Natural Gas Services Group Inc (NGS) 2022 Q3 法說會逐字稿

Good morning. My name is Dennis, and I will be your conference operator today. At this time, I would like to welcome everyone to the Natural Gas Services Group Inc. Third Quarter 2022 Conference Call (Operator Instructions) I would now like to turn the conference over to Micah Foster, Chief Financial Officer. Please go ahead.

Thank you, Dennis, and good morning, everyone. Before we begin, I need to remind you that during this call, we will make forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, based on our current beliefs and expectations, as well as assumptions made by and information currently available to Natural Gas Services Group's leadership team.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Please refer to our latest filings with the United States Securities and Exchange Commission for the factors that may cause actual results to differ materially from those in the forward-looking statements made during this call.

In addition, our discussion today will reference certain non-GAAP financial measures, including EBITDA, adjusted EBITDA and adjusted gross margin, among others. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see this morning -- yesterday afternoon's press release and our Forms 8-K, 10-K and 10-Q furnished to the SEC.

I will now turn the call over to John Chisholm.

Thank you, Micah. As most of you likely read in our press release last night, I've resigned as interim CEO for NGS, but will remain as a director until March 1, 2023. My focus over the past 15 years as a Director with NGS has always been on what creates the most shareholder value for NGS.

But I concluded it was my other growing obligations, some of which are international, the time required that I could provide would not be sufficient. I want to thank employees of NGS and my fellow directors for this last 6 months leading the company. I trust that I have extended the foundation of NGS and contributed to our value creation. Now my long-time friend and colleague, Steve Taylor. Steve?

Good morning, everyone. Thank you, John, and thanks for your contributions to NGS. We all value your knowledge and insight and look forward to your continued guidance. And thank you for the assistance you have given me during this transition. Before I get to my prepared remarks, I do want to reiterate and reinforce that the company will continue our search, which is ongoing for a permanent CEO. We will provide updates as required.

I would also like to note that in addition to Micah Foster, our Chief Financial Officer, with us today is Jim Hazlett, our Vice President of Technical Services. Micah, Jim and I will be happy to answer your questions after our discussion of the third quarter results and on our current operating environment.

Turning our attention to the business. As we noted in our second quarter earnings call, the current macro environment for energy industry is unique in my career. Upstream operating customers have typically continued with their capital restraint, which supports higher commodity prices. There's clearly a weak supply, strong demand dynamic in play that has been influenced by traditional natural gas demand, defining pressures and volumes in existing basins and increase in LNG consumption and a continued strength in crude oil commodity prices with a large amount of crude oil produced through gas compression assisted techniques.

It's a unique dynamic that demonstrates that gas compression demand is presently (inaudible) from appreciably higher capital spending. After a large-scale geopolitical event, we believe that we are at the beginning of at least a couple of years of higher commodity prices. NGS, with our past financial discipline is well-positioned to take advantage of these opportunities beginning this year and into 2023 and beyond.

While we have been and will continue to be focused on operational efficiencies, our visibility of organic growth opportunities in the large horsepower market has never been stronger. We have worked diligently with our customers to understand their needs in 2023 and beyond and have started discussions with our financing partners to provide us with immediate liquidity and to build out significant new large horsepower additions at highly accretive rates.

We have always been protective of our balance sheet, so we have the financial ability to execute on opportunities, and we are now in the land of opportunity. While the ultimate amount of capital required for our 2023 program has not yet been finalized, we are working with our Board and banks to complete the process. Along with this, we have already begun work on meaningful amounts of new large horsepower compression that is already committed under long-term contracts.

In addition, our previously announced electrification conversion project on a number of our 250-horsepower units is well underway, and we anticipate that we will complete the conversion of 60 of these units by midyear 2023. Additive to this, our plans to deploy our first 2,500 horsepower electric units in next year. While most of our capital is committed to traditional gas fired engine editions, we are seeing more demand for high horsepower electric units from our customers, and we do think there will be more opportunities in this realm.

Turning to our quarterly results. We are pleased to report our seventh consecutive quarter of increased rental revenues. Rental revenue increased 15% to $18.6 million from $16.2 million in the third quarter of last year and 3% over the second quarter's rental revenue of $18.1 million. Q3 saw a slight decline in operating margins on our rental business after consecutive quarters of improved margins. Inflationary pressures, primarily in labor, lube oil and parts drove this decline.

During the quarter, we worked with our customers to increase our rental pricing given these inflationary pressures. The price increases we rolled out will impact approximately half of the active rental fleet in the fourth quarter with the balance of the fleet seen increases beginning in January of 2023. These price increases will need to not only recapture operating costs due to inflation, but to roll back previously negotiated price concessions we've seen over the last 2 to 3 years and during the pandemic.

These will have a positive and sustained impact on revenues and EBITDA. We believe these price increases are appropriate given the current cost environment and will restore our margins to the levels needed to continue to invest in the business and bring on new compression to support our customers' activities. As you are all aware, we began our strategic shift towards the higher horsepower market nearly 5 years ago, and has been and continues to be an excellent source of cash, margins and returns.

Our asset mix, however, by unit count is still heavily weighted towards small to medium-sized compression. Our large horsepower assets comprised approximately 14% of our current utilized fleet by unit count, but these units provide approximately 45% of our current rental revenue stream. As the small- to medium-sized compression market is the most competitive, and thus the most price sensitive, we anticipate that our unit utilization will experience some volatility over the coming months, but it will not have a meaningful impact to our revenue stream.

However, we anticipate that our horsepower utilization will continue to grow, reflecting our large horsepower growth. With that, I'll turn the call over to Micah to discuss our quarterly results in more detail.

Thank you, Steve. As previously mentioned, total revenue for the 3 months ended September 30, 2022, increased to $20.7 million from $18.2 million for the 3 months ended September 30, 2021. Rental revenue increased 15% to $18.6 million in the third quarter of this year from $16.2 million in the third quarter of last year due to the increased deployment of rental units, primarily higher horsepower packages. As of September 30, 2022, we had 1,196 rented units, representing 305,953 horsepower compared to 1,221 rented units, representing 288,706 horsepower as of September 30, 2021.

We ended the third quarter with 60.5% utilization on a per unit basis and 72.2% utilization on a horsepower basis. Utilized horsepower increased by 6% in the third quarter when compared to the year ago period, while revenue per horsepower increased 6.8% when comparing the same periods. Sequentially, total revenue increased 4.1% to $20.7 million in the third quarter of 2022 compared to $19.9 million in the second quarter of 2022, primarily due to a $0.5 million increase in sales revenues and $0.5 million increase in rental revenues partially offset by a $200,000 decrease in service and maintenance revenues.

As noted in our release this morning, adjusted rental gross margin of $8.6 million increased 17% when compared to $7.4 million in the same period in 2021 with a marginal decline of 300 basis points when compared to the $8.9 million recognized in the second quarter of this year. Adjusted rental gross margin as a percent of rental revenues was 46% for both the third quarter of 2022 and '21 and 49% for the second quarter of 2022. Operating loss for the 3 months ended September 30, 2022, was $1.5 million compared to an operating loss of $1.6 million for the 3 months ended September 30, 2021.

Operating loss improved primarily due to higher rental margins, partially offset by increased G&A, primarily driven by severance costs related to the retirement of our former Chief Executive Officer, Steve Taylor. Sequentially, we reported operating income of $700,000 in the second quarter of 2022. The decline in operating income during the current period was a product of severance charges, and to a lesser extent, increased rental expenses.

Our net loss for the 3 months ended September 30, 2022 was $80,000 or $0.01 per basic and diluted share compared to a net loss of $3.6 million or $0.27 per basic and diluted share for the 3 months ended September 30, 2021. Improved rental margins, combined with a $1.3 million gain on the sale of certain assets from our rental fleet were the primary contributors to the decreased net loss. We reported a net loss of $70,000 in the second quarter of the year or $0.01 per basic and diluted share.

Adjusted EBITDA increased to $7.7 million or 44% for the 3 months ended September 30, 2022, from $5.4 million for the same period in 2021. This increase was primarily the result of higher rental margins and gains recorded on asset dispositions. Sequentially, adjusted EBITDA increased 13% from $6.7 million, primarily as a result of asset dispositions. SG&A in the quarter was approximately $4.1 million, a $1.4 million increase from the year ago period and an increase of approximately $1.8 million in the second quarter of this year.

These increases were primarily attributable to severance expenses related to the retirement agreement between the company and our former CEO, as well as other costs related to our executive transition process. While we anticipate fluctuations in SG&A with our heightened activity, we anticipate severance and executive transition costs to be temporary in nature, and do not expect them to impact our business beyond the midpoint of 2023.

Our cash balance as of September 30, 2022 was approximately $2.6 million with $2 million outstanding under our revolving credit facility. In the first 9 months of the year, we realized cash flow from operations of $18.8 million and used $35.4 million for capital expenditures, $34.6 million of which was expended on our rental fleet. As noted in our second quarter earnings call, the compression market remains strong, and we are fielding calls daily from our customers inquiring about the availability of new compression, primarily higher horsepower.

During the second quarter, we accelerated our new equipment development program and anticipate we will end the year at the high end of our previously forecasted $40 million to $50 million of CapEx spend.

With that, I will turn the call back over to Steve.

Thanks, Micah. In my opening comments, I mentioned that we will be fabricating and installing some 2,500 horsepower electrical drive units, our first. That's significant, but I also want everyone to understand that this is only part of the new phase in our large horsepower strategy. We started on this shift to remake our fleet about 5 years ago, and we have been quite successful, as evidenced by the fact that today, 45% of our rental fleet revenue is associated with our large horsepower assets.

We're now embarking on another complementary phase, and that is moving into the 2,500 horsepower asset size. Besides providing an additional growth avenue, we will be able to leverage our existing large horsepower compressor infrastructure that has already been established. In the past, we have been fortunate in being awarded rental contracts of longer term and higher price than the general market. These positive aspects continue as we contract equipment in 2,500 horsepower units. With our entry into the very large compression horsepower market, we anticipate that our utilized fleet horsepower will see double-digit growth by this time next year.

Supply chain disruptions and customer delays can certainly impact that. But in general, we anticipate this level of activity. Besides the problems we see in our traditional business, we think we also have the optimum type of gas compression packages to capitalize on the methane reduction initiatives that continue to be legislated, as recently evidenced in the Inflation Reduction Act.

Combined with our technological prowess and experience, our eComp compression package will not only reduce the carbon footprint of our equipment, but will simultaneously reduce the taxes operators pay related to those emissions. If you followed NGS for any time at all, I'm pretty conservative when it comes to predicting the future, but it certainly looks like we are uniquely positioned to take advantage of this positive cycle. I did not expect to be coming back into NGS in a daily operating role, but through John's efforts and the contributions of the NGS team, we're in an excellent position to grow the company.

Our focus will continue to be on capital execution, deployment of new compression equipment, and maintaining our service quality. I will, of course, provide further updates on our end of the year call. Now we're happy to take any questions. So Dennis, if you'll open up the lines.

(Operator Instructions) Your first question is from the line of Rob Brown with Lake Street Capital.

Stephen, good to be talking again. On the demand environment, you said it's quite strong, and you're seeing customer activity increasing. I guess, is that strength across the board? Or is it really focused on the high horsepower market or really what's driving demand and where are you seeing it?

Well, there is some increase across the board, but I mean, natural gas prices are good, but it's primarily a big horsepower that we're seeing, and the majority, I think the number was 80% or 85% of our CapEx is spent on large horsepower, which has been pretty indicative of the last few years anyway. But overall, it's -- we're concentrating and seeing large horsepower demand. Jim, do you want to add anything to that?

Well, Steve, you're absolutely correct. Most of our build out -- our planned build-out will be in the large horsepower, 1,500 horsepower, 2,500 horsepower size units. There -- as you know, there are some small ones, but not very much.

Rob, did you just ask the gas price has been, they are currently volatile, but I think still pretty decent compared to the last decade. There is uplift everywhere, I mean, even in traditional, just pure natural gas basins, Barnett, San Juan, South Texas places like that. But really, what's driving the large horsepower demand or oil commodity prices and gas lift techniques which require compression. So it's kind of an indirect activity, but the gas lift market is really the one that's driven our entry into big horsepower in the last 4, 5 years. So it's -- I don't want anybody to think that's a transient thing, is the high oil prices are driving the vast majority of the horsepower demand.

Yes. Okay. Great. And then on the methane reduction kind of market that's opening up in the government support, how -- how do you see that in terms of opportunity for you and kind of the growth drivers next year and beyond?

Well, it's a double-edged sword, right? So it's an opportunity, but it's also driven by legislation. And when legislation has made The Inflation Reduction Act, quite the misnomer, you're always having some portions of it directed towards methane reduction. I think even Biden the other day, kind of double downed a little bit on some of that stuff. So we're seeing that from a legislative standpoint everywhere. But certainly, there's an opportunity from the point that the cleaner the machine got, the more popular you're going to be, you're going to be the girl that dance, gets all the boys because all this stuff come along.

And one of the things I think was in the Inflation Reduction Act, and Jim, correct me if I'm wrong, but I think there is a tax regime in there based on carbon emissions, methane emissions, stuff like that. And so when you start looking at that and particularly the equipment, as I mentioned, that we're using whether it's the engines or going to electric drives or eComp phase of our top equipment, we can reduce operating taxes quite a bit just due to taxes imposed on methane emissions.

So there are -- there's all kinds of opportunities around it, whether it's (inaudible) environmental, whether it's financial, you have lot of bills, and we're going to get started on it. And it's just going to grow. So Jim, I don't know if you've got anything else about that Act or our equipment now, don't give away any secrets. But...

I won't, it involves capturing the escaping methane from a traditional package, and we do it by changing our end devices and things like that. And we can get it down quite a bit. On the electric drives, we can move it down pretty close to 0. So Steve, you're right. It's -- also, I would like to mention that I heard yesterday even that New Mexico is increasing their (inaudible) restrictions on methane. So it's coming down to who can do more and better. So you're right, it's the girl at the dance.

Yes. So and Jim mentioned New Mexico, it's a part of the Permian Basin. So supporting this driving a lot of this big horsepower, a lot of the concentrated (inaudible), et cetera. So we're going to be well positioned in that. And I think we start testing some phases of the equipment in about a month or so, but we're going to be able to offer to the operator a pretty clean machine.

Okay. Great. That's great color. And then I guess last question is on the pricing environment. You talked about increasing pricing and then maybe a second round for the rest of your fleet. How -- what sort of the degree of price increases you can get and how calling to take to flow into the average?

Well, the -- as I mentioned, about half of the fleet receive price increases in fourth quarter then the other half first quarter of next year, it may go into how much the increases were. I mean they buried and depending on the current price of equipment over time in the rental business for the same size and (inaudible) different rental rates on with the same customers, it's certainly among customers because depending on when you put that stuff out, environment with the high activity or lower activity environment, things like that and your cost in certain areas are higher than the other areas. So you get different rental rates out there. And one of the things we got to do is obviously get everything up to a decent return profile.

So the increases were all different. Generally, they were instead of shotgun, broad approach, like, we did in March, which is just spread across the board, 7% to 8%, this is more surgical. And to that and sort of give John some credit for leading that effort, and that will come in. Micah, I don't know if you got anything you will say on the price increases.

Yes. No, I think you hit it, Steve. This was -- this is when we say 50%, we're really looking at that from a revenue basis, right? So half our revenues will see a price uplift in the fourth quarter with the balance rolling into the first quarter. A big piece of that, we've got one large customer whose equipment is primarily still under contract terms. And so negotiating price increases there, we can't just do that unilaterally. It's a real negotiation there where we've got to prove out. Here's the cost burden we're bearing and kind of prove that out to them.

So that's what we're expecting to come in, in the first quarter. But in the fourth quarter, this was across the rest of our customer base. And as we kind of intimated within the script, a lot of this was on small compression that is obviously the most competitive in the market, as far as price is concerned. And so we anticipate, Rob, a little volatility in our utilization going forward as some of these units come back to us.

We also have on several occasions when we talk with the customer and said, here's the price that we need to realize to keep operating this machine in the field for you. This is some older equipment that does -- isn't really part of our core strategy going forward and those customers at times have kind of raised their hand and said, "Hey, would you sell that to us and then maintain it for us." And so we've done that as well. So we're working through all the options available to us to help our customers continue to -- with their operations, but at the same time help us realize the margins we need to go forward to continue to invest in the business.

Yes, Rob, as you -- a lot of inflationary pressures, a lot of supply chain issues still. I mean, supply chain is getting a little better in some aspect and other aspect it's not. Certainly price -- inflation-driven pricing has not abated in spite of what the government says. Obviously, excuse my digressing. Biden hadn't been to a grocery store or hadn't bought a compressor part in a while because they're all still advancing cost pretty significantly.

So as I mentioned in the narrative, a lot of this is to recover some costs and certainly get our margins where we need them to continue to provide equipment. There's a lot of demand out there. And it is unique. It's pretty high. And we're fortunate that we're in the (inaudible) the market right now, the 1,500 to 2,500 horsepower realm is pretty active. We think we're going to be in good shape (inaudible). And the new contracts we're getting, as I mentioned, on the bigger equipment is excellent, too. So I think you'll see that flow through certainly into 2023.

And as long as we don't have some disruption in the market that pricing should hold for a bit.

(Operator Instructions) Your next question is from the line of Tate Sullivan with the Maxim Group.

Steve, you commented earlier on kind of maybe seeking other financial partners to finance building larger compressors, I mean, in this type of market, I mean just as the customer demand enough to rationalize using more debt than you have historically? And how comfortable are you with using more debt to build a higher horsepower business.

Well, it's not going to be too hard to use more than we have more debt than we have traditionally because traditionally, it's been 0. And yes, we're -- as I mentioned, we're talking to others about additional liquidity and things like that. But the issue you get in, and we saw it moving on to the 1,500 horsepower. You in, say, medium horsepower, you run into equipment to run, brand new, maybe $250,000, $300,000. You move into the 1,500 horse realm, and you've got stuff that's $1.5 million to $2 million, you start moving in to 2,500 horsepower and you get $2.5 million to $3 million. So the magnitude of the expenditures grow, even though the number of equipment don't; so yes, we're going to have to -- and that's what we're doing, and Micah is leading the charge on that.

We just -- we're going to have -- to have some other sources outside of our operating cash. Certainly, that's still going to be a stronger driver, but we're going to have to supplement just because, number one, you get the higher cost of the equipment and just have such demand, but our cash flow just can't take advantage of it right now.

Micah, you are going a little more on that?

No, I think you hit it right on, Steve. It's something, as we've said numerous times, we've been very protective of the balance sheet, waiting for the right opportunity in this -- the market that we're seeing today with the wide gap between supply and demand, the rates we can secure with this new large horsepower additions are very accretive and something that we don't, it doesn't bother us to take on leverage in this kind of operating environment. It's just, the rates that you can get and the returns you can achieve on those investments is too good to pass up. So it's something we're working on diligently talking with our banks and others to make sure that we have the financing lined up so we can go execute on the opportunities available to us.

Tate, I will mention that we're keeping an eagle eye on the balance sheet. We don't go out there and get 5 to 6x EBITDA leverage and stuff like that. So we're going to keep it in the reasonable realm while still being able to grow the fleet pretty vigorously.

And then related to the large -- the 2,500 horsepower, is it not an element of the industry for customers to do installment payments or any upfront payments as they go to the larger horsepower? Or do you have to finance the whole construction until the rental -- receiving rental...

Well, yes. On rental, it's all on us. Now if we're building this up for somebody, certainly, we get upfront payments, [partial payments] and things like that. But that's not a capital expense. That's just build and sell the margin. So we're not too worried about that stuff right there that will impact our capital profile too much. It's a real equipment that we've got to put the whole bill and then we turn around and run it for that return.

At this time, there appear to be no further questions. I will now turn the call over to Steve for any closing remarks.

Okay. I appreciate everybody calling in. Certainly want to again thank John for his contribution to the company and continued insights and appreciate Jim and Micah join the call and certainly all the NGS employees. We've got a lot of opportunity in front of us. So thanks, everybody, and we will see you next quarter. Thank you.

This does conclude the Natural Gas Services Group, Inc. Third Quarter 2022 Conference Call. We thank you for your participation. You may now disconnect.