Natural Gas Services Group, Inc. (NGS) Q3 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group Third Quarter 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. 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. Thanks, Erica. Good morning to all and welcome to Natural Gas Services Group's third quarter 2012 earnings review. We had a strong quarter, and I'm happy to report that our revenues and margins are trending higher. Our markets continue to be active. Our rental fleet is growing. Expansions into new areas is continuing, and our sales revenues are steady. I'll touch more on it later, but we are optimistic going forward and see additional growth into 2013. Let's move to the numbers. But as a reminder, please note that some comparisons will be down sequentially due to the extraordinary sales from rental equipment we had in the first and second quarters of this year. Looking at total revenue in the year-over-year quarters. The third quarter 2012 revenues increased 9% to $19.3 million from $17.7 million in the third quarter of last year. For the sequential quarters of Q2 2012 compared to third quarter of this year, total revenues decreased $5.2 million due to the prior onetime sale we had in the second quarter. On a year-to-date 9-month to 9-month comparison, total revenues were up $23.7 million or 51%. Approximately 3/4 of that increase is attributable to compressor sales, including the nonrecurring rental sales in the first half of this year, with the balance being growth in our rental business. Comparing the third quarter of this year to the third quarter of last year, total gross margin increased 16% from $8.8 million to $10.2 million. Sequentially, gross margin decreased about $800,000 to $10.2 million due to the extraordinary sale in second quarter this year, that increases a percent of revenue from 45% to 53%. In the comparative 9-month year-to-date periods, gross margin grew $7.5 million to $32.4 million or 30%. SG&A increased $400,000 in the year-over-year quarters but decreased the same amount sequentially. We continue to run in the 9% to 10% of revenue range with both year-to-date periods of 2011 and 2012 at the 9% level. Comparative year-over-year quarters for operating income reflect a 16% increase from $3.6 million in the third quarter of last year to $4.2 million this current quarter. Sequentially, operating income decreased approximately $500,000 because of the second quarter nonrecurring sale but, as a percent of revenue, it climbed from 20% to 22% this quarter. Year-to-date, operating income increased 44% to $14.7 million this year when compared to the September 2011 year-to-date results. In the comparative year-over-year third quarters, net income increased 18% from $2.2 million last year to $2.6 million this year. Comparing the second quarter of 2012 to the third quarter this year, net income was off $400,000 to $2.6 million due to the onetime sale, but both quarters were in the 12% to 14% range of revenue. For the comparative 9-month year-to-date periods, net income was up 35% to $9.1 million. EBITDA increased 14% from $7.2 million in the third quarter of '11 to $8.2 million in the current quarter. Sequentially, EBITDA in the third quarter of this year was $8.2 million, which is off $500,000 compared to the second quarter this year due to the rental equipment sale in that quarter. But EBITDA did clock in at 42% of revenue. In the comparative 9-month periods, EBITDA increased $5.1 million or 24%. On a fully diluted basis, earnings per share this quarter was $0.21 per common share. Looking at sales revenues. In the year-over-year quarters, total sales revenues increased 3% to $4.9 million in the third quarter of 2012. Total sales revenues, which include compressor sales, flare sales and parts, fell to $4.9 million this quarter from $10.6 million in the second quarter of this year. This is wholly attributable to rental equipment sale last quarter, but this current level of sales is back to our traditional range of 25% of total revenue. Gross margin increased from 23% to 24% in the sequential quarters. 9-month year-to-date total sales were up $17.4 million or 165% because of the sale of the rental equipment. But even without that extraordinary event, we would have seen a roughly 60% increase from total sales. Looking at compressor sales alone. In the current quarter, they were $2.8 million with a gross margin of 24%. Our compressor sales backlog at the end of the third quarter was approximately $5 million. However, this does not include another couple of million dollars that have been verbally awarded, although we haven't received the PO yet. As such, we don't carry it in our official backlog. Compressor rental revenue had a year-over-year increase of $1.4 million or 11% from $12.7 million in the third quarter of 2011 to $14.1 million for this quarter. This growth rate is a bit understated because of the rental revenue that was lost with our sales in rental equipment order this year. Gross margins increased from 56% to 58% of revenue. Sequentially, rental revenues grew over 3%, with an increase of $450,000 to $14.1 million this quarter. 9-month year-to-date rental revenues rose 18%, with growth margins at 58% in both periods. We ended the third quarter of rental fleet utilization -- unit utilization at 75% and horsepower utilization at 77%. Fleet size at the end of September was 2,236 compressors. This is a net addition of 116 compressors year-to-date, but we actually built 165 units this year when you account for the rental equipment sale. We built a total of 69 compressors this quarter, and rental fleet growth capital year-to-date has been $25.3 million. Coincident with this continued growth, we implemented a price increase a few weeks ago of 7% to 8% for our rental compressors, new or used, deployed after October 1. We have continued our rental market expansion into the liquids-oriented areas, with the Granite Wash, Niobrara Shale and Permian Basin providing most of the current growth. NGS was recently selected as the sole provider of vapor recovery units or VRUs for a large operator and with newer plays, and we anticipate good growth from that. This is positive for all the obvious reasons, but an important aspect is that the equipment used on VRU applications is typically small horsepower compressors. If you recall, I've mentioned in the past that our smaller compressors are utilized on a relatively lower frequency. And this award will provide us an avenue to place idle equipment into service throughout 2013, with incremental gains in utilization margins. We have maintained our position in the Utica Shale and Barnett Combo, but we don't see much added growth there the rest of this year until we get into 2013. The Utica has some infrastructure and pipeline problems that are being worked through, and some operators in the Barnett Combo are waiting for new budget allocations. These look to be temporary delays, and we think that all these areas will continue to grow into 2013. One thing to keep in mind with our rental business is that slowdowns like these only delay our forward momentum. They aren't reversals in our positions because the existing install equipment stays in place while issues are resolved. Over 30% of our active fleet is now deployed in oil shales and liquids-oriented plays. The steady growing shift from gas to oil is a positive development we have seen over past couple of years from when we had 10% in oil and liquids-related activities in 2010, 20% in 2012 and now 30%-plus. This is up from 0 oil exposure in 2009 and gives the NGS a good diversified base of activity. Going to the balance sheet. Our total short-term and long-term debt was $920,000 as of September 30, 2012, and cash in the bank was $30.9 million. Our cash flow from operations through the first 6 months of the year was $31.6 million compared to $24.1 million in the same period in 2011 at 31% increase. From a macroeconomic perspective, the next 12 to 18 months looks fairly positive to us. I think oil-related activities is going to continue to be strong for NGS, and there are some developing tailwinds that will help drive natural gas activity. Some of these are tied to natural gas rig count. There were 811 natural gas rigs declining -- or drilling in 2012, generally, in 2012, but only 424 active this month. That's a 50% decline in 11 months to a 13-year low. Natural gas production between 2012 and 2013 is projected by EIA to be flat so no growth in supplies anticipated. Although power generation usage of natural gas will decrease somewhat in 2013 due to higher natural gas prices, it is predicted to continue at historically high levels. Additionally, commercial and residential consumption is predicted to fill any consumption gap. Natural gas storage is at a high level, but that's deceiving and hides a positive trend. Storage levels start at a higher-than-normal level after last year's very warm winter, but actual monthly injections since then have been lower than average. The delta increase during 2012 is the smallest injection season buildup since 1991. All positive and negative forces end up being reflected in the commodity prices, and they are projected to be steady to higher through 2013. EIA predicts WTI will average $88 in 2013, which is certainly high enough to oil shale activities at a strong rate. Henry Hub natural gas price is projected to average $2.77 this year and increase to $3.49 in 2013. That's a 25% average increase. There are even some predictions up to $3.75 as an average. But in any case, we should hit $4 sometime next year. The important fact is that the trend is up, with the projections generally increasing over time. I hesitate to get into 2013 predictions, but we are encouraged by what we are seeing in the market and what we are hearing from our customers. I think the oil shales and liquids plays will continue to grow, but I also anticipate that the natural gas market will start to see more life, too. Any of you that have listened to my calls in the past 4 years realize that the presidential election did not go to my liking and, frankly, I'm having a tough time contemplating another 4 years of what we've had. However, despite of that, my fervent hope and desire is that this administration does not squander the tremendous opportunity the U.S. has to move towards greater energy self-sufficiency through the talents and capital initiative present in our oil and gas industry. What I think should be a simple proposition of responsible development of our own natural resources and its attendant balance of trade and national security advantages gets caught in the environmental and robber baron hyperbole. I'm sure there will be many more topics to discuss in the future. But I've made my case relative to this administration, and about the only other thing I could do would be move to a swing state. And since I'm not going to do that, I'm stepping off my soapbox for now. However, I reserve the right to resume my perch and comment on any especially egregious acts, and I have no doubt there will be some. That's the end of my prepared remarks. I'll turn the call back to Erica for questions anyone might have.

[Operator Instructions] Our first question comes from Matt Beeby from Williams Financial.

Steve, you mentioned the VRU contract that's upcoming. Can you provide any more color on that as far as maybe the number of units, timing that those get deployed or split of idle versus new units? Any color there would be helpful.

Yes. It's not that I'm trying to be too secretive, but it's pretty ill-defined actually. It was -- the award was pretty much of a general award that we did all that work. Now it's -- the initial flush of equipment going out is, I think, pretty well all idle in our yards, and that's probably the first 20 or 30 units. We think beyond that -- I mean, we're just estimating it will be maybe 100 plus throughout 2013, but that's purely our feel of conjecture. Because, as I say, there was not any specific award. It can be, as everything else, dependent on success and economics and everything else. But it was positive from the point of what I've mentioned, a good award, a good news shale area and idle equipment going out.

Sure. Kind of along those lines also. Did you mentioned the number of overhauls that you had this quarter? I'm assuming you had a little bit less than last quarter, and that's kind of the reason that margins were up and maybe kind of how this flows in 4Q with these units, the relative ramp and maybe more overhaul that you're doing at 4Q relative to 3Q. Can you just talk about that a little bit as well?

Yes, well -- and I think you're right. The increase in margins we had was, as I've mentioned before, was depressed them. I mean it only depressed them down 1 or 2 points each quarter has been the overall activity to move equipment out. Being that double-edged sword, certainly, the revenue is welcome, but there is expense upfront. We'll see some of that with this. So if we're in the high 50s on margins. There could be 1% or 2% variation in a quarter depending on how much is going out and with deployment rates. So we can see some of that. It's hard like, say, it's not really defined as to how much goes out, at what rate and things like that. It's pretty much dependent on those operators' drilling frac, et cetera, schedule. So it's hard for me to predict when that might happen or what quarters and to what magnitude, but we'll probably see some of that. But as you see this quarter, when that stuff gets done, it bounces back pretty quick to.

So it's spread out over the next several quarters is kind of...

Yes, yes. It's going to be, we think, just a gradual build over time of equipment going out.

Got you. Okay. And one more for me and I can re-queue. Just any change in the dry gas activity? I think it's been pretty steady. Now we've seen gas prices well above 3, really, at least this quarter, in the last 5, 6 weeks. Have you had any change in conversations as far as ramping up just on the dry gas applications for compression?

No real plans for ramp-up on that from customers, although we're seeing some incremental equipment going out in those plays. And I think what you're seeing is probably just a relative economics of return from the operator's perspective still in oil versus gas. Because most of the operators we work with, as you know, are large operators, and they've got operations in all of these, dry gas areas, liquids areas, oil wells and things like that. So you get some of this relative, "Where's my money going to go?" Well, typically, right now, it's going to oil shale versus gas shales. Even if price is up on a relative basis, oil is still the most popular so -- but we're seeing some incremental move in that. And I think as we start going forward in '13, we anticipate we'll see just a little more of that. I think oil is going to stay the busy thing, certainly, I mean, if the predictive prices stay, as I mentioned. But I think we'll start seeing a little move off the base we've had the last couple of years on the dry gas side, too.

Got you. Just real quick into -- on the oil side growth you talked about, big quarter for adds in the third quarter, just the new units you expect. Maybe with the oil rig count now trending lower like through the year, and then we start 2013, can you just give a quick idea of what the adds of compressor might look like in 4Q they're relative to 3Q or earlier this year, where it was more like 30 or 35?

Well, yes, I think it's going to be more on the lower end like at the beginning of the year. We'll probably get it back. This is probably our biggest quarter. In fact, it was this year, the Q3 add. 6 to 9 years is pretty high and more than we had anticipated even. But I think as we get into the fourth quarter, we get the natural winding down of budgets and things like this, so I think in the holidays -- and things tend to slow and always do. So it's not an indication of slowing momentum on growth. It's just what that capital might be deployed into. So I don't think we're going to need as much of that. We do -- I've been actually surprised and maybe little bit nervous about the activity that we see next year. I'm not nervous from slowing but just how active we think it may be. And my nervousness is from, generally, if you look in the market of other service companies and things like that, certainly they're having a little more trouble from forecasting growth in that way. But these oil shales and then the gas lift, we are employing these compressors on just seems to be -- it looks like it's going to stay active. We think 2013 will be a good growth year.

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

Just a couple of questions around the price increase. You referenced 7% to 8% across the board. I was curious, is that based on specific or this is across the board? Is that more liquids directed, you're applying that? Or is it across the board on your rental fleet?

We -- it's -- in that scenario, it's pretty much across the board. We -- I don't think -- we've got 20, 25 different models. And certainly, some of these models, these oil-shale-type equipments that's 100% utilized. And those are obvious ones we can go up on price, but we've pretty well raised price across the board. Now again, some are less utilized, maybe not going up as much. But that average has been 7% to 8%. So we just felt like, based on what we're seeing, we're seeing a little movement in all directions, plus we just need to get some cost recurred in this stuff. We haven't been able to do that very much lately. So it's pretty much across the board. It will vary by model, whether it's maybe a 5% or a 10% or -- but we try to touch every model we got.

Okay, helpful. It sounds like you're encouraged by trends. You referenced $2 million kind of verbally awarded additional backlog there. I was curious, is that Lower 48 or is that international on the compressor sales side?

That's Lower 48. There's -- we've got some pending international, but it's not close enough for me to even mention too much. But I only mention this one because it's -- we've been verbally notified, we are really just waiting for the paperwork.

Okay. Are you getting any more visibility on the compressor sales side? I understand it's been choppy for a long time, but you sound encouraged. In general, more of it rental-driven, of course, right now, but are things are picking up a little bit more in terms of visibility that you can see on the sales side?

No, the visibility isn't any better. I mean, our encouragement is primarily rental because that's just a lot easier for us to see, and customers tend to be a little more forthcoming. Because that relates a lot to -- and with these oil shales, operation have drilling schedules out for 6-plus months, frac schedules. And along with that, you kind of slot in the compressor schedule with that one. So from the rental side, it's a little easier. From the sales side, we still have trouble getting a good handle on that from a future standpoint point. And again, even the ones we know we have in hand as we've seen in the past, they can vary by quarter-to-quarter just based on schedules, deliveries, et cetera. So still not much visibility for us on the sales side. I think quite generally, it will get a little better. But I just -- as you know, I just caution our balance sales piece. It's a variable piece of the business. It always has been and always will be. It will be up and down.

True, fair enough. A last one for me. Just -- I know you had previously talked about shifting some of your rental fabrication into Tulsa out of the Midland. Is that pretty much done? Are you sort of appropriately kind of calibrated down? I know you're having some problems getting welders and fitters in Midland. I just kind of wonder where the things stand on that front?

Yes. We've shifted some from Midland to Tulsa, mainly because Midland is at capacity from a personnel standpoint. And we'll kind of use Tulsa as a swing as required. Again, we want to -- Tulsa is traditionally our sole compressor facility. They've got little different capabilities up there from a perspective of building bigger equipment. So we don't want to -- or have it take over the rental side and hurt the sales side too much. But we are using some of that space in Tulsa as some swing rental stuff. And if the year does develop, 2013 does develop as robust as it may, we may ship a little more up there, too. That's something the rental gives us a better return and better margin in the business. So we'll look at that as we quarter-to-quarter really where our best bang for the buck is.

Fair enough. I appreciate it, and we'll strap on the helmet for the next 4 years here.

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

I'm sorry if I missed this, Steve, but did you reference with the uptick in the oil and liquids-driven contribution of the rental fleet, if there was a specific base? And I know we talked in the past about the Barnett Combo, Granite Wash, Utica, et cetera, that was driving the growth in that end. But just wanted to see if we'd get some more color around that.

No, I didn't say exactly where it's coming from. I did mention most of the current growth is coming from the Niobrara, Granite Wash and -- well, shoot, I'm going blank -- Permian Basin. So that's where most of the current equipment is going out to. The Utica and the Barnett are just kind of -- they flattened. We anticipate them to pick back up next year, but the majority is really is in these newer plays.

Okay, great. And did you reference, I guess, compressor sales backlog is still in that $7.5 million to $8 million range?

Well, it's $5 million on the books. We count that backlog as where we have a PO in hand. That's why I mentioned this other $2 million we've been verbally notified, so that brings it back up to that -- the $7 million to $8 million we've been normally running. We just don't have a -- paperworks being processed we just don't have in hand yet.

Okay. And with the move into the liquids basins, I know we talked about this before. Seeing more signs of competitors showing up there, is pricing, I would imagine, still relatively firm given the growth profile in those areas?

Yes, we're not seeing -- I mean, I think the competitive profile, the number of competitors in the areas is pretty much the same. I mean, you get some movement in and out, but you get the same players about all these plays. We probably tend to be the interlopers in some of these -- I think we caught the oil shale way first back in early '10. But we tend to be an interloper in areas, say, as in Niobrara, from a point of -- we haven't had -- traditionally had operations up there in what was used to be known as the DJ Basin to move off of. So we're moving in based on the oil shales. And same way in the Granite Wash, we didn't have anything traditionally in there over time from the old Borger, Pampa, Dumas natural gas fields and just able to shift into the oil -- the liquids plays. So interloper from a point that we didn't have traditional operations in there. We're one of -- we're moving into those plays because we had customer demand, customer's advice, things like that. But we're not seeing the. [Audio Gap] and pretty good luck in going in and getting setup and getting share pretty quickly. And I think that's what we see in this award I've mentioned. It's a new area for us. It's actually new shale area overall. And we've been pretty successful pretty quickly.

[Operator Instructions] At this time, we have no further questions.

Okay. Well, just to tack on another answer to Jeff's question that I didn't answer about pricing. We do -- as I mentioned, we are pricing. We have increased it. We've increased it, some in the past, too, but this is probably the first time we're doing across-the-board sort of increase. But we are seeing maybe not as bad a predatory pricing environment. Of course, that can change at anytime somebody gets a different thought in their mind, but pricing does seem to be stabilizing a little bit more. But you always have to watch it as you go. Anyway, I appreciate everybody's time. We look forward to talking to you, I guess, in 2013 when we report fourth quarter. Thanks a lot.

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