Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group 2016 Third 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 Ms. Dada. You may begin.

Thank you, Erika, and good morning listeners. Please allow me 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 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 Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Yes. Thank you, Alicia and Erika, and good morning and welcome to Natural Gas Services Group’s third quarter 2016 earnings review. Although our markets continue to be very competitive, I think NGS had another quarter, the rate of decline in our real utilization slowed for the second quarter in a row, our gross margin and operating income dollars were essentially flat between quarters, our rental gross margins hit a ten-year high of 66%, our compressor sales backlog grew, we were able to deliver higher earnings per share this quarter than last and we generated free cash flow at a rate of 55% of this quarter's revenue. There are some indications of a tightening market with the higher commodity prices but it is not fully settled into our business yet. If present trends continue, we may be in the bottoming of the cycle. Since our production oriented activities tend to lag the beginning of market upturns, I think all things being equal and as I have said before, we're still looking into 2017 before a definitive recovery we will be seeing. That being said, I comment in a more detail to review the financials. Starting with total revenue and looking at the year-over-year comparative quarters, our total revenues decreased $5 million and $21.2 million in the third quarter 2015 to $16.2 million in the third quarter this year. Quarterly sales were constant at $2.5 million while rental revenues dropped to $13.2 million this quarter. The sequential quarters of Q2 2016 compared to the third quarter of 2016, total revenues dropped $1 million from $17.2 million to $16.2 million. The decrease was due to rental revenues following $1.5 million but this was offset by increases in our sales and service and maintenance revenues. Reviewing the comparative nine month year-to-date periods, total revenues…

Ladies and gentlemen, at this time we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Tate Sullivan from Sidoti and Company. Please state your question.

Thank you. Can you review your comments on CapEx in the nine months and I think you said it will be subdued in 4Q? But was that total CapEx in first half of 2017 will exceed what you spent in all of 2016, is that right? There's just one part of the business.

Yes, the CapEx we spend on the new rental units we're going to build in the first two quarters will exceed what we spend year-to-date to nine months. So $3.4 million, we will probably spend about $3.5 million around that on the new rental units in Q1, Q2 next year.

Okay, thank you for that. And then can you talk about your asset mix of your rental fleet a little bit? I mean how old – if you can give us information, how old is your average compressor? How long can a compressor last? How will you manage that if the downturn lasts longer than you think? If you can just go into some detail there if you can?

Yes. Our average age of the fleet is probably in a five year range. It’s stays pretty young on an average [indiscernible] in high times we tend to have a lot of equipment each year. So we've got one of the youngest if not the youngest fleets in the market. We look to appreciate everything on 15 years and we don't hardly have any book depreciated equipment at this point and the company is only 16 years old, 16, 17 years old. So we're just starting to get into some zero book equipment. But as I mentioned, we're converting some of that into our new VRUs so there is a little bit of recapitalization going on on some of that equipment. Our overall fleet is, active fleet is running about 55% gas layer and about 45% dry gas, it was typically the traditional San Juan basin Barnett Shale type gas.

Okay, thank you.

Thanks, Tate.

Our next question comes from Rob Brown from Lake Street Capital. Please state your question.

Hi, Rob.

Rob, are you on the line?

Yes, I'm here. Thank you. The 600 horsepower market, what's sort of the market opportunity there that you're going after and I guess does that overlap with your current customer base?

In the higher horsepower market?

Yes.

Okay. I estimate that market at prior you an additional 25% - the size being about another 25% of the size of what we address right now. So right now we roughly address this say 50 horsepower, 60 horsepower it's about 300 horsepower market. And I think this 600 is probably another 25% large. Now something like [indiscernible] overwhelming but you have to remember this 400 horsepower, 600 horsepower equates to about double the rent and double the cost, so a 25% larger market from a revenue standpoint is probably the equivalent about 50% larger or 50% as large.

Okay, good. Thank you. And then sort of the cash situation you're using a little bit of it in this new market but where do you think your base line cash needs are and may be your thoughts on how much excess cash you have and what you might do with it?

Our baseline cash right now of course are much less than we're generating just succeeded by the free cash flow or we're show now of course a rising bank balance. We're rebuilding some real equipment that from the point they were really haven't built in a couple of years, nothing that we have existing, it's all new products but as soon as some cash going into that and hopefully that'll fix salary as we go through 2017 and 2018 as things start getting maybe a little more active, that remain to be seen. We'll see what happens. But we have a really, I don't know exactly what will spin in capital next year, you have the next call, a fourth quarter call, we’ll give a little indication of that of course that's kind of cheating because that's in the 2017 but they get a little better feel for exactly what the customers budgets are. [indiscernible] in December January so we can gear around that a little bit to see what we think we might be doing from a capital standpoint. So obviously we've got - we're generating, it’s a good problem to have, we’re getting more cash than we require right now. But hopefully we can start tune up just a little bit more of it as we go forward.

Okay, thanks. I'll turn it over.

Our next question comes from Mark Brown from Seaport Group. Please state your question.

Hi, Steve, I just wanted to ask if you can maybe just clarify how are you able to get the higher margins on the rental side even compared to last year given the ongoing pressures in that business.

Well, yes, a couple of things. Number one, I mean just done a great job on costs. As our customers come back to us and ask for some relief or negotiations, that fun stuff flows downhill right. So we've done the same thing with our suppliers and certainly they've been cooperative and we've looked at everything we can to continue to get those costs. So I give all the credit to our employees who live for everything. And we pride on to two or three initiative in the past couple of years just trying to find more and more and more, and every day we get some of that. So we give some of that, now some of that is natural. As oil comes down in price lubricating oil and things like that stuff we buy a lot of so that tends to come down itself. But we don't say you – other initiatives from rent the uniforms to parts and pieces you buy, a great job on that. So you get some of that and then I think you also get a little bit make shift. As I mentioned, two years ago our active fleet was about 50% gas, now it's about 55% gas. So when you - if you recall, the gas lift units are the bigger more expensive higher rent equipment even in this market. So you’re getting a little bit of a shift towards a little bit higher margin equipment out there. So we're getting some of that also, getting some lift from just a little bit of a shift in the mix and then I think that the majority of it is still some good cost cutting.

Good, good. And I wanted to just dig on the VRUs a little bit and how big of a commercial opportunity do you think that could be? And also just in terms of your competitors, you’re pretty clear that you're willing to grow that part of your fleet but are your competitors doing the same or are they constrained by the cash pressures that they're facing and may not have the budget to build up or upgrade to VRUs?

Well I think it's all the above sort of thing. I mean we see, if you remember, in the past the VRU market price started five years ago, but it started a very, very small 10 horsepower, 20 horsepower stuff that we weren’t interested in plus we didn’t see a whole lot of operators jumping into it because it is just a cost. There really wasn't a whole lot of revenue associated with it. But now you've seen more enforcement, you've seen some - the operators consolidate locations go to pad drilling, so you can – you’re aggregating gas farms that makes it more economics, we’re seeing some lift from that, additional enforcement regulations. So that's driving the side of VRUs up into what we're interested in, more of 50 to 100 horsepower that we can convert some of our older low pressure, low volume gas units into. So that's providing kind of a natural uplift. Now, as far as competitors getting into the market, mostly competition we see are smaller fleets. It's not the bigger guys. You'll see some of that but generally the bigger fleets in our business tend to lean towards bigger horsepower. So we've got the fourth or fifth largest fleet and we're kind of in the wellheads piece of it, but the bigger guys – the larger fleet tend to be bigger horsepower. So that didn’t really fit into the VRU market. So we tend to see smaller mom and pop organizations more so than the bigger guys. And on air based cash constraints, [indiscernible]. So I imagine if you get to pick and choose where you’re putting your money if you’re one of the bigger players is probably not going to be in that market, it’s going to be in and you know who are your fairway is, the bigger step that you're already trying to move out.

And then I was just - you mentioned flare sales and that they may start to track the - typically track the drilling activity. Do you see the flare sales coming back? Or some of the regulations that were proposed especially in North Dakota, is that going to put a lid on in terms of the amount of sales that you can do in that segment?

Yes, I think we've seen the golden age of flares three or four years ago. I mentioned that when our revenue was climbing up in that business to $5 million or $6 million a year, that was a opening and closing window. Number one, you had all the oil shale wells coming on. You had a lot of flare requirements because I guess it's very rich. There was no pipelines for a lot of this all associated gas. So you had lots of flares going out just to take care. You can't then if he had to burn off. So you saw a lot of that and then it started coming off with the downturn. And I think I'll get back into that it's low now. I think when we get back into that $1.5 million, $2 million a year, minimal is good margins but overtime you still need players from emergency situation, production flares typically are just standard and it's the - one of these businesses that. Nobody wants to buy a flare. You have them but nobody wants to buy because you do not – if they're on emergency basis you never want to work right. You buy something you never want to use. And then with more and more of the regulations and it's not as much regulation as just public perception of flares, that's kind of put a cap on some of this stuff to. Actually, the EPA is okay with flaring. It meets all the environmental requirements they care to put out but generally the public doesn't like to see gas flared and operator don’t like it either [indiscernible] you have to do it. So to short that answer, I think yes, we're in a low point now, we're in a high point we're kind of get back and just said normalized $1 million to $2 million prior year or two. But it’s not going to be as big as it was.

Okay, understood. Thank you. Appreciate it.

Thanks, Mark.

We have a follow-up question from Tate Sullivan, please go ahead sir.

Thank you. And following up on my earlier question on spending two did you say that the 600 horsepower gas compressors you're building for sale but you might build some for your rental fleet? Is that correct?

Yes, we introduced the 400 horse last year and then when we have the 600 in back of our mind, but then we had the opportunity to build and sell some and we haven't sold them yet. So they'll be in that backlog. So we're going to go ahead and start putting some of those in our rental fleet also. So you we’ve sold I don't know six or seven, and then we're not starting out big, I will probably build two or three in the fleet, just can't get a math. We did the same thing, we did the 400 horse, we dealt – five or ten as we rent and we built some more, we kind of role it like that. So we'll do the same thing with these 600 horse and start to roll them, and I think there's a good market there just same - same customers essentially that we do it right now, sort of the same customers and do some of this 400 horsepower stuff. But this all still tends to fall into that well head type work that we're essentially specialist at. And so, we should have good luck with those two sizes we have had generally with our main fleet over time.

Okay, great. And then just background question, what was the total number compresses you have and when the compressors reach the end of their depreciated life do you take them out of your total number that, compressor that you may rent?

Well we had 2,626 at the end of the quarter, and when they appreciate to zero but no we don't take them out of count. We just get to make a whole lot of net income out. The only way we take them out of count is essentially just right them off and cannibalize messages we did in the second quarter last year when we around 250 compressors, we wrote down zero. We took those out of count but they were going to be used anymore or stripping them down, converting some of them VRUs and they'll be added back in the accounts or converted into back end fleet. And then we used a lot of parts and pieces but this is one thing. Utilization is all over the map anymore in this kind of market and you see utilization 40%, 50% up to 90% and 90% is a little suspect in this kind of market. Other fleets do tend to take equipment out of their count just because it hadn't been refurbished or overhaul or something like that, we don't do that. Now let’s see it go to zero we cared a part. We keep everything in the camp that we have. So our utilization provide tracks little lower than the general market that way.

Okay, great point. And then I mean longer term, is there a chance that the type of compressors you're running will change meaningfully based on new technology or new equipment going into them and let's say ten years or do you foresee compressors will be pretty much the same in ten years they are today.

Yes, I think the good part about this business is there's very little technical obsolescence. This tends to go back and forth on a horizontal motion that's been about same for couple of hundred years. So you know the only technical thing we've really seen over the past years have been environmentally or in or emissions equipment and that's typically on the engine, that's a engine manufacturer issue. Usually we can retrofit with bolt on stuff if need be. But now when you an engine it's already all emissions compliant. So we don't have to really worry about that from our perspective. It’s just a system issue to us anymore. So we don't - I don't anticipate anything that would technically obsolete any of our equipment. The other thing you see change over time is the type of equipment you might need. Ten years ago, it was dry gas, low volume low pressure units, now it's more high pressure, high volume units. We've got the gamut of those. So you tend to have these shifts and whatever people are drilling low pressure gas wells or high pressure oil wells. That's the only change we have, just a model shift.

Okay. Thank you very much for that.

Okay. Thanks, Tate.

Our next question comes from Jason Wangler from Wunderlich Securities, please state your question.

Good morning, Steve.

Hi, Jason.

I was just wondering how it's going with the pricing conversations? Obviously you talked a lot about utilization kind of starting to see the floor decline. How is the pricing discussions gone? Is that kind of changing as well as you kind of start to see kind of a bombing effect?

Well, a little. I think I've stated maybe in the past that the problem would be more pricing conversations if our competitors quit discounts so much. We tend to hold our pricing higher. That impacts our position a little last night but it also impacts our ability to make money. You know I think you can see both those numbers. Yeah, I think the operator is okay with where prices are, the sort of if somebody comes in and says, hey I can give you this greater deal, that's -it's less, it's gotten certainly the frequency of those conversations is less than say the first half a year. But it is still out there and I - we're still going to have some as long as we have too much equipment in the market and we do, we're still going to have some of these guys pricing and you know where they should in my opinion. They've got a different opinion obviously but there's also got that dynamic and in a slower than normal market we're going to have some pricing issues going forward.

That's fair. And on the product sales which obviously continue to hold up a lot better I think than any of us would have thought, you got the backlog kind of moved up a bit to? I mean it is kind of the two- three type million run rate kind of fare you think as long as we have a backlog in the current range as well as we look at on a quarterly basis.

Yes, I think so. I think the nine – has a nine month periods. Total sales for compressor shows like $6 million to $7 million. I think $7 million to $7.5 million. When I compared to nine month period, if you analyze that you're in the 9 million to 10 million. I still think $9 million to $10 million is going to be the range we're going to see certainly this year and probably next year. And I don't know as I’ve said many times, convert are volatile quarter-to-quarter especially compressor sales and we've been very fortunate last couple years and they kind of stayed up for hours. Every now I go to bed and kneel down and pray that they stay the same too. If they could change any quarter but so far so good so I'd say you know nine to mean what we've seen last year, what we see this year and hopefully that’s what would see next year.

Okay. That's great. Thank you, Steve.

Thanks, Jason.

[Operator Instructions] Our next question comes from Craig Hoagland from Anderson Hoagland & Co. Please state your question.

Hi, Steve.

Hi, Craig.

I'm curious if part of what's benefiting gross margins is having less Quitman overhaul expense or equipment prep for rental expense.

Well you get some of that when we have equipment come back in half of contract or that it's your busy time or not busy time like now we don't overhaul or go through an equipment to we have a new contract on it. So right now with that activity being subdued, certainly more coming and going out, we don't have as high an expense on that. Now we do have an expense because obviously we're still putting equipment out is just a lower rate than has been terminated right now. Looks like maybe it's hopefully it's bottoming somewhere. But we do get a little bit of that and we will see an impact on gross margin you’re saying it pick up because as more quick goes out, we’ll start billing them on that too. But that's always been I think that’s kind of built into the average a bit. Also one of the things we don't do, we don't capitalize any maintenance so it's all seen every quarter. You’re probably getting a little bit of that but if you look back, this compares to 62% average last year, 61% average year before. So we're getting a little bit of that but still our margins run pretty high.

Okay. Thanks, Steve.

Okay, thanks.

At this time, we have no further question. Okay. Thanks, Erika, and thanks everybody for joining me on the call. I appreciate your time this morning and look forward to meeting with you again next quarter. Thanks.

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