Natural Gas Services Group Inc (NGS) 2018 Q2 法說會逐字稿

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Second Quarter Earnings Call.

(Operator Instructions)

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

I will now turn 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 risk 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 cash and 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 to Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group.

Steve?

Thank you, Alicia, and Erica, and good morning.

And welcome to Natural Gas Services Group Second Quarter 2018 Earnings Review.

NGS exhibited a significant increase in total revenues of 24% compared to the sequential quarter, led by our overall sales volumes.

Rental revenues were flat, but we see encouraging trends in the rental business that should result in improved revenues going forward.

We placed more active horsepower in the field led by our shift into the higher horsepower rental compression market, and our backlog of contracted rental equipment is significant.

Our rental margins were lower due to expenses incurred to prepare equipment to meet pending rental demand, a necessary current cost to capture future revenues.

We continue to see opportunity in the future, especially in the higher horsepower market, and I'll comment in more detail as we review the financials.

Starting with total revenue and looking at the year-over-year comparative quarters, our total revenues increased 12% from $16.2 million in the second quarter of 2017 to $18.2 million in the second quarter of this year.

Sales increased by $2 million.

Our rental revenues saw a slight increase but overall, rentals remained fairly flat.

For the sequential quarters of Q1 of '18 compared to Q2 of '18, total revenues increased $3.5 million from $14.7 million to $18.2 million.

The increase was primarily in our sales component, which saw an increase of $3.4 million, while rental revenue again remained fairly flat.

Summarizing, total revenue is up in both year-over-year and sequential quarters.

Looking at gross margin and comparing the second quarter 2017 to this current quarter, total gross margin eased from $8.1 million to $8 million and was 44% of total revenue compared to 50% of total revenue in the second quarter of 2017.

Sequentially, total gross margin increased about 3% from $7.8 million to $8 million.

However, total gross margin as a percentage of total revenues declined to 44% from 53% in the first quarter of 2018.

I'll discuss the individual margin impact on the total margin later, but we are seeing a mix shift between higher margin rentals and lower margin sale revenues, which will also lower the overall margin.

Sales this current quarter were 35% of total revenue but it was 27% of total revenue a year ago and only 20% last quarter, so we are seeing an appreciable mix shift.

Our sales, general and administrative expenses decreased over $75,000 in the year-over-year quarters, was up less than $300,000 in the sequential quarters of Q1 '18 to Q2 '18 and was down over $1 million in the year-to-date comparisons over the prior year, with this large reduction being due to the accelerated noncash stock expense we took last year.

SG&A as a percentage of revenue is running at 13% of revenue this quarter.

In the comparative year-over-year periods, operating income decreased from a little over $400,000 to a little over $225,000.

Sequentially, operating income decreased from approximately $350,000 to a little over $225,000.

The impacts to operating income in these periods were due to higher-than-traditional expenses in our rental business, primarily due to makeready expenses we incurred repairing compressor units before they go on contract.

It is important to note that the operating income impact is larger when compared to our industry pairs -- peers because we do not capitalize any maintenance costs but instead expense all of it, which has a more significant impact on current operating income.

We believe that is a more appropriate measure of performance in our business.

In the comparative year-over-year second quarters, net income dropped over $125,000 to about $250,000 this year.

Sequentially, the second quarter of 2018 saw a slight net income increase from nearly $225,000 to approximately $250,000.

On a fully diluted basis, earnings per share this quarter was $0.02 per common share, steady with $0.02 last quarter.

On a year-over-year quarterly basis, EBITDA increased slightly from $5.7 million in the second quarter of 2017 to $5.8 million in the current quarter.

Sequentially, EBITDA increased from $5.7 million to $5.8 million.

EBITDA margins have roughly averaged about 35% of revenue in all comparative periods.

Total sales revenues, which include compressors, flares and aftermarket activities increased by 45% in the year-over-year quarters from $4.4 million in the second quarter of '17 to $6.4 million in the current quarter.

For the sequential quarters, total sales revenues more than doubled, reflecting an increase from $3 million to $6.4 million.

Compressor sales for the current quarter were $4.7 million, up from $3 million in the second quarter of last year and $1.8 million last quarter.

This quarter's total gross margin is 23% compared to 27% in Q1 and 15% a year ago.

This is quite a bit of margin variation quarter-to-quarter in our sales business due to scheduling and the different projects that might be on the floor at any given time, some with lower margins than others.

But significantly, the margin is averaging 24% on a year-to-date basis this year compared to 17% year-to-date last year.

Our backlog as of June 30, 2018, was $4.1 million and has grown to $7.3 million as of July 31, 2018.

We also anticipate further significant sales in the next 30 days that is not in this backlog number.

Rental revenue had a year-over-year quarterly slight increase but remained at approximately $11.4 million in both the second quarter of '17 and the second quarter of '18.

Sequentially, rental revenues were off about 0.05% from $11.5 million in the first quarter of '18.

While rental revenue and numbers of utilized compressors are relatively flat in comparative quarters, we have seen the average horsepower running in the field increase 5% sequentially and 8% year-over-year.

The significant decline in rental revenues the past couple years has been arrested, and we have seen active horsepower in utilization grow this quarter, but revenues have remained relatively flat due to downsizing and consolidations, stand-by rental rates on some large horsepower stations and pricing pressure in smaller sized units.

Downsizing is a natural economic transition as well as mature and compression needs are correspondingly less.

The result is no change in unit count but lower revenue per compressor.

Standby rental rates on some large equipment have been implemented due to construction delays but this is only a delay, and we will see full rates kick in over the next couple quarters.

We also saw a 1% decrease in rental rates per unit and a 5% decrease per horsepower in the sequential quarters.

This average pricing decrease is due, again, to customers downsizing compression equipment and continuing price pressure in the smaller horsepower lines.

There continues to be too much capacity in the small horsepower part of the industry, but we have been able to mitigate most of that weakness with our large horsepower penetration.

Our transition to a higher horsepower fleet is working just as we expected.

Larger horsepower units and revenue are not only replacing the moderation in lower horsepower metrics but will, over time, provide more robust revenue and margins when compared to our traditional lower horsepower fleet.

We expect this trend to provide better rental revenue and margins in the coming quarters.

Gross margin this quarter was 55%, down from last quarter -- last year's quarter of 63% and Q1 '18 margin of 59%.

The impact to our margins this quarter was due to a large amount of overhaul work as performed on rental compressors being prepared to go out on contracts.

I discussed this in previous calls, as we start to set more equipment, we will experience higher current expenses getting them ready and this will be reflected in the income statement.

As I mentioned, we do not capitalize these maintenance costs, we record them as a current expense, contrary to most others in the industry.

This impacts current quarters but does give the public a more accurate view of our actual spending.

For example, in the year-ago quarter, we overhauled 12 compressor packages.

Last quarter, we did 31 and this quarter we made ready 74.

We spent $330,000 more this quarter on makeready costs than we did in the year ago quarter.

We do not overhaul equipment unless it's contracted already or has a high likelihood of being rented.

As such, revenue will be attached to this equipment in the future.

Lots of moving parts, but this all combines to show some underlying positive trends.

We have more equipment going out, and we should see margins and utilization start to catch up.

Fleet size at the end of June was 2,557 compressors, an addition of 6 units last quarter.

This represented 4,358-horsepower of which 95% was our 400-, 600- and 1,380-horsepower units, our larger horsepower units.

Our utilization measured by horsepower climbed to 51% in this current quarter, while unit base utilization grew to 49%.

There are 2 items to note this quarter as far as utilization goes.

First, all 3 months and each month of this quarter had net positive sets.

The last time we had this was happen was in the third quarter of 2014.

And second, the higher utilization that accompanies our shift to larger horsepower rental units is starting to be reflected in the overall fleet utilization.

Over the past 12 months, our total horse -- fleet horsepower increased 5.7%, but rented horsepower increased 8.7% over that time period.

Our fleet and the industry have essentially bifurcated into larger and smaller horsepower classes, accompanied by different utilization dynamics.

For example, our large horsepower equipment utilization is presently at 91%, where our medium and small lower horse -- lower pressure compressors are presently the mid-40% to mid-50% range.

As we set additional large horsepower compression and the wellhead compression market picks up more, we will see steadily higher utilization.

But presently, we are in a transition.

Over the past 12 months, we have added 31 new fleet units that total 21,000 -- a little over 21,000-horsepower, with, again, 95% of that being in our large horsepower category.

To demonstrate the growth and penetration we are seeing in our large horsepower line, as of June 30, 2018, a full 14% of our active horsepower is classified as large.

Additionally, we have an equivalent amount of large horsepower in various stages of construction, with the majority already contracted.

We indicated last quarter that capital expenditures for rental compression in 2018 would be $20 million to $25 million.

Year-to-date, we have spent $13 million of that, but we now anticipate that number will grow to between $25 million and $27.5 million.

Looking at the balance sheet, our total bank debt is $417,000 as of June 30, 2018, and cash in the bank was a little over $62 million.

This amount is down about $11 million since our cash peaked last year and it's all been invested back into the company, with the vast majority for our new horsepower rental compression equipment.

In closing, NGS continues to deliver good results and this quarter demonstrates that as follows: Our sales business continues to deliver good revenue and margins, our rental business looks to have good underlying trends as demonstrated by the backlog of equipment to prepare for contract.

We are 1 year into our move into the high-horsepower market, and our utilization and market traction and penetration are showing good results.

We have raised our capital expenditure target for the year by roughly 15% for rental compression and our cash flow and balance sheet continue to provide the capital source and flexibility required to fund our growth in the future.

All of this fuels our optimism about the market and our performance as we finish 2018 and head into 2019.

Erica, that's the end of my prepared remarks, so please open up the phone lines for any questions.

(Operator Instructions) Our first question comes from Joe Gibney from Capital One.

Just a question on the smaller horsepower price pressure.

What tranches specifically are you seeing that?

Is this very low horse?

And then where regionally, I guess, are you seeing more of that pressure?

Or is it just broad based?

It's primarily what we would classify as small, just roughly 125 horse and lower.

And that varies between some of the reciprocating units and the low pressure screw units but primarily the lower pressure -- lower volume screw units.

And we're seeing most of it in mature areas, you get the old Barnett, some of the Central Texas mature stuff, San Juan Basin, things like that.

So it really trends along with what we're seeing in the overall just dry natural gas market, right?

Kind of static pricing, static activity, et cetera, et cetera.

So when you get static activity in a somewhat oversupplied market, obviously, that's where we getting some of the pricing pressure.

Got it.

And on the standby rate side, you referenced construction delays some -- on some of the higher horsepower units.

Is that regionally specific to areas of the Permian?

Or just where exactly is that -- are you encountering some of those issues on the standby side?

It's primarily the Permian.

And again, I want to reiterate it's just construction delays.

The rental rates will take place.

It's not -- everybody probably goes on point as to, well, is this in the bottlenecks or things that we hear about in the Permian.

But it's not that, it's just some delays in construction.

And actually, that's good because there's so much construction going on, it's just taking time to get crews and get things set up, so.

But those rates will kick in.

They're contractually bound to kick in.

So that's not an indefinite delay and it was put in there for instances like this.

Got it.

And last one from me.

Just the compressor sales margin on the quarter, I didn't catch that.

It seems like sales aggregate margin is a bit all over the place.

You referenced just some timing there.

Tough to peg, just a little help there on maybe baseline compressor sales margin and then how to think about that on a go-forward basis?

Yes.

Let's see, the margin this quarter, we had total gross margins -- I didn't -- well, hold on.

I must not have given you the compressor sales.

Did you want compressor sales or total sales?

Yes.

The compressor sales margin, I think, you did $4.7 million in sales.

I was just trying to get the margin number on that one.

Yes.

The compressor sales margin this quarter was 18%.

Okay.

And that's up from last -- last year was 5% and last quarter was 26%.

So you get -- again, you get variation, as I mentioned, I think it's -- we're averaging higher year-to-date than we did last year, but it's just -- it's just up and down.

It depends on -- some equipment has got a higher margin and some has got lower, it just kind of depends on the schedule as it goes through.

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

First on the sales revenue, I think in the past you've talked about a shift away from sales to rental and now it seems like the sales is stronger.

What's kind of driving that?

What are the sizes?

And what are the market dynamics going on there?

It's -- our sales have been strong throughout the last 3 or 4 years.

I've mentioned that in the past, kind of contrary to what we would think in a downturn.

And it's just continued that way.

And so we've got a couple of pretty good legacy customers have just continued to buy through the downturn and actually have started to accelerate purchases a little.

So we're just seeing a continuation of what we've experienced the last 3 or 4 years.

And that's -- I don't think it's -- well, I say this, I was going to say I don't think it's a permanent fixture, although it's been going on for 3 or 4 years.

But as the rentals -- I mean, the high horsepower rentals are starting to really get some traction and sort of we think the other wellhead type or size rentals will as we go forward.

So I think we'll get that mix shift back to our traditional ratio between rental and sales.

But right now, it's just been -- right now, it's pretty strong and it has been, really, for the last 2 or 3 years.

Okay, good.

And then on the makeready work you did, is that -- was that in wellhead compression units that are starting to get traction again?

I guess, what's going on in the wellhead market, specifically?

Or is this a shift to high horsepower?

Yes.

No, that's primarily wellhead stuff because all the high horsepower is essentially new.

So it's out on contract, goes out on contract as it's being built.

Well, we have 91% utilization in that.

So obviously, 9 out of 10 are going out right away.

But yes, all of the makeready is our traditional business and is primarily what we saw from 2010 on, the wellhead type gas lift equipment.

So we -- that looks like it's picking up pretty well, and we expect that to continue.

Okay.

And then, I guess, in the same vein, should we expect additional makeready kind of margin compression for the rest of the year?

Or is that kind of over at this point?

No.

We'll continue to see it.

And like I say, we -- that's one of those double-edged swords, right?

You like it but it does impact current results.

But there's revenue attached to it.

So it's just a typical part of our business since we do expense all those costs, we take those hits currently and don't capitalize them on the balance sheet.

So we take them currently, but again, we'll see revenue come from that in the next couple of quarters.

But we expect -- well, that will continue.

It's hard to say how long it will continue, but I think I've probably made a comment last couple of quarters that we could see 4 to 5 quarters of this.

But again, once it starts, it keeps rolling as long as things keep growing.

We'll have those maintenance expenses and this is our biggest quarter so far.

But we ought to have corresponding revenues going forward, too, to take care of them as we go into the future.

Our next question comes from Richard Dearnley from Longport Partners.

I'm new to your company.

And when you were saying you did 12 overhauls in the second quarter of '17 and 31 in the first and 74 in the second.

Then you said, was it $30,000 of makeready costs increase year-to-year, or -- I guess I was (inaudible).

No.

It was $330,000.

Oh.

Okay.

How does that number compare to the roughly 800 basis points of difference in rental margin year-to-year, which would be about $900,000.

What's -- if the overhaul was $330,000, is the rest of it some other kind of makeready or...

No.

That -- I mean, we highlight that because we always see that coming out, but we also had -- there were a couple hundred thousand dollars in increased oil expenses year-over-year because, as everybody knows, oil has come up.

There was some appreciable overtime expenses last quarter due to the extremely hot weather out here in the Permian.

A lot of cooling issues on equipment, things like that.

So there are other expenses that go into it.

I mainly highlight the makereadies because they're not -- they're somewhat extraordinary in that they will tick down over time, but they're a good indicator of what we think will be some future activity.

I see.

And so the -- if the makeready was $330,000 and you did 74 units, that would be $4,000 or $5,000 a unit?

Yes.

$5,000 or $6,000.

Yes.

That's the right range?

Yes.

That's about typically what it will run.

Okay.

Of course, those averages vary by quarter, depending on what equipment is going through there.

And then the price per -- did you mention -- my phone disconnected in the middle.

In the first quarter, you said price per horsepower was down 5% overall, what is the -- what's the gross number for the second quarter?

It was down 5% Q -- hold on -- I think Q2 compared to Q1 on a per horsepower, then 1% on a per unit.

Let me look here.

Yes, saw a 1% decrease in rental rates per unit in the sequential quarters.

Yes, that's sequentially.

Our next question comes from Jason Wangler from Imperial Capital.

Wanted to maybe ask a bit about the makeready in a different way maybe.

It sounds like obviously you're seeing a lot more units going kind of out in that.

I mean, is there a number we should kind of think about on a per unit basis or anything like that as we think about kind of the expansion of the rental fleet from an activity standpoint or is that kind of the -- you kind of figure that out as you go out and actually start working the unit?

Oh, you mean as far as the cost?

Yes.

Yes.

It's going to -- it'll vary depending on what we've got going through.

But roughly, and very roughly, it's going to run $5,000 to $6,000 per unit per overhaul.

That's held fairly steady but you can have some variation in it.

Sure.

But it's pretty nominal versus even what (inaudible).

Yes.

If you look at our average rental revenue, that's 1.5 to 2 months of rental.

And on the CapEx side, I mean, you spent a little bit of money but certainly not very much in the quarter.

I mean, as you think about kind of that expansion, you kind of gave us a CapEx budget, but as you see, it seems like there's still not going to be much cash burn going forward really.

Is it just a function of, as you see the market kind of participate, you'll kind of participate in kind?

Or just how you're thinking about the spending levels as you move forward?

Yes.

Pretty much.

I mean, we just updated this a little from the point we see more coming in from the rental side.

And again, all of our capital is new growth capital so that would portend additional rental equipment going into the fleet.

And obviously, we're not building much for spec right now, we're building (inaudible) what will rent.

So that's a positive indicator, we think, going forward.

But yes, if it picks up more next quarter, we'll update it then.

But yes, we're not -- we're spending capital money primarily, I'd say, 95% on our large horsepower class, which we count as 400-, 600- and 1,380-horsepower.

So all the growth capital is going toward the big stuff.

And like I mentioned, we've got 14% of the active fleet now is big horsepower, and then we've got another equivalent amount in work in progress.

So we've got a fair amount of rental CapEx backlog going forward, probably stretching at least 2 or 3 quarters out.

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

Okay.

Thank you, Erica, and thanks, everybody, for joining me on the call.

Appreciate your time this morning, and look forward to visiting with you again next quarter.

This concludes today's conference call.

Thank you for attending.