Natural Gas Services Group, Inc. (NGS) Q4 2012 Earnings Report, Transcript and Summary

Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group as it announces its audit committee conference call. [Operator Instructions] Your call leader for today's call are Lindsay Naylor, IR Coordinator; Steve Taylor, Chairman, President and CEO. I will now hand the call over to Ms. Naylor. Ms. Naylor, you may begin.

Thank you, Erica, and good morning, listeners. Please allow me to take a moment to read the following forward-looking statements 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 forward periods to differ materially from forecasted results. Those risks include, among other things, the loss of market shares through competition or otherwise; the introduction of competing technologies by other companies; and new governmental safety, health and 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, Lindsay, and thanks, Erica. And good morning and welcome to Natural Gas Services Group's full year and fourth quarter 2012 earnings review. We had an excellent year and an especially strong fourth quarter, and I'm happy to report that the year was a record setter in a few ways. I'll touch on those points as we go through the numbers, but suffice it to say that we're optimistic going forward and anticipate additional growth into 2013. From a total revenue standpoint, 2012 full year revenues increased 44% to $93.7 million, up from $65.2 million in 2011. This was a record level revenue for NGS. In the sequential quarters of the fourth quarter of 2012 compared to the third quarter of 2012, total revenues increased $4.3 million or 22%, primarily due to a surge of compressor and flare sales orders delivered in the fourth quarter. In the year-over-year comparative fourth quarters, total revenues increased 26% to $23.5 million. Comparing the full years of 2011 to 2012, total gross margin increased $9.1 million or 26% to $43.8 million. Gross margin percentage decreased from 53% to 47%, but this is due to a mix shift from predominantly higher-margin compressor rentals and flare sales in 2011 to a stronger blend of compressor sales in 2012. In the sequential quarters of Q3 and Q4 of 2012, gross margin increased 12.3% to $11.4 million, while the year-over-year comparative fourth quarters grew 16%. SG&A increased about $2 million in the full year of 2012 compared to 2011. However, as a percentage of revenue, it moved from 9% down to 8% in the same annual periods. In the sequential quarters, SG&A was down 9%, increased less than $300,000 in the comparative year-over-year fourth quarters. We expect our SG&A to typically run in the 9% to 10%…

[Operator Instructions] Our first question comes from Jeff Spittel from Global Hunter Securities.

Maybe if we could start off, it sounds like you're pretty comfortable with -- from a strategic standpoint this year, if we rank order to the priorities, it sounds like kind of concentrating on growing the market penetration in those oil plays where you already have a footprint, represents the most attractive opportunity rather than trying to move into some of these nascent plays where maybe things aren't ramped up quite as much. Is that a fair statement?

Yes. Generally, that's what we're going to do, Jeff. The past couple of years, we moved into 3 or 4 new areas, and they've had a pretty good ramp-up in activity. But there's still more coming, we think. And so yes, it's going to be pretty easy just to grow that and start putting more people and more equipment into those existing operations. Now that doesn't eliminate any other movement into new geographies, and there's 1 or 2 that we're kind of keeping our eye on. But we're probably not going to go into some of the brand, brand new ones. An advantage we've got if you look at these plays and especially here in the Permian, there's just so much activity predicted that there is going to be plenty to do just where we are even if we don't move anywhere else for the next year or 2.

Sure, sure. That make sense. And then switching over to the VRU business. Is this mostly driven by kind of the majors trying to get into compliance ahead of time from an environmental standpoint? How much longer do you think it takes for some of the smaller mid-cap operators to start paying a little bit more attention to this as they look forward to 2015?

It is primarily driven by the majors right now because, I mean, they are doing this stuff as we put wells in as we go even though it's not technically required yet. They just -- they got the resources and the wherewithal to do as they go right now. That will -- as we get close to full implementation that will shift to everyone. And it will be interesting to see how that moves as we get into full implementation and then full application of the rules. But it's not unusual and not going to be a surprise that there's going to be a rush at the end to try to get people in compliance that aren't.

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

You saw a lot of compressor sales this past year, especially in the first half. And you spoke on being sort of one-off and -- but is there any change in the market dynamics that would suggest that sales might continue to be -- you might see more one-off sales or it might be a little bit stronger than you anticipated?

Well, if I'm terming it right, the one-off, or what we call extraordinary, was a sale of some installed rental equipment that a large customer had requested we sell to them. And that's typically not something we've done very much at all in the past. So it came up. It was a good deal on both sides and we did it. So that's kind of the one-off I referred to, and it is around approaching about $11 million of the sales last year. So I don't -- those are hard to -- impossible to predict because just the last one we did was in 2006, and they just come up sometimes. And if they come up, we'd just address them as they track themselves and present themselves. But for the general level of compressor sales, our backlog has been running consistently in this, plus or minus, $6 million range for the last 4 or 5 quarters. That's what it's at now. That's what I kind of anticipated running at. So there seems to be at kind of the level it will hang in there at And if we do get into these other type of sales that come in, that will just be gravy or icing on top of that but nothing that we consider really repeatable.

Okay, okay. Secondly, think you have about $28 million in cash on the balance sheet and presumably if you could generate another, I don't know, $10 million to $15 million in free cash flow potentially next year, and so you'd be up to maybe, I think, over $3 a share in cash. What's your thoughts on how you would use that cash rather than having it sit idle on your balance sheet? What might be your intentions?

Well, first, we probably won't -- the past couple of years, free cash has essentially been negligible because we just spent just about all of it on fleet growth and anticipate that being about the same situation this year. So I don't think there's really been much of a net add last year or this year to that balance. I don't think there'd be much this year. So that addresses that, but still...

Well, you added -- I mean, Steve, you have added -- I mean, your cash balances went up about $15 million this year.

No, I think it's about the same.

Well, I have at year end last year, $16 million in cash.

Well, okay, yes, that's right. I was thinking of something else. Yes, well, this year, it balanced out. We think it will be the same in '12, and we think it will be the same in '13. Our intention with that is not to hoard cash or just keep it on the balance sheet. We're going to watch the market there for 12 or 18 months. If it -- based on what we saw in '12 and what we're seeing in '13, we think, like I say, it will be a little neutral there if this market picks up more than what we anticipate. And there's a chance it could. We can start whittling into that a little quicker. Now if we get, say, 18 months down the road, 24 months down the road, the market's about doing about what we predicted and either the cash is the same or maybe we've added to it. I think at that time, we would need to start looking at whether these markets -- the markets will grow like this, this cash is sitting there. We need to do something from a shareholders standpoint then.

Okay. Do you need any additional physical capacity to meet the demands of this market?

Yes, we're looking at that a bit, and we haven't made a decision on it. We've got 2 fabricating plants, 1 in Tulsa, 1 in Midland. What we've been able to do to this point is shift back and forth, Tulsa primarily being the place we build the sales units and Midland being the rental fab. So we've been able to shift back and forth and address what we need to, but we are looking at that from the point that if -- we build about 200 units a year in the last couple of years. If that does get up to 250 or more, we'd have to have to do something else, and we're starting to put continuous plans together to address that if that does do that. And of course, that's, again, where the cash will be used from that standpoint also.

Our next question comes from Matt Beeby from Williams Financial.

I wanted to follow up on the VRU work, a nice win at the end of the year last year. Can you talk about how you're pursuing more of those type of larger agreements and the impact on your idle fleet that's in the yard now, maybe talk about reactivations over the quarter? And then maybe how many units are left and how the trend of work either coming to you or your pursuing more of that? Maybe you can address some of those questions on the VRU side.

Yes. As I've mentioned last quarter, this is kind of a new phenomena where people are just going out and bidding for VRUs. And it's not like everybody is out there doing it. There's not a real big movement yet. I think there will be more and more as we get more of this implementation going on, but it's kind of a new phenomena. But I expect it to grow. So just in our typical sales prospect and identification that, yes, we run along those. And some of this stuff is with existing customers. So we're doing -- maybe we're doing some gas lift form or some just regular gas sales compression form, and it's a natural thing that they'd look at us for VRU-type equipment also. So that's how we're identifying some of it. We're able to, in some situations, with our flares, that's kind of an environmentally focused sort of product also from a point of not venting and flaring. So there's some tie-in you're starting to see and that people are trying to put together on some of those stuff. So we're trying to tie this stuff together where we can and then where we can't. Just from the compressor side, we've certainly got that capability. It is helping our utilization. And certainly from the point of being a very profitable utilization that for the last 2 or 3 years since the downturn, the majority of our equipment idle in the yards has been the smaller horsepower, smaller gas compressor size, which now fits a lot of these VRU applications. So for example, that award we got last year, we've already moved probably 40 or 50 units straight out of the yard, didn't have to build a thing, and operations. And that particular contract, the guys are going to be pretty busy this year. So we're seeing movement in that from this VRU standpoint that's really going to help incremental utilization, incremental margins with no incremental capital.

Great. And then does that contract to that last year, is it a multiyear type of an agreement? Or maybe it's not completely defined, but maybe talk about the length of that expectation there, bigger picture?

Well, it's a -- I won't go into the details of it too much. I know you're going to ask for that. But I'll say it to you, I would say it's a medium-term contract that will evergreen after that. And of course, any contracts, whether it's compression or whatever it is, it's always at the pleasure of the customers. So as long as you're doing a good job and performing out there, you get to stay. The contract just kind of gives you a little preparation and some advance notice on what might be required. So -- but it's a -- medium-term, say 1 to 2 years with evergreen provisions in there, and we don't expect anything other than them being out there for the duration.

Got you. If I can get one more in on the sales side. You talked about, I think, $6 million in backlog. Any guidance that you could offer on what that looks like in the next quarter or 2 and maybe what a baseline for your build capacity is and how that translates into revenues?

Well, it's -- and again, the reason I hesitate on the sales side is because I hesitate on the sales side. It's just always very, very nerve-racking for me to give any sort of indication on that because we don't get a whole lot. Just like that example I gave. We have this equipment is sitting around for 2 or 3 quarters, we finally get to recognize it. Generally, just historically, we've been running in that $6 million range. I think that will probably continue. It can be lumpy. It has been lumpy quarter-to-quarter. It could be $3.1 million, $7 million in another one. Again, it depends on the order flow, number one, and just when we could recognize some of these revenues, number two, especially on some of these larger jobs. So we're just kind of getting an anticipation that the backlog would be expected to continue about the same level and throughout this year. But again, just still very, very sketchy is -- with only that much backlog compared to back up through '08 where we had 3 to 4x that. It's hard to get more than 1 quarter or 2 confidence with some of that.

[Operator Instructions] Steve, at this time, I have no further questions.

Okay, great. Erica, I appreciate it. I tell you what, I want to thank all of our employees for all their efforts this past year. It's really the success of the business and the results I get to report are strictly their doing, so I want to really express our appreciation on that. And we look forward to visiting with everybody again next quarter. Thank you.

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