Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group 2016 Second Quarter Earnings Call. At this time, all participants are in a listen-only mode. [Operator Instructions]. Your call leaders for today’s call are Alicia Dada, IR Coordinator; and Steve Taylor, Chairman, President and CEO. I will now like to turn the call over to Alicia. You may begin.

Thank you, Ross, and good morning listeners. Please allow me a moment to take 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 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 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 Stephen Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Yes. Thank you, Alicia and Ross, and good morning and welcome to Natural Gas Services Group’s second quarter 2016 earnings review. In the second quarter, we continued to see pressure on our business as a consequence of the worst downturn in decades. Notwithstanding recent gains, the rig count has dropped 47% over the last year, with oil prices approximately 60% lower. While most of the drilling-oriented industry saw their businesses retreat starting in 2015, we are just now seeing the primary impact on ours. NGS is typically shielded from declined activity two to three quarters due to our position on the production side of the business. But with U.S. oil and gas production starting to fall, not to mention last quarter’s extremely low oil price, we have experienced a greater contraction in the business recently. Rental activity in the second quarter continued to decline as a natural consequence of last quarter’s utilization drop and the bottoming of the oil price experienced in the first quarter. However we have seen this decline begin to mitigate itself from the second quarter and the month of July. Sales activity which is always volatile on a quarter-to-quarter basis also declined but our backlog continues to hold steady. Our rental gross margins were again very high due to excellent cost control and 53% of every revenue dollar was converted into free cash flow this quarter. The first part of the year has been difficult but continued upon the commodity price, we believe the worst is behind us. I’ll comment in more detail as I’ll review the financials. Starting with total revenue and looking at the year-over-year comparator quarters, the total revenues decreased 29% or $17 from $24.2 million in the second quarter of 2015 to $17.2 million in the second quarter of this year. Sales…

Ladies and gentlemen, at this time we will conduct the question-and-answer session. [Operator Instructions]. Our first question comes from Jason Wagner from Wunderlich. Please go ahead, Jason.

Good morning, Steve.

Hi Jason.

I was curious on a couple of things you said at the end of your prepared comments. Just one, setting out some dry gas units. Could you maybe talk about the geography of those and also if that’s coming onto new wells or if that’s from shutting stuff or just maybe the thought process for the client there?

From a well standpoint, it’s not really new wells, it’s some existing - either existing wells that have been turned back on or some displacement of some other competitors and some of the stuff. So but primarily it’s been some new stuff going out. So it’s been - and again there has been a whole lot, you wouldn’t even miss that if you just hadn't seen it long time. It kind of ties in with maybe a couple of little bright spots on natural gas side of it and I’m hesitant to say that because tomorrow gas price will drop. But it’s not a big deal yet but it’s first time we’ve seen in a little bit. From a geographical standpoint, I hate to say too much about what we’re seeing. Yes, I would just say it seems some very mature areas that we haven't seen much activity out of years actually.

Okay. That’s fair. And another bright spot I suppose on the VRU side, could you just talk about kind of the thought process on what that plan would be for second half of this year? You mentioned you’re sold out, so curious if you could maybe comment on how many you have now and then just how many you kind of intend to build, at least I guess if you look at the second half of this year given that’s kind of the - certainly that’s the brunt of the build for the rest of this year?

Yes. Our initial run on that stuff and this is - some of these numbers not confusion but a little mix, but yes, if you remember some of that crude run off last year we were refurbishing and recommissioning into VRUs and some of that stuff is more new. So we got a combination of what we’re doing. As I mentioned, we decommissioned five older units and are going to rebuild them as VRUs, there is four of those. You were building some new ones going forward too. So our initial run was in the 10 to 15 unit range. Those are set or committed. Now aside of that, we’ve done some minor conversions on some existing equipment to place on VRU applications. Not confused to say but not strictly the pure VRU line we’re building but kind of semi-converted enough for customers’ requirements. So if you do that, you can probably double that if you’re thrown [ph] it into a VRU column. And while we’ve approved some new ones in to the schedule, so we’re adding in five to 10 more by the end of the year in combination with the ones we’re recommissioning.

Okay.

Yes, not big numbers but certainly biggest thing going.

I heard sold out, sold out. So we’ll take it at this point.

Right, it is actually [ph].

Yes, one more if I could just on the other side of it. The larger units, I know you kind of put I think a couple out either late last year or early this year. Just how you’re seeing that program go and if you have any indications or interests to build some more of those as we go through either this year or even looking further out?

Yes, we’ve got - we’re about 80% utilized on those and it’s slowed down the activity on that, it looks like everything else has slowed down for the last couple of quarters. But we think there was some opportunities coming up in the last half of the year to hopefully get those towards sold out level and then start build some more of that. But right now it’s had a good flush to the end of last year, kind of stalled here with these couple of quarters, but we see some opportunities out there. So, not as quick and not as much traction as the smaller VRUs and of course not as much money. But we’ve still got good high hopes for that line. And it will come about. It’s just in this period right now just not a whole lot of stuff moves out like that.

That makes sense. I’ll turn it back. Thanks Steve.

Okay. Thanks Jason.

Our next question comes from Rob Brown from Lake Street Capital Markets. Please go ahead, Rob.

Hi good morning, Steve.

Hi Rob.

On the utilization rate, you talked about it sort of starting to decline at a lower rate but maybe give us a sense of where you think that kind of bottoms and that sort of backed out a couple of points a quarter, or do you have a sense where that bottoms?

Well, this is all - the bright spots are all relative, right, and not absolute at this point. So we’re talking about deceleration of utilization drops and deceleration of pricing pressures and things like that. We still see it out there. It’s still a very competitive market. As I mentioned in the first call, well and production side we’ve had our lag and now we’re getting hit more so the [indiscernible] obviously production has fallen off and compression and a world like that. Yes, so that’s - I mean, we still - there is still an advantage of our business being a little behind the curve on some of that stuff but we’re in the middle of the curve now. So I - Bob, I hesitate to even tell you because I wouldn’t have guess two quarters ago where we’d be. We’re 56%. Whether that goes to two, three quarters - I mean, 2 or 3 points a quarter like it was in ‘15. It gets back to that or not, I don’t know and I’m real hesitant to even try to say anything public along those lines what we’re just saying, we’ve seen 13 point drop in last two quarters, which is obviously way more than we were predicted. And that was - I didn’t look but that was probably about four year - that was last year. So if we can get back into that 3 to 4 points a quarter until it bottoms, I think that’s certainly the good indicator, but boy, I’m real reluctant to tell you what that might be. Now on the plus side essentially just as we’ve shown even with the deterioration in pricing and deterioration in utilization, we’re still - top line obviously gets impacted but we’re still holding bottom line and pretty well from a margin of free cash flow standpoint. So we obviously look at that real close, but I’ll let you put your own market utilization. I’m sorry, I can't help you there more.

Okay. Thanks for the color. I know that’s a tough one to predict. Thank you there. On your SG&A cost, I think you mentioned sustainability. Can you clarify was it $2.5 million in quarter that you said you could kind of keep it there?

Yes, we actually ran $2.2 million this quarter. That was down, I’m just - I’m hedging a little which is kind of the world right now. But we think the deterioration - or not deterioration but cost savings was seen which was in the 15% to 25% from a quarter range is sustainable through the end of the year. So that is the main point I want to make on that that we can hold it down. We gave a little - you get some quarterly fluctuations on that stuff, so things can go up and down, but generally we’re going to be able to hold that tight from a cash basis on next couple of quarters.

Okay, good. And then last question for you. A nice progress in your receivables balance coming down. What’s - is there any - how do you feel about that receivable situation and should it stay at this level?

I’m glad you mentioned that because our price has been a little more time on that. We’re certainly happy with the progress being made there. We’ve got certainly there are other people watching that and making sure we don’t get too far out. It’s just been good old staying on people and getting paid. And obviously in a market like this you got a bifurcation of customers. You got the big guys that pay you but they drag you out a little more. Then you got little guys that may or may not pay you and they certainly drag you out. So it’s just good credit management actually and I won't take the credit, I’ll give credit to our credit supervisor. Staying with them, staying close, understand what the customer is going through, what the business is. We don’t hesitate to share equipment in. We don’t hesitate to file liens, sometimes we don’t hesitate to sue to get our money. So we don’t - we do a good job for everybody, we won't get paid for. And I think everybody understands that and we’ve been here with some bankruptcies too. And actually less this downturn than the last downturn but fortunately and of course bankruptcy is not [indiscernible] still thanks to good business strategy but the thing that has changed now versus five or six years ago in the last downturn is you get a lot more prepackaged bankruptcies. It’s less of a free for all or less of a lawyer’s holiday and more of an organized pre-negotiated sort of business for your organization, which tends to put us from the point if we can be a preferred vendor. We tend to take much less of a pre-petition hit, of course post-petition you’re typically paid, but we tend to come out a little better on those. So that’s helped also just, I guess, a maturation of how bankruptcies work over time. But generally it’s just we have a very good credit person there watching us.

Okay, great. Thank you. I’ll turn it over.

Okay. Thanks.

Our next question comes from Peter Van Roden from Spitfire Capital. Please go ahead, Peter.

Hey Steve.

Hi Peter.

Couple of questions. So you mentioned that pricing on newly set units was, I guess, down over double-digits, but as you think about pricing in the overall business, how has that been trending if you kind of look at blended price for the year?

Well, that’s the average and compared to, I think, sequentially and year-over-year, I think year-over-year we’re still up 2%, sequentially we’re down to about 2%. So if you want, you can say as probably roughly flat with any comparative quarters or periods over the past year on the average. So what happens obviously the new set stuff is more of a current market rate and reflects what’s going on currently. What’s - nobody is real surprise, there is lot of price pressure and price competition out there. Now the price pressure tends to come is shifted over time. Last year and going into the first quarter, it’s primarily driven by customers. Crude prices drop. They needed some concessions, discounts and that was what drives a lot of the pricing pressure. It’s changed since the first quarter and it’s shifted more so away from operating more towards competitors. As I mentioned and kind of went into a little detail, some of this pricing is just nutty and we don’t - I don’t know if we choose not to participate and I don’t know we just don’t, but that’s why you see that 12%, I think the 12% year-over-year and 13% sequential decrease in current new sets. Now the bright part of that and this is a dimmed bright point, right, is there is not something new sets going out now or times are busy, so it’s got a muted impact on the overall average. And I think that will continue. Now this is a severest contraction we’ve seen in the pricing on that percentage basis and hopefully we see some relief from that, but again we tend to still be a little more premium priced and the most people as I mentioned we maintain market share with that. But it probably shows a little more severe with us than anybody else as far as what that pricing contraction might be because we’re coming off a hard point.

Got it. That’s really helpful. And would you say that the pricing has gotten competitive enough where customers are thinking about going through the whole rigmarole and was actually taking offsets or is that still too much as pricing now got to that point where it’s not very attractive from a service and cost perspective?

When you say taking offsets, what do you mean?

I guess replacing an NGL.

Just replacing competitors or us or anything?

Yes.

We don’t see a whole lot of that. We replace - I think we replace more competitors than it happens to us. Everybody is always taking pushups [ph] and everything, right. But I think we’re able to generally hold in pretty well with existing customers. Now sometimes you may have to give discounts obviously to match pricing to the market, but we generally are able to hold in because we could - when you install that our service continues to be superior. So you could protect that piece fairly well. Where we do see more impact is in new bids, new market bids and things like this where the pricing is what I think is ridiculous. As I mentioned, I think it’s predatory. I define predatory is not sustainable and I think you can do that for a little bit but ultimately you can do that. And as I mentioned, we still mentioned in last call, say it again. We still make net income. We think net income is important and a lot of people don’t. And if you want to price that way, that’s fine but we choose not to. We want to keep the price where we think it’s reasonable and competitive in the market. But as far defending present installations, I think we do a pretty good job there. It’s the new stuff coming out that’s pretty competitive and sometimes hard to get.

Got it. Okay. And then two more questions. As you think about your sales gross margins, I guess, this quarter they are suffering from lower compression sales and then also your new build rate on your actual units that you’re building put out in the field. I guess what level of both compression sales and then new CapEx do you need to see to start to see that absorption rate get better and hopefully see sales gross margins get back to a more normal level?

Well, you got two curves there, right, the revenue curve and the cost curve and they were constantly moving. One of the things that hurt us in Q2 was the sales were down and we have one or two units that moved out a little more than what we anticipated. So we had some misses some absorption there and we’ve continued to pair back and both the fab facilities we’ve got from just a pure operating expense standpoint and unfortunately from headcount standpoint. So that cost curves continue to coming down, obviously we’re trying to get that revenue curve up a bit and that’s the tougher part. So it’s hard to predict it exactly. And number one, yes, as we always get into volatility quarter-over-quarter on what equipment is that we can put revenue on and recognize that revenue on. And this quarter we had a couple we didn’t get in and there is late a little bit and couldn’t do that. If we had those, we might not have had an issue. But generally - and this is generally because point of something else that happens to you, generally we think we’ll probably be about breakeven the rest of the year. We won't see any positive or any negative out of it. Obviously we saw negative, as I mentioned $0.02 or $0.03 this quarter. But one thing that impacts this and we do this is we’ve moved some VRUs into the schedule to build from a rental standpoint [indiscernible] sold out. We still have customer demand. We don’t want to go out and market that equipment and not have it available and not build it, all right, because you lose all that effort and money. But what happens is you move out some of this backlog, right. So we could take the position that, well, hey we’re just going to cram all this sales stuff there because it’s made the day and we got to have and everything else. You already try to bounce the stuff and say, you know what, some of the sold equipment may fall over in the first quarter of next year. We may not see it this year but we need to build from the VRUs from a rental standpoint. So you get into some of these, so we’re trying to make these decisions that are based on the good of the business and sometimes the long-term gets into way the short term and it shouldn’t situation we think. But that ends up causing a little more absorption problem. So lot of movement parts to it, but short answer is we think now we can probably be essentially neutral for the rest of the year but that’s a quarter-by-quarter decision.

Got it. And when you say neutral that also would be inclusive of the D&A because you guys have positive gross margin in this quarter, so I guess I’m trying to understand do you think that gross margins go down again from here?

On the sales side?

Yes.

No. That’s what I’m saying. We showed - on compressors only, we showed we had a negative 10% gross margin. We absorb all the costs.

All right, got it.

Now on all sales we had a positive 3% so obviously the other sales subsidize the compressor sales on that. So what I’m saying is we’re hoping we have a zero gross margin with all the absorption in there and we’re still making 14%, 15% gross margin on a project basis. So we’re not losing money as we build the equipment, it’s just as absorption issue.

Got it. That makes sense. Okay, so gross margin should all things equal on the sales side of the business would go up from here?

Yes, fully absorbed.

Okay. And then final bit is as you think about, I guess, if this is the bottom and sounds like this isn't bottom for utilization, so other than the VRUs, there isn't a ton of need to build new stuff but let's just say next year activity picks up and there is a chance to start putting new units out, do you think you can do that out of the existing fleet or would you expect to have to start building new units to kind of match the well profile or the places that those units would be needed?

Yes, I think we’ll be able to certainly - let's say it picks up Q1 ‘17. We’ve got enough equipment available that we can just put out, so I don’t think we’ll have appreciable capital expense next year even if the market turns up and even if it turns up appreciably. We can just use equipment we’ve got now. What we will have we saw at the last downturn, we don’t capitalize any maintenance expenses. So unlike a lot of competitors in the business, we expense it all. So when you do that and you start putting equipment out, you had to go through it, check it out, even if nothing is wrong with it, you have some waiver to make sure it’s runnable condition when it gets out there. So there is expense going into that and that’s an income statement expense. And as we saw last upturn, our gross margins on the rental side may drop somewhat, but because we have expense to put it out but we have no capital to do that. So I think that’s a dynamic you’ll see going forward. And I think we can go 12 to 18 months without any appreciable capital expense and ride the wave of a recovery. So that’s really probably good part of this business is when this thing does turn up, we’ll have very high incremental contribution to the income statement. Now I hope the capital we do spend is additional VRUs and additional, as a larger horsepower stuff, we want to put out. And I anticipate that’s what our capital will be allocated to. Now talking about the bottom, and I’m going to let you call a bottom because I’m not going to - the improvements we’re seeing like I say are relative and not absolute at this point. So we’re seeing a relative deceleration, a relative improvement of things like this. We still see pricing pressure. We still see utilization pressure and I think we will, for the rest of the year, I think we’ll bump into long bottom on this but we’re going to bump. But again, I mean we’re well-positioned. We’re in fine shape, but I don’t want to read in the San Francisco paper tomorrow that Steve calls the bottom.

All right, thanks Steve. I appreciate it.

[Operator Instructions]. And at this time, there are no further questions.

Okay. Thanks Ross. Thank you, Alicia, and thank you everybody that’s called in. Good questions. Appreciate your time this morning and look forward to meeting with you again next quarter. Thank you.

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