Good morning, ladies and gentlemen, and welcome to the Natural Gas Services Group's Second Quarter 2022 Earnings Call. [Operator Instructions] I would now like to turn the call over to Mr. Micah Foster, Natural Gas Services Group's Chief Financial Officer. Mr. Foster, please begin.

Thank you, Luke, and good morning, everyone. Before I turn the call over to John Chisholm, our Interim President and Chief Executive Officer, I remind you that during this call, we will make forward-looking statements within the meaning of Section 21E of the Securities and Exchange Act of 1934, based on our current beliefs and expectations as well as assumptions made by and information currently available to Natural Gas Services Group's leadership team. Although we believe that the expectations reflected in such forward-looking statements are reasonable, we can give no assurance that such expectations will prove to be correct. Please refer to our latest filings with the United States Securities and Exchange Commission for the factors that may cause actual results to differ materially from those in the forward-looking statements made during the call. In addition, our discussion today will reference certain non-GAAP financial measures, including EBITDA, adjusted EBITDA, and adjusted gross margin, among others. For reconciliations of these non-GAAP financial measures to our GAAP financial results, please see yesterday afternoon's press release and our Forms 8-K, 10-K and 10-Q furnished to the SEC. Now I'd like to turn the call over to John Chisholm, Natural Gas Services Group's Interim President and Chief Executive Officer. John?

Micah, thank you, and thanks to each of you for taking the time to join us for today's second quarter 2022 Earnings Conference Call an operational review. In addition to Micah Foster, our Chief Financial Officer. With me today is Jim Hazlett, Natural Gas Services Group's Vice President of Technical Services. Micah, Jim and I will be happy to answer your questions after our discussion of the company's second quarter results and some comments on the current operating environment. Every good plan is subject to the power or lack of technology. We apologize for the inconvenience this morning, but apparently, our conference call provider's carrier had a massive outage at 7:59 a.m. Eastern Time, just in time for our call. We aren't telephony experts, so we aren't exactly sure what happened, but we will get to the bottom of it to make sure it never happens again. This, after we had a practice run with the system last night. That said, here we are about 90 minutes later than expected, but everyone is safe, and we're ready to go. And in the big picture, this is the biggest challenge of the week, we will all have a pretty good week. Now as they say, on with the show. Yesterday, NGS released its financial and operating results for the 3 months ended June 30, 2022, in a press release and filed its quarterly report on Form 10-Q with the U.S. Securities and Exchange Commission. Financial details for the second quarter and first half of the year can be found in those filings. While we will not regurgitate all the data in those reports, we will discuss the highlights of the quarter, provide some additional context regarding the current operating environment, detail key initiatives of the company, and provide some conclusions and…

Thank you, John. As John mentioned, total revenues for the 3 months ended June 30, 2022, increased to $19.9 million from $17.7 million for the 3 months ended June 30, 2021. Rental revenue increased 16% to $18.1 million in the second quarter of 2022 from $15.6 million in the second quarter of 2021, due to the increased deployment of rental units, primarily higher horsepower packages. As of June 30, 2022, we had 1,281 rented units, representing 311,379,000 horsepower compared to 1,245 units, representing 287,365,000 horsepower as of June 30, 2021. Utilized horsepower increased by 8.4% in the second quarter when compared to the year ago period. Sequentially, total revenue decreased 2% to $19.9 million in the second quarter of 2022 compared to $20.3 million in the first quarter of 2022, primarily due to a $1.6 million decrease in sales revenues partially offset by a $1 million increase in rental revenues. As noted in our release yesterday, adjusted rental gross margin of $8.9 million increased 36% when compared to $6.5 million in the same period in 2021 and nearly 13% when compared to $7.9 million in the first quarter of this year. Adjusted gross margin as a percent of sales for the second quarter was 49% compared to 42% in the year ago period and approximately 46% in the first quarter of 2022. Operating income for the 3 months ended June 30, 2022, was $0.7 million compared to an operating loss of $2.3 million for the 3 months ended June 30, 2021. Operating income increased due to higher rental margins. Similarly, operating income increased due to greater revenue and rental margins in the second quarter of 2022 from $0.4 million during the first quarter of 2020. Our net loss for the 3 months ended June 30, 2022, was $70,000 or $0.01…

Micah, thank you. Before we take your questions, a couple of concluding thoughts. As noted in the press release yesterday and in my earlier comments, the compression market remains strong and demand for equipment, especially high horsepower equipment, continues to exceed supply. As a result, we've accelerated our new equipment development program and increased our capital budget forecast to $40 million to $50 million. The vast majority of that spending is for equipment that is already contracted with favorable pricing. The new budget also includes capital for our electric compression conversion program. While we are starting our conversion program with smaller horsepower equipment, our survey of the market suggests there is strong demand for those units, and we expect demand to build as we complete the initial conversions. We are excited to see where our commitment to electric compression will take us. While opportunities abound in the compression market, there are challenges to consider as your company prepares for the future, whether it is the quest for improved energy technology from clients, the push for more environmentally responsible services from multiple stakeholders, our requirements resulting from regulations and legislation, including the recently passed Inflation Reduction Act, the operating environment, challenges and future business opportunities have evolved significantly in recent years, with the evolution accelerating in recent months, creating the possibility of new initiatives in and around the energy compression market. I am privileged to have an opportunity to step into a daily leadership role with a group of women and men, who come to work every day wanting to make NGS a better company for all its stakeholders, our clients, our vendors, our shareholders and for each other. In today's frenetic oilfield market, there is a lot of work to do, and our professionals come to work each day with a mission to make your company the best compression concern in the business. It is hard not to be energized by that. I will continue to focus each day on smart growth, expanding our commitment to technology leadership and creating efficiencies and opportunities that result in durable value for you, our shareholders. Execution is the key to turning opportunities into positive results. While we won't always get it right, our mission is to strive for executional excellence in everything we do. I, of course, want to thank all of our employees for their effort during this past quarter and the entire year. And I want to thank you for your time, patience today, interest and confidence in all of us here at Natural Gas Services Group. We are now happy to take your questions. Operator?

[Operator Instructions] Our first question comes from Rob Brown with Lake Street Capital Markets.

First on the kind of the demand environment, you were pretty clear about the strength in the demand environment. How much visibility do you have in that continuing? And I guess, how do you sort of handle that at this point? Is it a function of pricing? Or does the CapEx increase kind of gets you there as well? How does that take to kind of play out?

Yes. So our visibility, not just by us, but outside manufacturers that we use, our financing institutions, all believe through at a minimum the end of next year, this demand supply situation is still going to be the way it is today. And our challenge, as we mentioned in our prepared remarks, is to equate that capital spend with the proper pricing and contracts in many, many of the cases before we even send out the money to build the equipment.

Okay. Great. And then when you look to adjust pricing, how quickly do your contracts allow that to happen on average? I think you have a fairly quick turn on that, but just wanted to get a sense of how that pricing can start to flow through.

Sure. In most of the contracts, it's a 30-day notice, and we're working on that right now. We're not going to be overly specific due to competitive reasons. But as you could tell by the way, we mentioned it in the call, it has our undivided attention and Micah may want to say a couple of things on that as well.

Yes, Rob, good question. Some of the contracts are newly issued contracts, we believe those price -- current price point is a fair price. A lot of our deployed units are on a month-to-month basis. And so all we lack is a 30-day notice to get that pricing improvement pushed out.

Okay. Great. That's good color. And then last question on electrification. I know you had a fair number of units that are starting that. Where is that at in terms of being rolled out? And are you seeing more units kind of falling into the electrification pool?

So it's in the early stages. We actually have a handful, probably more than that of electric units already in the field, generating revenue, and that's what gives us such a strong opinion of the returns from a margin standpoint on the electrification units. And Jim, you're welcome to add anything if you'd like to as to where we are on the initial build-out.

On the initial build-out, we are currently through the design phase. We're ordering equipment, the motors and the necessary equipment that we need, and it's well underway for the first 20 units scheduled for October.

And then just to follow up on that. How -- from a customer standpoint, what are their requirements? Are there certain locations that obviously have electrical power or I guess, what's the field availability to electrify these units? Is it what percentage of the base or how do you sort of think about that?

Right. Great question that I'm sure other people are thinking about. So right now, the limitation of electrification is the grid and then the stability of the grid. And so the clients themselves are trying to work on that to figure out how they can create greater stability in the grid. And this is going to be a crawl and walk, before a run. And everybody just needs to kind of appreciate that. This is not going to be a flip the switch and all of a sudden, a large percentage of compression in this industry goes electric. But clearly, all indications are that is a preferred way to provide this service, be respectful of the environment and actually have, as we mentioned, lower operating costs for everyone involved.

Our next question is from Tate Sullivan, Maxim Group.

More on the electrification effort. Did you say that the initial wave for the near future for the electrification will be on the smaller compression horsepower equipment?

We did. And we'll give you a little bit of definition on that in terms of horsepower. Jim, go ahead.

Okay. So the main thing with the horsepower, there's a lot of it being used in the higher horsepower areas, but it's mainly the grid that John talked about. There's a lot more or a lot more available systems out there that runs on 480 volts instead of 4140, which is the higher voltage. So with that, we are seeing a successful entry into the 200, 250 horsepower market using those grids that have that voltage and that capability.

Okay. And then to convert the smaller horse -- the 200 to 250, are these units that are already in your facilities and ready to...

These are -- these are units that we actually have out there right now. If you remember that John in his program mentioned the capabilities of the CiP compressor. It allows us to go from a gas engine to electric motor in about 3 days, if we have the equipment. So we have plenty of those style equipments in the gas side right now, and we're converting them to electric.

Great. And just one more on the smaller horsepower. Just John, have you seen with this durable cyclical growth, any indications of higher demand for the smaller horsepower?

Yes. There is certainly higher demand increasing. And we want to, again, provide some real good clarity. The vast majority of our capital is committed to the high horsepower market. But that's not in any way to say we're neglecting the smaller horsepower, and we think that will really start to realize greater potential as more and more electric units are able to be applied into the smaller horsepower market. Hopefully, that helps for you.

Our next question comes from Mr. Kyle Krueger, Apollo Capital.

Congratulations on a very nice quarter. Question as you significantly ramp up CapEx, you talked about $40 million or $50 million, and we see that your cash balance is being drawn down in anticipation that. What kind of an ROI can we expect out of that CapEx, incremental CapEx? You talked about sort of a build-to-suit scenario.

Sure. We'll let Micah handle that for you.

Yes. Kyle, good question. A lot of this capital -- there's long lead times on this. So we're expecting the bulk of the capital that we incur this year to be deployed first part of next year, going into the middle part of next year. So you're looking at revenue realizations coming in to the latter part of next year. And on an ROI basis, we kind of -- when we look at CapEx and we look at pricing, we got to factor in somewhere in the 15% to 20% range on return on that invested capital.

Yes. Okay. So at $40 million or $50 million, which is $4 a share at 15% to 20%, the -- that ought to take you to a solidly earnings positive position starting next year and be significantly accretive to earnings per share. Is that a fair view?

Yes. But I would point again that -- these are 5- to 6-year contracts, right? So that realization happens over time. I would say, absolutely, it's going to be accretive to revenue. We're forecasting continued inflationary pressures on labor costs and parts costs and all that kind of stuff. We think we've accounted for that appropriately in our expense models, but anything can happen. But that's -- so we've got to keep expenses in line, but we think the revenue projections that we're going to get off of these incremental units will be very accretive to the bottom line.

Yes. Okay. Last one for me, John, while you've only been there 2 months, you still have interim in front of your name, in front of your role, your title. What is -- what can we expect in terms of filling the CEO role on a permanent basis?

Yes, it's a great question. I'm sure others are thinking about it. And the independent directors of the Board are considering a number of options. We wanted to make sure that there was minimal turbulence in this transition. I think the quarter speaks to that or the character of our people and the leadership team that the adjustment from Steve to myself was very seamless. But in addition, between Steve, Jim, Micah, members of the Board, we've got pretty deep rolodexes in this industry and not just limited to compression. So we're looking at that as well. That's a winding answer I know, but I'd say stay tuned, and we'll be able to give you more definition on that on the next call after the third quarter.

Thank you, everyone. That was our last question. Mr. Chisholm?

Sure. Thank you there, Luke, and thanks for hanging in there with these technical gremlins. And again, thank you, everyone, on the call for your time, patience and interest. We look forward to visiting with you again after the third quarter, if not before. Have a great day and rest of the week.

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