VRUs will keep growing. In fact, we're trying to fit in the schedule some more, because we're almost 90% utilized on those. So I think that will stay pretty well. And, again, obviously, we think the big horsepower market is a place to move into and certainly, this conversion helps that.

Our next question comes from Tate Sullivan from Sidoti.

On the terms of the rental commitment going from sales to rental, is it a service challenge to service these larger, greater-than-1000 horsepower units?

It's different servicing. You start getting into this type of equipment, number one, it's very expensive, and number two, takes a pretty high level of scalability. Now we've got service people in our organization that are familiar with this equipment and things like that, and we're in the process and have been in the process of gearing up for this, once we were approached with the conversion. So it's a little different. But the main thing that we think will be able to be competitive and attractive on this is the service level. So whether it's 10 horsepower or 1000 horsepower, it's run-time response. It's -- that's the key to the customer. So we expect we'll be able to do the same thing on these. Customer expects that, and we're gearing up for all that right now.

Okay. And to confirm the 7 units that you introduced in the quarter. I think you said you rented almost all of your 400-horsepower units. Is -- did you rent all 7 of those units?

Let's see, I think except for -- we had 12 out of 13 of the 400-horse rented as of July, 6 out of 7 of the units this quarter were 400-horse, and I think we got 2 idle in that, so those are renting. And then 1 600-horse, then I'd like to say, we have 1 600 rent too, damn it. Just now -- we've got another scheduled we're going to put out. So -- those -- we still got 2 to 3 of the 400s available to ramp, but again, they just rolled off the floor in the last 30, 40 days. So they'll get rented. It just, sometimes, takes a couple of months to get it all done.

(Operator Instructions) Our next question comes from Jason Wangler from Imperial Capital.

Congrats on the contract. I was curious how much you might just talk about the actual use of that horsepower, kind of where it fits? Is it still wellhead with lot of wells? Or has it maybe moved further up the stream? And then maybe even the geographies that you guys will be working at with those piece of equipment?

Yes, the application is much as -- is one of the factors that I've mentioned over and over as to why we're moving to big horsepower -- bigger wells, centralized last gas lift and pad drilling. This is centralized gas lift. So instead of wellhead units on this -- wellhead being maybe a smaller unit that would handle 1 or 2 wells on a gas lift, this unit may handle -- and I don't know the exact number, but may handle 10 or 15 wells on a gas lift application. So more gas, more horsepower. Again, this doesn't eliminate the smaller ones, because we've -- some of those orders we got in October are smaller wellhead units. But this will be more of a centralized gas lift. So it's exactly along the lines that we start moving into the big horsepower for. This is one of the primary applications we're looking at and this is where it'll go. And no surprise, it's a Permian location -- or multiple locations.

Okay. And -- that's helpful. And you mentioned in your prepared remarks that the sales margin look like they did quite a bit better in the third quarter. Could you maybe talk if there was something specifically there? And also just kind as you look forward, are the -- the backlog, is it a little bit more favorable contracts or is it just you guys getting a little better at building these larger units or just anything there?

It's probably a little of both. I mean, we had 5% margin last quarter and 4% last year. Last year is more so an absorption issue. We had a pretty low level of backlog, I think, $3 million or $4 million. So we had more expenses relative to revenue we had to carry and that depressed the margins. This -- you will get some margin variance quarter to quarter. So last quarter, we had actually more smaller units go out that have -- that carried a little lower margin on it. And then we had some bigger units go out this quarter, which can get a little better margin on, which is a little different than what you would think. You would think maybe the large units had a lower percentage margin. But it was reversed on that. So it kind of depends on the flow through the shops of what kind of jobs you got going, who the customer is, what the bidding situation was and everything else. But very happy, obviously, with the 17%. This is kind of getting back to the good times margins. But going forward, we certainly -- I think we'll -- and like I announced last time, I think we'll be in that 10% to 20% margin range. Of course, that's a range wide enough to drive a truck through. But still much, much better than the industry. Industry is running single digits right now.

At this time, we have no further questions.

Okay. Thanks, Erica. And I appreciate everybody joining me on the call. Appreciate your time this morning and look forward to visiting with you again next quarter. Thanks.

This concludes today's conference call. Thank you for attending.