Natural Gas Services Group, Inc. (NGS) Q1 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group First Quarter 2011 (sic) [2012] Conference Call. [Operator Instructions] Your call leaders for today's call are Leann Conner, IR Coordinator; Steve Taylor, Chairman, President and CEO. I will now hand the call over to Ms. Conner. You may begin.

Thank you, Erica, and good morning, listeners. Please allow me to take a moment to read the following forward-looking statement prior to commencing our earnings call. Except for the historical information contained herein, the statements in this morning's conference call are forward-looking, and they are made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, as you may know, involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group's actual results in future periods to differ materially from forecasted results. Those risks include, among other things, the loss of market share through competition or otherwise, the introduction of competing technologies by other companies, 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 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 stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Okay. Thanks, Leann, and thanks, Erica, and good morning and welcome to Natural Gas Services Group's first quarter 2012 earnings review. In our earnings release this morning, you can see that our revenues and profits continued to increase in the comparative year-over-year and sequential periods. We did have a nonrecurring sale in the first quarter that I'll detail later, but even without that contribution, our business continued to grow in a very difficult environment. In the comparative year-over-year quarters, the total revenues in the first quarter of this year, 2012, increased 75% to $26.4 million from $15.1 million in the first quarter of 2011. From the sequential quarters of Q4 '11 compared to the current quarter of 2012, total revenues rose almost $7.7 million or 42%. These large comparative increases are primarily due to a one-time sale of compression fleet equipment in the first quarter of this year. However, I do want to point out that our sales and rental revenues increased in the same periods even with the effect of this sale eliminated. Since this sale will be referenced throughout the call, let me give you some background. The sale is at the request of a good customer of ours who wanted to purchase equipment they were renting. Although we are reluctant to sell fleet compression and in fact, this is the first time since 2006 that we have sold a number of units like this, it was a minor amount relative to what we still have rented to them. Along with this transaction, they are buying additional new equipment from us and continue to increase their rental business. This is overall a financially attractive opportunity for us, and we think we have enhanced our business prospects with this customer who, by the way, is a large and very active operator. The sale is in 2 parts, with the second half of the sale being finalized in April of this year. As we go through the rest of the numbers, they will include the effect of the sale as reported. But I'll give you a rough break-out for comparison purposes before we get to the segment details. I'll also note that some of the revenue ratios, for example, gross margin to revenue, operating income to revenue, et cetera, appear to be falling. That is only due to the mix shift resulting from the high volume of sales this quarter, which carries lower margins. We had about a 50-50 mix this quarter compared to the 75% rental, 25% sales mix we have had the last couple of years. Comparing the first quarter this year to the first quarter 2011, total gross margin increased 40% and grew from $8 million to $11.2 million. Sequentially, gross margin increased to 14% from $9.9 million in the fourth quarter of 2011 to $11.2 million in this current quarter. SG&A increased to $1.8 million from $1.4 million in the year-over-year quarters and increased $300,000 sequentially. These increases were primarily first quarter occurrences and should reduce through the rest of the year. As has been the case over the last year, SG&A continued to stay in the 7% to 9% of revenue range. Comparative year-over-year quarters for operating income reflect an increase of $2.3 million from $3.3 million in the first quarter of 2011 to $5.6 million in the current quarter. Sequentially, operating income increased almost $1 million or 21% to $5.7 million. In the comparative year-over-year first quarters, net income increased 40% from $2.5 million last year to $3.5 million this year. As a reminder, in the first quarter of last year, we had a gain on the sale of our old fabrication facility in Midland that contributed over $700,000 to our bottom line. So in fact, our operating increase is actually larger this year. Comparing the fourth quarter 2011 to the first quarter of 2012, net income increased about $500,000 or 16% to $3.5 million. EBITDA increased from $7.3 million in the first quarter of 2011 to $9.4 million in the current quarter or 29%. Sequentially, EBITDA grew from $8.5 million for an 11% increase. Fully diluted earnings per share this quarter was $0.29 per common share, compared to $0.25 last quarter and $0.20 last year. As a footnote, in eliminating the effect of the extraordinary sale, the following are the comparative year-over-year numbers for our first quarter operations. Taking the contribution of the sale out, gross margin would have increased approximately 24% versus 40% with the sale included. Operating income would have increased approximately 30% versus 69% with the sale included. Net income would have increased approximately 8% versus 40% with the sale, and EBITDA would have increased approximately 11% versus 29% with the sale. I mention these comparisons to demonstrate that our base level in non-extraordinary business continues to grow. Looking at our balance sheet, our total short-term and long-term debt was $1 million as of March 31, 2012, and our cash balance was $29.4 million. Our cash flow from operations for this year was $14.8 million or 56% of revenue, compared to $9 million for the same period in 2011. In the year-over-year quarters, total sales revenues increased to $12.4 million in the first quarter this year, compared to revenues of $3.9 million in the first quarter of 2011. Approximately $4 million to $5 million of this was the first quarter effect of the one-time compression sale. So removing that, we had excellent inherent growth and a good sales quarter in the overall sales business. Sequential quarterly total sales revenues increased from $4.8 million to $12.4 million. Compressor sales alone in the current quarter were $10.7 million, and our backlog at the end of Q1 2012 was approximately $7 million to $8 million. Rental revenue had a year-over-year increase of 26% from $10.9 million in the first quarter 2011 to $13.7 million this current quarter. Gross margins were consistent at 60% for both quarters. Sequentially, rental revenues were up from $13.5 million in the fourth quarter of '11 to $13.7 million this quarter. First quarter growth was impacted by the one-time sale, but we think rental growth will pick up towards the end of the year. There is obviously some resonance in the dry gas markets due to natural gas price, but our oil-based activity continues, and we think it will pick up as the year goes on. We aren't seeing any broad shut-in signals from customers, but we have had some returns due to the economics of particular wells. But these have been minor and less than I would have guessed based on natural gas prices, but we have to keep a close eye on the summer months for any deterioration. But since this is already May, we have only 5 to 6 months before winter demand starts to appear. Gross margins in our rental segment did, however, improve sequentially from 57% to 60% of revenue. We ended the first quarter with a rental fee utilization rate of 75% on a fleet size of 2,135 compressors. Our horsepower utilization is running at 77%. Rental compression CapEx year-to-date through March 2012 was $5.6 million. Although there were some moving parts this quarter, we're happy with our performance. Growth in our primary business lines continue, and our movement into new geographical areas is proceeding as we anticipated. We, of course, do have the specter of low natural gas prices hanging over our heads, and I'm sure everyone is familiar with the stats. Natural gas drilling and prices are at 10-year lows, with storage running almost 50% higher. But the EIA report published Tuesday had some good news in it. Natural gas consumption is projected to rise 5.1% this year compared to 2011. This is driven by an anticipated 21% of gain, and 21% is huge in power gen usage and is over and above a 6% decline forecast for residential and commercial users. Consumption growth in 2013 slows to 2%, but it will shift to the residential and commercial sectors. So for the next couple of years, including this one, there's a good broad-based growth curve developing. Natural gas production grew 7.9% in 2011. The projected growth for 2012 was down to 4.4%. It's still growth, but there's finally an indication that lower rig counts are starting to make an impact. Some experts even predict lower growth because the full effect of this laydown rigs won't be felt for the next few months. Combining higher consumption rates with the lower growth of supply results in an average Henry Hub gas price forecast of $2.45 this year. Being that Henry Hub was $1.95 in April, it means that natural gas prices should approach $3 by end of this year. The June futures price this morning was $2.45. Price in 2013 is projected to be no lower than $3 and ending up between $3.50 and $3.75. Most interesting is that EIA's forecast this low point for natural gas prices between January 2011 and December 2013 at the second quarter of this year. That's right now. If they are right, we're at the low point, with increasing prices forecast for at least the next 18 months. I personally quit forecasting price trends when I told everyone last fall that natural gas always increases in the winter. Well it doesn't. So I'm leaving the prognostications to the other experts. I did, however, say in the first quarter 2011 call that natural gas is moving towards its rightful spot as a preferred fuel, and I think the EIA report bears that out. It's certainly encouraging and if true, NGS should be a prime recipient as usage increases and prices trend higher. I'll wrap up with some brief comments on our fracturing controversy, a controversy pretty much invented by the EPA, our current administration and their supporters. This has already been a full call, and I won't spend much time on it, but I didn't think I should let the fact pass that the EPA is now 0 for 3 when it comes to finding the elusive, might I'd say, nonexistent link between fracturing and groundwater contamination. In spite of the fact that there have been multiple studies over the years that have never ever established a cause and effect between fracturing and contaminated groundwater, our bureaucrats at the EPA refuse to let pesky things like facts stand in the way of giving us a world in their image. Recently, the EPA dropped its claim that Range Resources had contaminated the drinking water in Parker County, Texas. This retreat happened after they threatened Range with huge fines if they didn't identify the source of contamination, clean it up and supply water to the local residents. And the EPA bypassed the Texas Railroad Commission, which just wasn't acting responsibly. Now considering the fact that the Railroad Commission concluded that the gas in the water source was caused by a natural seep, Range decided to appeal the ruling, and during a Railroad Commission administrative hearing, the judge noted that an environmental consultant in the matter personally knew the Regional EPA Administrator, Al Armendariz, that there was an intentional effort to misstate facts by the consultant, and that there was evidence of a conspiracy to defame Range. As the EPA dropped their case, the Railroad Commission accused the EPA of "fear mongering, gross negligence and severe mishandling" of the case. In their response, the EPA said they dropped further pursuit of their action because, get is, it "allows EPA to shift the agency's focus in this particular case away from litigation and toward a joint effort on the science and safety of energy extraction." How do you spell BS? This is only their most recent defeat. The EPA also had to agree to retest alleged contaminated water in a Wyoming action because their methods were questioned by the state and others. And in Pennsylvania, they angered state officials there by conducting an independent analysis. They only confirmed the state's finding that water once tainted by the state -- once tainted by gas was now safe. Besides the egregious manner in how these bureaucrats approach things, it's interesting and validating that it isn't just the oil and gas industry complaining, it's also the actual state regulators crying foul over their tactics. Despite of all this and contrary to the fact that states effectively regulate fracturing and have forever, the federal government is proposing their own regulations. Apparently, if you can't intimidate or fine a company out of the fracturing business, there may still be the chance to overregulate them. Remember, this is the agency that had Al Armendariz as their recent regional administrator. Recent, because he had to resign last month after he said that he would use threats and coercion as enforcement practices. He certainly lived up to that promise. It is absolutely a miracle that any of us have survived the paramount incompetence of this agency. That's the end of my prepared remarks, and I'll turn the call back to Erica for questions that anyone might have.

[Operator Instructions] Our first question comes from Joe Gibney from Capital One.

Just curious if you could kind of help us calibrate a little bit on 2Q and how we should think about the sort of the rental fleet count with another round of the sales happening in the 2Q on the -- coming out of the 1Q event?

Well, we -- the little over $5 million we spent on capital in Q1 -- actually, if I remember the numbers right, we built 35 or 40 units. So the net -- in fact, the net effect was about 15. So I think if you -- I would guess we probably have a same to a little higher net, maybe a 15 to 20 to 25 net increase in the fleet once we back out the sale in Q2.

Okay. And I apologize if I missed this in your prepared remarks, but did you give the dollar amount of what that sale was in the first quarter? I missed that.

Yes, it was in the range between $4 million and $5 million.

$4 million to $5 million, okay. And what were your compressor sales margins? Low 20% still within that figure?

Yes.

Okay, got you. And last one for me, just curious where we stand on borrow [ph] pricing on the rental side. I think last quarter you indicated kind of year-over-year average rental pricing was plus 2% kind of holding the line. Does that still kind of stand today, given some of the noise on dry gas base and shifting and some of the pressures on the dry gas side?

Yes, I looked at -- I actually looked at incremental pricing, the overall pricing kind of gets diluted by what's out there versus what's going out. And I looked at incremental pricing and I didn't put this in the remarks because it looked, frankly, a little better than what I wanted to say. But incrementally, all the units we put out in Q1 this year versus the average in 2011 will run about 5% higher in price on the average unit now. Again, the 2011 units, put out about 200 of them, we've put out about 30 or 40 this quarter. So there's a little difference in magnitude. But it looks like -- and it looks like the pricing is certainly increasing a bit, but I'll think you'll still get comparison from the point that most of the stuff is going into oil plays. So we're seeing pretty good price in these oil plays and obviously, that's where we think the growth's going to be. Probably the next year now, you may see additional growth with this pricing, if this natural gas pricing does continue to firm and dry gas stuff comes back, but right now pricing looks pretty good.

Our next question comes from Gary Farber from CL King.

Just a couple of questions. I don't know if you gave it out in the call, your rental utilization rate is approximately how much now?

75% on a unit count and 77% horsepower.

Okay. And the -- can you quantify the percentage of the overall fleet that's focused on liquids right now?

At end of Q1, it was about 20% -- I mean end of Q4, sorry, 2011, it was about 20%. So it's inching up. It's not going to change a whole lot just on a quarterly basis, but I would guess we're up 1 point or 2.

Great. And then just lastly, just back on the question on the sales margins. I just want to be clear. The product that you actually assembled and sold, what kind of gross margins did that product have?

Well, it's going to be the same traditional margin.

Like 30% range? The sales stuff is in the 30% range?

No, no, no. Compressor sale stuff's in the 20% range.

[Operator Instructions] Our next question comes from Ian Breusch.

Steve, one quick question on your CapEx budget. I know last quarter, you had mentioned probably a $25 million to $30 million CapEx budget for 2012, has that, does that stay consistent for the rest of the year? Has anything changed in your mind on that front?

Well, I think, we're -- I said a little over $5.6 million in Q1, and maybe just annualize that, that's what $22 million, $23 million. But we're thinking there's going to be somewhat of a ramp-up towards the end of the year. So yes, I'd still stay with that $25 million to $30 million, probably right in the middle of it, maybe. But we still think there's -- based on the oil activity continuing, we're having some pretty good luck in the new areas we're moving into and penetrating and putting equipment in. And again, if this gas price does hold and I think it looks like it might, we think the rest of the year is going to accelerate just a little.

Okay. And then on utilization, I know historically, all of your oil plays have been basically 100% utilized. Is that number going to drop off a bit now that you guys have been doing oil for a couple of years now? Is there some equipment that might be coming off and bringing down that sort of oil-based utilization rate at all?

Not yet. I mean we're still building, and all that stuff is still going out. So we don't see -- and just what we project the rest of the year, we don't see much change in that. Now again, we think the growth rate in the capital and the addition slowdown was this year just because last year was such a flush and plus, we're thinking maybe we can use some of the -- hopefully move some of the equipment out of fleet. But so far, it's still staying pretty vibrant, and we're still thinking it will. I mean, what happens is even if equipment comes off of one of those wells, it goes right back on somewhere else, so it's really -- it don't even skip a beat hardly.

Right. Okay, great. And then last question. Just in terms of cash management and capital allocation. You guys increased cash by about $13 million this quarter so you're at about $30 million now. Is that sort of a comfortable level for you here on out. It seems a, slightly high, but I guess given concerns about the natural gas market, maybe you're trying to be a bit safe. But can you talk about sort of capital use for the rest of the year?

Yes, they really jumped this quarter from that sale, and then we're spending a lot -- awful lot of operating cash. And with only about a little over $5 million spend, we made more than that. So it is -- I'd say it is a little high, but as we ramp up, if you look at over the year of $25 million to $30 million, that's not too far off of operating cash, maybe -- we might add a little throughout the year, but we'll kind of keep that in there. We had some of the same questions in '09. Since the '09, when we built a lot of cash. Once this thing turns, we spent a lot of cash just building the fleet. And so we don't want to get into a situation of not having the cash to take advantage of opportunities or things like that. And that's actually what's driven a lot of this oil stuff. We were able to move pretty quickly into these plays and build equipment whereas some competitors couldn't. So that cash comes in handy when nobody else has got any, and everyone needs equipment. So right now, we're not going to just sit here and build cash until it's some astronomical number and hoard it or anything like that. But we think the markets will pick up for the next year or 2, where that cash will be required. And then like you say, it doesn't hurt to have a cushion in this market right now. But we've been able to pretty effectively build the cash and manage it, so I think we'll -- right now, we're just going to be steady as it goes sort of for the rest of the year and see what it looks like.

Our next question comes from Craig Hoagland from Anderson Hoagland.

Steve, I may have missed this, but could you talk about or just go over the size of the increase in the rental fleet in the first quarter?

Yes, it -- we had a net increase of 15 units, but that took into account the total that we built less what we sold. So we built in the 30 to 40 range. And I'm trying -- guys, I'm intentionally being a little vague about some of these numbers, so I'm trying to -- I don't want to be -- from a competitive standpoint, I don't want to give out exactly what we're doing on some of that stuff, but we built from that range and then netted out to 15.

Okay. And that build rate, would you expect that to continue into the second quarter?

Yes, I think so. And as I mentioned, we think -- we anticipate the quarter-to-quarter growth to even be picking up a bit on the rentals because certainly in Q1, we had a negative impact from the equipment we sold, that rental went away. Although we still grew it, certainly the growth would have been appreciably higher with those rentals still in there. So and we'll have that from Q1, then Q2, and then I think you'll start seeing the underlying -- We're still grow in those quarters, but you'll start to see a higher growth rate in Q3 or 4 just because the effect of the sale will be over.

So Q2, we'll see similar one-time sale numbers, similar dynamic in the fleet?

Right, right.

And then could you give us a little more color on how your gas customers are viewing the environment and the decision to shut in wells or keep wells operating, and if that's affecting the churn you're seeing in the gas fleet?

Well, it's just -- it's all over the board. But as I -- everyone's got different views of how they're doing or everybody's got different cost structures, different basins or different situations. But obviously, it all comes down to kind of the same decision, it looks like. There's not -- there certainly doesn't seem to be panic from the standpoint of operators and having to -- like we saw in '09, just shutting in things right and left. And I tell you, with the last 30 days, with this gas price coming up, in fact, it's come up 20% the last month, which nobody anticipated, but certainly nobody anticipated it going down as fast as it did either. Yes, I think that's provided just a little bit of relief for anybody thinking of something and actually just in time because summer is typically low demand time. So I think the operators are -- they're in much better shape going into this gas price lull than what everybody was in '09 when it dropped precipitously very quickly. So I think everybody's of the mind that, keep up on what we can. And like I mentioned, there are some wells you give equipment back just normally. And our churn hasn't really increased and our amounts of equipment going out has stayed pretty steady. So that's why I'm not too concerned about what's going on right now. Now again, as I mentioned I quit forecasting 6 months ago. So I'm not going to guarantee anything, but just by some of the internal measures we look at, it looks like they're holding.

Our next question comes from Jon Braatz from Kansas City Capital.

Could you talk a little bit about maybe the reason or rationale that your large customer opted to purchase some equipment as opposed to rent it? And are they making more of a statement on what they see ahead, or is it just a simple economic decision that they opted for?

Yes, I think it's just -- as I mentioned, the amount they bought was -- there's really 3 aspects of the sale: number one, what we sold them; number two, they bought some additional newbuild equipment that we're going to build for them; and three, they are going to continue the rental business. So I think it's just a particular -- they saw some particularly good economics in some areas with some real long life stuff that they figured, you know what, we'll just go ahead and buy this. And as I mentioned, what we sold is a -- not a appreciable amount of the stuff we still have rented out there and what we project to still rent this year. So I think it's just a spot sort of thing, that this is all oil shale based. And I think there's -- obviously, it has some good wells and those things can be a long time and they like the equipment, and thought that this -- just take some off the table.

Any reason to expect maybe some of your other customers to do likewise?

I don't. Never say never. But as I mentioned, this is the first time in 5 or 6 years we've even had a request like this. And in 2006, it's about the same number of units, but of course, our fleet was about half the size. So this is even a smaller effect, but I don't -- every once a while, we'll get somebody wanting to buy 1 or 2 or something like that, and that's typically what you get. And those aren't any big deal. And sometimes we sell, and sometimes we don't. This is a little bigger piece, but I don't anticipate that because I think what you -- you're getting a margin like this, and rental is -- and really, rental is your better way to go because when things are kind of uneven, there's not a whole lot of reason to put capital out there on some things you might not need for longer term. So but obviously, they saw these as good wells, they're going to be out there a long time and a good established active area they're going to be in, so they bought some of them.

Our next question comes from Joe Gibney from Capital One.

Steve, just one quick follow-up on the $12.4 million on the sales revenue for the quarter. What was the non-compressor piece of that, flares, rebuilds, et cetera?

How much?

Yes.

Let's see. It's about, I think right around $3 million.

$3 million.

Our next question comes from Jeff Spittel from Global Hunter Securities.

Steve, I wanted to touch on -- you guys were really first movers in a lot of these oil plays. Are you starting to see some evidence of some of your competitors being able to mobilize some equipment in there? And if so, are they behaving reasonably rationally. Are you seeing any discernible trends in terms of pricing?

Yes, I mean everybody's moving into this stuff because you'd have to be a mushroom not to know what's going on. So yes, I mean people are coming in. But we've always had pretty good, and I think these oil shales are the same way, we've had pretty good luck moving, we have good equipment, good service and we pay attention to the customer and what we're doing. And so we were able to get in there and get traction pretty quick and get equipment moving in. And that's what we're seeing. There's about 3 -- there's probably 3 oil shale plays that we've started moving into significantly within the last 12 months. So there's always going to be people going into that thing. Yes, from the rational behavior aspect, certainly the oil plays, I think that's a little better because everybody, I think knows that you can -- it's a -- you have to be cutting price to get some work in there and things like that. So I think there seems to be some holding. Now I don't know if there's -- we haven't really seen any price increasing going on and stuff like that. Now our prices have been able to trend up but we haven't really seen an overt thing on, hey, prices are going up and this and that. We tend to do it on per job basis and move it in. And we've always been more of a premium price provider. But so far, so good. Now dry gas side, you get a little different story. There's still some shenanigans going on there, but we're holding our own there. So we think we're staying pretty even on the dry gas side. And even in areas that really aren't growing dry gas-wise, we're able to -- we're taking some share by moving other people out. But the story is your oil stuff and so far, that seems to be holding up pretty well.

Okay. That's encouraging. And then maybe just kind of some qualitative thoughts on how you expect things to evolve in the flare business this year. I'd imagine it's still behaving pretty well for the most part.

Yes. We had a big surge in flares in Q4 '11, of course, everybody was trying to get money spent and everything else. And it's -- Q1 was back to more of a normalized level. But that's still a good business. And I think you're still going to be pretty active. Our margins are holding in and everything else. And we're actually going to be -- trying to push that business just a little more in some other areas. So we think that'll be just -- last year's a record year. We think this year will be just as good, or track to be just as good.

At this time, we have no further questions.

Okay. Well, I appreciate everybody's time and questions and for joining us on the call today, and look forward to visiting with you again next quarter.

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