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Natural Gas Services Group Inc. (NYSE:NGS)

Q4 2008 Earnings Call

March 4, 2009 10:30 am ET

Executives

Kimberly Huckaba – Investor Relations

Stephen C. Taylor – President, Chairman & Chief Executive Officer

Analysts

Neal Dingmann

[Joe Givney]

[Gary Farber]

Michael Drickamer

[Steve Farazone]

Operator

Good morning ladies and gentlemen and welcome to the Natural Gas Services Group fourth quarter and fiscal year end earnings conference call. Your host for today is Kimberly Huckaba, Investor Relations. (Operator Instructions)

I will now turn the call over to our moderator, Kimberly Huckaba. Please begin.

Kimberly Huckaba

Thank you so much Michelle and good morning listeners. If you would, please allow me to read the forward-looking statement. Except for 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; 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 only 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 that now stated, I will turn the call over to Steve Taylor, President, Chairman and CEO of Natural Gas Services Group. Steve.

Stephen C. Taylor

Okay. Thanks Kim and Michelle. Good morning and welcome to Natural Gas Services Group’s fourth quarter and full year 2008 earnings review. As noted in our earnings release this morning, we’re very, very pleased with our fourth quarter results, particularly in this environment. Comparing the fourth quarters of 2007 versus 2008, our diluted earnings per share grew 10%; net income was up 9%; EBITDA was up 28% and total revenue was up 13%. You compare the 12 months ending December, 2008 to 2007, diluted earnings per share year-over-year were up 27%, net income was up 28%, EBITDA was up 27% and total revenue was up 18%.

If you look at total revenue comparisons between the fourth quarter of 2008 and the fourth quarter of 2007, revenues were up 13% from $19.5 million to $22 million. Sequentially, total revenues declined 12% from the third quarter of 2008 to the fourth quarter of 2008 from $24.9 million to $21.9 million. This sequential decline in revenue is due primarily to the comparison itself. We had record comparison sales revenue and corresponding high total revenues booked in Q3 ’08 which, due to the inherent quarter-to-quarter variability and lumpiness in that business skews quarterly comparisons. In fact, the fourth quarter of 2008 was a good quarter and second highest revenue of the year. This skewed quarter-to-quarter revenue change will show up in other areas of our financial report today.

The 12 months of 2008 versus the 12 months of 2007, total revenues were up 18% from $72.5 million to $85.3 million. Our total gross margin in the fourth quarter 2008 was $10.8 million. It grew 26% compared to the fourth quarter 2007 which was $8.6 million. Sequentially, gross margin moved from $11.6 million down to $10.8 million, again as a result of the revenue variations between quarters.

Comparing the 12 months of 2007 to the same period in 2008, gross margin increased from $31.4 million to $40.3 million, a 29% increase. Our sales, general and administrative expense was $1.6 million or 8% of revenue in the fourth quarter 2007 and $1.5 million, $100 thousand less, in the fourth quarter of ’08, 7% of revenue also. If you compare the full year periods, we maintained SG&A at a flat 7% of revenue.

Looking at net income after tax, the fourth quarter of ’07 versus the fourth quarter of ’08 rose 9% from $3.6 million or 19% of revenue to $3.9 million or 18% of revenue. This year-over-year quarterly increase to net income is relatively modest due to an end of the year tax adjustments. During the same period operating income increased from $5 million to $6.5 million, a 30% increase.

Through sequential quarters, our net income was $4.8 million in the third quarter 2008 and $3.9 in the fourth quarter of 2008. Looking at the full year comparisons, net income increased from $12.3 million in 2007 to $15.6 million in 2008, a 27% increase. EBITDA earnings before interest, taxes, depreciation and amortization in the fourth quarter of 2008 was $9.3 million, which is up from $7.3 million in the fourth quarter of 2007, a 28% increase. There was also an increase of 37% to 43% of revenue, and 43% of revenue is a record for the company. Sequentially, EBITDA went from $10.1 million in the third quarter 2008 to $9.3 million in the fourth quarter but grew as a percent of revenue from 40% to 43%.

Looking at the 12 months, EBITDA in 2007 was $27.4 million compared to 2008 when it grew 28% up to $34.9 million. This also rose as a percent of revenue from 38 to 41% of revenue for comparative 12 month periods. Our fully diluted earnings per share for the fourth quarter 2008 was $0.33 per common share and for the full year period diluted EPS grew from $1.01 to $1.28, a 27% increase.

Now looking at particular segments, wholesales revenue which includes compressor sales, flare sales, part sales, rebuilds and CiP compressor sales was $10.8 million in the fourth quarter of 2007 compared to $9.4 million in the fourth quarter of 2008. This decline is primarily attributable to a comparison between our highest revenue quarter in 2007 and our second highest quarter in 2008. Again, the lumpiness of the sales business makes quarterly comparisons less representative at times.

Total sales gross margins were essentially flat at 32 to 33% in the comparative year-over-year quarters. Sequentially, total sales revenues decreased from $13.2 million to $9.4 million with gross margins flat at 32% for both quarters. This decline is relative to the extraordinarily strong quarter in the third quarter 2008 which was a record quarter. The full year total sales revenue for 2007 and 2008 were essentially flat at a little over $41 million.

Compressor sales alone were $9.2 million in the fourth quarter 2007 versus $7.1 million in the fourth quarter 2008 and were $11.3 million in the third quarter of 2008 and $7.1 million in the fourth quarter of 2008. Full year compressor sales grew slightly from $34.2 million in ’07 to $34.5 million in 2008.

Although we don’t normally provide a forward look at our revenues, we did anticipate compressor sales revenues in the fourth quarter during last call would be between $6 and $6.5 million. That actually came in at $7.1 million. Compressor sales margins were down in comparative year quarters from 31% to 26% and went from 29% to 26% in consecutive quarters. Comparative full year margins were identical at 29%. The compressor sales backlog at our fabricating facility in Tulsa at the end of the fourth quarter 2008 or December 31 was about $17.5 million and is about $12.5 million mid-February of this year.

Looking at compressor rentals, rental revenue continued to grow at a very strong rate. The fourth quarter of 2007 we had $8.4 million in revenue. We increased our revenue in the fourth quarter of 2008 up to $12.3 million or 47% growth. Rental gross margin as a percent of revenue in the fourth quarter 2008 was 63%, up from 58% in the year ago quarter. Rental revenue increased sequentially from $11.4 million to $12.3 million for the current quarter, an 8% quarterly gain.

Looking at the 12 month periods of 2007 versus 2008, rental revenue increased from $30.4 million to $42.8 million, a 41% increase. Year-to-date rental gross margin is 62% compared to 59% in the full year of 2007. As far as rental fleet additions, we added 90 new compressor units to our rental fleet in the fourth quarter of 2008. That brings the total fleet to 1,752 units. This is up from 1,353 units at year-end 2007, an increase of 399 rental units in our fleet in 2008. This is compared to our projected addition of 300 units that we made at the end of ’07. We ended the fourth quarter at a rental fleet utilization rate of 85% which was the same as third quarter ending, and that has held as of January 31 of this year.

Our balance sheet continues to be very strong. Our total short term and long term debt, total debt is $16.6 million as of December 31, 2008 and we currently pay 4% on our term loan. Our total debt to capitalization was 11.3% on December 31 with net debt to capitalization of about 10.5%. We presently have $7 million drawn on our $40 million line of credit, upon which we also pay 4% and our borrowing base now exceeds $100 million. As an indication of strength, if you looked at our last 12 month EBITDA compared to our net debt, we could pay off our total debt in about six months.

Capital expenditures in the fourth quarter of this year were $11.1 million, down from $14 million in the third quarter and totaled $46.3 million for 2008 compared to $25.3 million in 2007. In 2008 we generated about $28.3 million cash from operations.

We are fortunate that due to our excellent operating history and balance sheet strength our bank stands ready to extend additional credit to us when and where we might need it. As stated on our last call, we anticipate being cash flow positive in 2009 and not adding to our minimal debt load unless there are extraordinary opportunities that present themselves and we think some of those might be out there.

NGS had a very good year, a record in many ways though we are now in a different world. Demand is down for natural gas and production is up and resulting commodity prices have fallen very quickly to tenuous levels. The Energy Information Administration, or the EIA, is projecting an average Henry Hub spot price at $5 for 2009, down from $9.13 average in 2008 and down from the $8.17 average price they predicted just three months ago. So you can see the speed of the decline that is upon us. This decline is primarily driven by the industrial and power generation statements. It’s a tough time and I think it will get worse before it gets better.

On the last call I thought we could see some recovery by mid-year but now it looks like it will be probably towards the end of the year. But we are best positioned to weather any storm. NGS has grown our gross margin EBITDA absolutely and as a percent of revenue, so we’ve been very efficient in our ability to generate cash. We have consistent industry high margins in growth. Even in this environment I think we will still maintain our higher percentile margins and growth relative to the industry. We have consistently reduced debt to a minimal part of our total capitalization.

When in the past we were pressured to lever up we resisted because we didn’t see any good reason to do so. We could and would have if the right opportunity had presented itself, but valuations didn’t make sense and knowing that this is a commodity, a cyclical business, we were very cognizant of the need to maintain a strong balance sheet. This isn’t our first rodeo. We have flattened or reduced our SG&A and overhead. At 7% of revenue we operate a very tight ship.

In the good old days which were about six months ago and in the last three to four years we have had consistently low overhead expenses. I don’t have to send out emails telling people not to fly first class. We have never done that. I don’t have to stop construction projects in the works. We don’t build buildings or invest in real estate. And I don’t have to cancel airplanes. We have spent 95% plus of our capital on growing our rental fleet and have added hard, tangible, revenue producing assets for our shareholders. This is equipment that has 15 to 20 year lives and we’ll make it through this bump in the road and continue to provide long term returns that our investors deserve.

Going forward we are well prepared to compete and win. Strategically we have the ability to generate free cash. We are well kept [lines] and have access to additional credit if required. We are very strong in our existing operating areas and we have built and maintained a compressor service network second to none.

Tactically, we are paying our expenses. [Rental] fabrication and fuel costs are coming down. We have added emphasis on rebuilt and repair and maintenance services. Slow times tend to drive operators to repair rather than replace compression equipment and we’re participating in a more vigorous manner in those areas. We are dramatically reducing our rental and fabrication through put and we are adding sales people. We intend to get more than our fair share and continue to penetrate the market.

There are a couple of signs that the light at the end of the tunnel may not in fact be a train. In December, 2008 EIA datas of flat growth and month-over-month gas production from November, 2008 for the lower 48 states and if you exclude the Gulf of Mexico, onshore production declined 0.6% month-to-month. After months of onshore natural gas supply growth, this is a bullish sign. Quoting one analyst, “We were not expecting the onshore growth of [flatheads] until the second quarter of this year. Oil supply in the second half of ’09 should set us up for a gas price recovery later this year.”

EIA’s newly released Power Report for 2007 said net natural gas power generation increased 9.8% from 2006 levels as the gas market share of the overall power supply picture rose to 21.6%. And less drilling and reduced well productivity should cut U.S. output by 4 billion cubic feet a day or 7% in the second half of 2009 compared to the same period a year earlier.

Now from an investment standpoint, I of course think NGS is a good place to be. I am not, can not and will not advise anyone from a personal standpoint. But I will quote two independent sources and let investors decide for themselves. From an energy investment banking firm, “We believe the bad news for natural gas is largely discounted into the price for corporate stocks although it well get worse for several months. There inconsistency seems to favor oil lead companies names which makes us think that smarter moves to be accumulated in the gas firms. Hedged low cost names and solid balance sheets are likely to perform best in this environment.”

And, a well known conservative long term mutual fund operator had three things he watches in a stock. What’s the stock price relative to peers? Do the company’s strategies make sense? And are they prudent operators and well positioned to weather the storm?

This is a tough time but it’s not unprecedented. Been there, done that, got the T-shirt. Are we confident of what the LP markets or what the economy will do? No. But we are confident of what we will do. We will get through this period in the same relative shape we did in good times, performing better than our competitors and relative to the compression services market.

Now, let me comment on the macro picture; the economy, the government and energy. There are of course two tragedies to our current situation. First, they could have been prevented by a Congress that had a clue and second, that the remedies being proposed are likely to be worse than the sickness. I won’t get into the never-ending bailouts that I think will prolong the agony except to say that I’m extremely disappointed to see our Congress and both parties of Congress use this decline in our economy to advance their particular agendas. There were 9,000 earmarks in the last bail-out round after President Obama said he wouldn’t allow any.

I’m actually glad that this has been acted upon and Congress can get back to the real dangers of this country, did A-Rod really use steroids?

Concerning energy policy, there have been numerous actions by the current administration that will intensely hinder the oil and gas energy, [punitively] I think. Ken Salazar, the new Interior Secretary, has taken three actions in the past four to five weeks designed to damage the oil and gas exploration and production of this country; withdrew leases that were offered for the extraction of oil from shale on federal land; major operators have been among some of the companies working on technology to extract oil by heating the rocks; oil shelf formations in western U.S. states could hold as many as 800 billion barrels of oil according to a government estimate.

Now, Bobby [MacAnane] of the Natural Resources Defense Council, called oil shelf development “nothing more than a dirty, expensive pipe dream.” That’s an interesting comment when one, Canada has developed oil shelves as a viable energy source and two, the U.S. currently consumes a bit over 7 billion barrels of oil a year. So there’s no sense trying to develop a domestic energy source that can make us independent of the Middle East.

The second thing Mr. Salazar did was push back a plan to expand drilling for oil and natural gas in the Intercontinental Shelf. This when in fact the majority of Americans want to develop those resources. And third, he nullified all natural gas drilling leases on about 130 thousand acres in Utah over the objections of the Utah governor and his Congressional members. The excuse was that additional review was needed to make sure national parks won’t be impacted, even though the National Parks Service had already approved the plan.

The Obama administration just proposed a huge tax increase on the domestic oil and gas industry, seven different tax increases. All would hinder production but in my opinion the most egregious are the repeal on the marginal well tax credit. This is a credit that serves as a [inaudible] produce small amounts of oil and gas. Most of these wells are barely economic to keep operating but collectively they supply almost 20% of the nation’s oil and 12% of its gas. This hurts the small operator which may be a surprise to some but who is also a small businessman.

And the excise tax on Gulf of Mexico production. This is where the nation produces much of its oil and natural gas resources and where much of our future energy supplies are located. Why in the world are we [adjusting] tax on an area already developed that provides a large source of our energy needs?

And finally, I wish, on February 3 guest Speaker of the House of Representatives, Nancy Pelosi, named Karen Wayland, currently a legislative director of the National Resources Defense Council as her policy advisor for energy. There’s the NRDC again, now in a policy making role.

Now let’s look a little internationally. Moscow’s recent push for the creation of an OPEC-style gas cartel and gas [pumps] plans to push for 20% market share for L&G in the next 20 years are clear indications that Russia plans on being anything but a passive player in gas markets, L&G or otherwise. Russia, Iran and Qatar have taken the first serious steps towards forming an OPEC-style cartel for natural gas. These three countries together account for 60% of the world’s gas reserves and Russia and Iran have both been accused of using their hold on energy supplies to [buoy] neighboring countries.

We have huge reserves of natural gas resources in this country, the U.S., and our government does nothing but discourage its use and what they allow they tax to their best ability. We seem to be placing our bets on windmills and sunflower oil, and if we do not wake up we’ll be fighting the same issue of natural gas as we do with oil and soon.

That’s the end of my prepared remarks so I’ll now turn the call back over to Michelle to open the lines for any of you that might have questions.

Question-and-Answer Session

Operator

Thank you very much, Steve. (Operator Instructions) Your first question comes from Neal Dingmann.

Neal Dingmann

Say, was wondering, obviously you don’t give official guidance but, you know, as you tended to say as far as a bit more pessimistic view now, maybe not lasting just through mid-year but the longer term out, sounds like you’re cutting some costs but adding sales, etc. Would you give any idea as far as the number of compressors that you potentially could add this year for starters?

Stephen C. Taylor

Well, boy, yes we’ve said in the past, I think last call, that we can add I think it was up to 200 just based on cash flow, cash flows from operations. Now but I’ll also follow that with a quick caveat that we’ll only add what we see the market taking. And right now I don’t see the market taking that many. I’m a little hesitant to say what number because it’s a very fluid situation but right now we’re not on track to do 200. We’re probably on track to do you know less than half of that. And again, we’ll adjust that up or down as far as we see things developing.

And it could pick up towards the last part of the year. Again, if some of the pundits and everybody that I quoted are right, we could see it ramp up a bit in, say, fourth quarter particularly but right now we’re being very, very cautious about what we add.

Neal Dingmann

And then how big – you mentioned the service and maintenance component has recently or I guess in the last year or so been relatively small. How big can that grow in this type of environment and obviously as you mentioned, I don’t like to look at sales on a quarter-to-quarter, but more on an annual going forward, have you seen sales decrease as well demand on that side?

Stephen C. Taylor

Well, the service and maintenance business probably won’t – it’s about 1% of our total revenue right now and I don’t anticipate it growing. I don’t think it’ll double or anything in that respect because it’s – that’s a business you build to some degree slowly, just like you do anything else, and unless this slowdown lasts longer than we anticipate, I don’t think it’s going to be a big, big piece of the pie. But it does provide us some cushion in the field from the point of doing some rebuilds and some field work, field operations, field repairs that I think can help us support us through some of these times where we may see some softening.

So I don’t see it being a big piece immediately. And we’ll reevaluate it probably a year down the road. This is something if you’ll remember in the past we haven’t gotten into it too much just because when things are real busy it’s hard to get enough people to go around to everything, so we concentrate on the rental fleet and use the people there. We’re trying to stay nimble enough to move in and out of the business lines that we need to, depending on what the market’s demanding.

As far as, you know, sales, compressor sales or total sales, right now the backlog at the end of year was about normal, $17, $18 million. It’s about $12.5 mid-February. We’ve still got a lot of the year to pad into that. I’m not – I don’t think the sales revenue is going to be what it has been the last couple of years. I’m not really prepared to say what kind of decline I might anticipate or we might see.

I think the main thing from our business is we have gotten the sales piece down to half of the revenue. Over the past years it’s been higher than that, so we’ve got the rental piece half and the sales piece half. Of course, rental carries two and three times the margin. So for example, as a calculation, we can suffer a 25% decline in sales revenue and only suffer a roughly a third decline in bottom line, just due to the margin difference. So we’re still early in the year on the sales piece of it and this is one of the reasons we’re kind of looking at some sales people, too. We want to keep that thumbs up and do what we can there. So we’ll just have to play it as it comes along.

Neal Dingmann

In this type of environment do you see any of your clients returning or just letting some compressors go or the ones that are out there are most likely going to continue to work, it’s just the incremental that we could see a difference on?

Stephen C. Taylor

Yes, we’re going to see something of everything. We’re going to see stuff come back, stuff going out, there’s going to be price pressures on new stuff, on existing stuff and everything else. I think generally operators are trying to keep out what they’ve got out. The ones we’ve talked to and the things we’ve seen, they’re generally trying to stay out there. And I’ve actually been pleasantly surprised with based on how low the gas price has gone as to how we’ve been able to maintain utilization.

So I think the operators are trying to stay out there and certainly we’re trying to do everything we can to assist in that by keeping that equipment there and having some other equipment available to go. Right now everything seems to be holding together although the threads holding it are probably getting a little stretched, but unless we have a much deeper decline going forward we’ll probably be able to muddle through.

Neal Dingmann

In the past you’ve sort of selectively thrown some pricing increases in there. I guess that would be tough to look at this year on that side.

Stephen C. Taylor

Yes, I don’t think we’re going to have any price increases this year. This isn’t the environment to do it. We’ve had good luck in the past and primarily just because we’ve got a good service network out there and that’s actually going to be the thing. We’re going to cut back on our expenses but we’re not going to cut back on our ability to respond to customers and to maintain and rent our equipment. So we’ll be very prudent in where we cut expenses or conserve our dollars, but we do intend to maintain the service capability. And that’s what’s actually keeping our utilization at a decent level nowadays.

Neal Dingmann

It’s to your credit you’ve resisted, I guess, during the last up cycle and even prior to that, adding externally as people approached you on acquisitions, in this type of an environment obviously your financials look quite good. If you’re approached or are you being approached? Would you consider anything externally? I mean, if some mom and pop shops approached you would you consider adding that way? Or is there just because of the demand, you just wouldn’t have any interest?

Stephen C. Taylor

Again it would depend. I think just as we’ve been approached in the past we would look at some of the fleets or some of the compression or gas oriented businesses that might make sense to us. You know, our discipline that we’ve practiced in the past we’ll continue to do in the future and probably just be a little more cautious about it just because of the environment we’re in, not because of where we are but the whole environment.

So we’re not – based on where we are from a balance sheet perspective where the operations are and our continuing access to credit, yes, we’ll still look at things. If they make sense, we’ll take a look at them. We haven’t – you know, obviously we haven’t pulled the trigger on anything yet. We’re constantly getting approached and looking at things and if something makes sense, we’re not – we’ll apply the same thing, you know. Are the metrics right for us from a valuation standpoint? And is the operational integrity of the equipment right to fit our fleet?

Operator

Your next question comes from [Joe Givney].

Joe Givney

Just want to follow up a little bit, just a point of clarity there on the call. Did you indicate your compressor sales were $7.1 million in the quarter? Is that correct?

Stephen C. Taylor

Yes.

Joe Givney

So your flares, parts and rebuilds still churning a little bit higher? I know typically this runs 15, 20% of your compressor sales. You commented there on the rebuild-repair emphasis for some of your customer base. Do you think that kind of holds here as we work our way through? You’ve been running around 2 million or so for a quarter now for the last couple of quarters in this segment.

Stephen C. Taylor

Yes, I think it’ll – yes, I do think it’ll hold in there. And probably become the relatively larger piece of that total sales just because we do expect some softening in the compressor sales piece of it.

Joe Givney

And just touching on mix within compressor sales, I know you guys have the capability to build up to about 1,500 horsepower in Tulsa. Are you – as we degrade now a little bit here on the sales side are you seeing a little bit of a mix shift more higher horsepower? Or how is that playing out? How should we think about margin side which is running mid-20s still?

Stephen C. Taylor

Well, no, the mix is staying about the same. I don’t anticipate seeing too much difference there. Margin wise I think if we can stay in the low to mid-20s I think that’s a heck of an accomplishment for a year like this. So we’ll play it as we go. We’ll stay competitive but we think we have a good enough product we can still deliver industry beating margins in that respect.

And kind of interestingly, the inquiry level on the sales piece is still seeming to hold up. Now it’s taking longer for [Bill] to make some decisions, but there still seems to be some modicum of activity out there.

Joe Givney

And then just circling back on the pricing side for the rentals, [inaudible] you pushed through that 26 hundred, 27 hundred in August. I think you’d be holding with a little bit higher horsepower mix. Are you getting price concession demands from your customers? I know you indicated no impetus for a pricing increase this year but are you thinking about your rental rates and revenue per month holding flat in this environment or do you think it’ll degrade a little bit?

Stephen C. Taylor

Well, I think we’ll get – we’re getting pressure and we’re – if you look at our customer, the operator, their product price has come down about two-thirds and I think its incumbent upon all of us to try to work through those situations. And I think it’s unrealistic to think that we can hold across the board totaling what we’ve got. So we’re getting some price pressures, we’re working with some customers on what we think we can do in some of this. They’re not drastic approaches that people are taking with us.

And again I think it all comes to what we’ve been doing in the past, here, building a good service network and get equipment out there. And I think that that – although there’s – you know, an operator needs some help in some of these things, I think we’re getting some preferential treatment just due to how we operate and run our equipment.

Joe Givney

Just a final rental fleet count, in the press release it’s 1730 but you indicated it’s a little higher. What was that number?

Stephen C. Taylor

What did I have here? Let me find it. Well, we billed for 399 units in ’08 so the difference could be between what was built and what ultimately went in the fleet.

Operator

Your next question comes from [Gary Farber].

Gary Farber

Can you talk about what you’re seeing from your competition, so the smaller competitors that you’re seeing in the market? And what do you think the financing outlook is for them? You have good liquidity but I’m just sort of wondering if some of your competitors don’t and that might be an opportunity for you.

Stephen C. Taylor

Yes, and of course we get a lot of anecdotal information on that because the smaller guys aren’t, you know, public. But yes there’s some problems out there. We’ve heard of some pretty large layoffs from some people, some people have some trouble with cash, some people have some trouble paying bills and things like that. And that is certainly not unusual in a period like this when you get some of the smaller guys playing at it. So we are hearing some of that. Certainly we think there’s opportunities there that we can take, if not just from a regular business standpoint, you know, maybe otherwise. But again we’ll be very careful there. What was your second question, Gary?

Gary Farber

Just I guess on their financing. You know, you have plenty of capital. Do you think these people are going to be more constrained and that’s an opportunity there as well?

Stephen C. Taylor

Well, I think they will be constrained. We’ve heard a couple of situations like that from – you know, smaller players than us and some, you know, not very much smaller. So you know it depends on how they built the business and what they’ve done, but a fair amount of these guys have used a lot of debt and of course that – in a market like this that debt stays level and equity goes away. So I think there’s some issues out there and we’ll see how they pan out. I imagine as we get into second and third quarter we’ll see a little bit more of that starting to show up and some of the cracks starting to become apparent.

Gary Farber

And do you see pricing as an issue at any of your bidding, the rental or sale relative to your competition? In that environment is the competition – are they giving up on price more than you think and creating a more difficult environment?

Stephen C. Taylor

Yes. Competitors and one or two in particular are doing what I think are some silly things. And we watch that and if we have to compete on some of that, we’ll make a decision as to whether we do or not. We intend to certainly stay with our good customers. And our good customers typically don’t come in wanting real radical changes. So those aren’t the issues. The ones that we really look at pretty close are if somebody’s, you know, if we get in a competitive situation on some smaller things or some things that are non-strategic or things like that. We’re not too worried about those.

We’ll maintain our share and we’ll fight for what we want, but we’re not going to get silly about it either. And we think some of that’s going on in some markets.

Operator

Your next question comes from Michael Drickamer.

Michael Drickamer

You know last quarter you commented that one of your biggest problems is the same problem your customers have and that’s no visibility. Is that still a problem or are you starting to see more visibility?

Stephen C. Taylor

Well, no, I think the visibility has come out. It’s just all down. You know, three months ago hardly anybody released their capital budgets. Now about everybody has.

Michael Drickamer

And then revised them down 12 times.

Stephen C. Taylor

Yes, exactly. There’s not a single one of them that’s got a plus sign in front of it. So I think that visibility there has become better but again you can’t – you said the revisions are continual, too. So it’s real hard to really put your finger on something. That’s why we’ve slowed our rental fabrication way down. We don’t think we’re going to need to add a whole lot to the fleet this year. Our intent is to maintain what we’ve got, rent what we’ve got in the working inventory, and approach it like that. And, you know, use existing equipment we’ve got. If we need to modify something, we’ll do that instead of building.

You know, so just pull back into a defensive position from that standpoint but stay offensive from the point of sales and marketing efforts.

Michael Drickamer

Did I understand you correctly earlier when you answered one of the questions that previously you said you could build 200 compressors this year but right now you’re on track to build less than half of that?

Stephen C. Taylor

Yes.

Michael Drickamer

So you could add 100 or less compressors in 2009?

Stephen C. Taylor

Yes. Again, the 200 was based on what we thought we could build just with cash, free cash, just to, you know, not add any more debt. But right now based on what we think and see, yes, it’d be less than 50% of that. And again if some of the prognostications come and we get some uptick in the third and especially fourth quarter within the winter, you know, that could go up. And the main thing with us is we’re in a position to take advantage of any upturn. I mean, we’ve got – we’ve still got crews. We’ve got skeleton crews. We’ve got a good amount of position of work in inventory, so we’ve still got some equipment we could put out without really spending a whole lot of money on doing anything.

So, yes, as we see it right now we don’t see a big add this year to the fleet. But if things turn and we need to ramp up, we can do that fairly quickly.

Michael Drickamer

So just for clarity and to make sure I understand you correctly, what’s driving the lower add? Is it the, you know, lower cash flows expected now compared to three months ago? Or is it just that you don’t think you’ll have the demand in the industry to push out 200 compressors?

Stephen C. Taylor

Demand.

Michael Drickamer

And then you also commented that utilization is pulling in flat around 85%. How long are the compressors, the newly fabricated ones, sitting in the yard before they head out to the field?

Stephen C. Taylor

Well, that’s slowing down. Probably in the past year or two we had relatively better times. You always have some in the yard a little longer, but you probably – they’d be in the yard average three to four weeks. Now when we put a new one out, it could be there a couple of months before it goes out. So the growth is slowed which is sort of what we anticipated, what anybody anticipates in this. And in fact we’re about hanging in even. You know, you always get turn in this business. You’re always getting some out, I mean, getting some back and putting some out. When you grow, of course, you put more out than you’re getting back.

But I think in this year and in this environment to maintain utilization we’re at or even a little deterioration of utilization is going to be a positive.

Michael Drickamer

If you look at the demand you are seeing, is there any change in the horsepower requirements within that demand? And is it higher than you’ve previously seen or lower than you’ve previously seen or?

Stephen C. Taylor

It’s probably about the same. If I had to pick one, probably turning just a little bit higher. I think I’d give you numbers last year as to our fabrication has trended higher from a bill standpoint versus what our average horsepower in the fleet was. And that’s continuing. Our average fabricated horsepower is about 145, 150 and our average fleet is about 130. So the past two years we’ve trended up in horsepower and I think that’s continuing. Some of its operating characteristics and some of the wells the operators are drilling.

And some of it’s just we’re tending to build some bigger units and trying to go after that market more so, too.

Michael Drickamer

How regularly do you look at the industry and look at your cash flows and deciding how many compressors you’re going to add to the fleet? I mean, is that something you do, you know, monthly, quarterly, weekly, daily?

Stephen C. Taylor

Closer to daily than weekly or monthly. I mean we’re really budgeting, watching cash flow. We don’t want to get out of balance on that if we have an opportunity to do something. So we watch that. But the overriding factor is the market. If we see the market picking up and we think there’s some opportunities out there to go get some more business or grow a bit, we’ll go ahead and do that. Again we’ve got the ability to either through cash flow or going to the bank to take advantage of those opportunities.

If we see the market slowing down more, you know, we’ll slow down more, too. So market is the primary guide and then we’ll look at well, how are we going to pay for this stuff? Or what are we going to do?

Michael Drickamer

And then Steve I think one of the main concerns of investors with your stock is that you may have this wave of compressors coming back as, you know, if these companies shut in wells. You said earlier that you are seeing some compressors come back. That’s kind of part of regular business. Can you provide a little bit more color there? Are you seeing a lot of it coming back? How many more are coming back compared to what you normally see? Are there any geographies you’re getting a lot of them back from?

Stephen C. Taylor

Well, again, our utilization has been – it was 85% in Q3, Q4 and it’s 85% in January of this year. So, you know, some are coming back but the same amount are going out. So it’s staying even from utilization. And we’re adding a little each month, so we’re actually gaining just a bit. So we haven’t seen anything to this point from the data that’s more or less.

Now again I think I’ve said this in the past, I would fully expect some decline in utilization. As we go into the summer months we typically get that anyway a bit, just summer is a little tougher from a gas price situation. And so we can see some softness in that utilization going forward. But we watch that pretty close and the market drives us, but we also watch that utilization pretty close because we want to keep it reasonable. And again, if we can maintain it in the 80s I think that’s a good deal.

To this point, Mike, we’re not seeing anything other than what utilization indicates. Just some are going back and some are coming back, and this is the bill for growing just slightly in that respect. Now again, we – this is a month-to-month thing right now so I think we’ve just got to stay pretty close to it and diligent. And we’ll adjust the business as the market and/or utilization dictates we need to.

Michael Drickamer

And then how about geographically? Is the San Juan area still your largest market, followed by I guess then the Barnett?

Stephen C. Taylor

No, Barnett has been the largest really about a year-and-a-half now. And then San Juan. So those are still the two largest. Michigan is the third largest. And right now there’s still some activity out there. And again this is not the same amount of activity we had last year or the year before. I don’t want to say that. But it’s still enough to where we’ve got the full fleet out there, the full force of people and everything else and staying busy out there.

Michael Drickamer

And even with the concerns about the Barnett right now and whether or not it’s economic at current gas prices you’re not seeing a wave of compressors coming back from that market?

Stephen C. Taylor

We’re not seeing any more come back than are going out. Whether that’s an even thing between the customers that we have or whether we’re making some additional penetration with new customers, it’s probably a little bit of both. But right now as it sits, everything’s staying even. Again, as we go into Q2, Q3 and we could still get some softening in gas price and that’s what drives this whole business, if we see a little bit more softening there it wouldn’t surprise me if we have some deterioration in utilization.

But our main – the main thing we can do is again we’ve already pulled back on fabrications so we can maintain utilization where we wanted. And I think that’s been one of the criticisms in the past in this business that compression [inaudible] just tend to build, build, build and, you know, just think [most] of them will never be used and we’re not doing that. We want to pull back and try to temper what we’re doing and maintain our share and place in the market.

But there is and there will be more price pressure. There is and there will be more pressure on utilization. There is and will be more pressure on margins. I mean, that’s the world we’re in. There’s nothing I or any of the guys here or girls here can do about it. The best thing we can do is anticipate it, adjust as quick as we can which I think we’ve done certainly to this point, and muddle through ’09. I think ’09 is just kind of a muddling year. I don’t think it’s going to be anything spectacular up or down.

I think we know how to operate in this business. We certainly know how to operate in good times. I think we’ve shown that. I think we’re starting to show we know how to operate in bad times. And so we’ll just have to be aware and stay on top of it and do the best we can. And again I think we’ll end up - in the past three or four years, everybody grew but we grew the fastest. Nobody can touch our margins and our share. And I think the whole industry gets resettled, though, in a year like this but we’ll continue to be in the top piece of that.

Operator

Your last question comes from [Steve Farazone].

Steve Farazone

Can you talk about the size of the rentals outside [inaudible] now? Are you moving forward with plans or are you just slowing down the geographic expansion plans given the current market conditions?

Stephen C. Taylor

Well, we don’t have any current plans to move into any new areas. Our plan is to consolidate in existing areas. Of course Barnett and Farmington are the biggest. And you know in reference to Mike’s question before as to what about the Barnett economics and things like that. You know, in Farmington in San Juan we have such a large number of compressors and such a density, we can make decent [pay] in those markets in a lot of respects, no matter what the gas price does or the operator is running into. Density and response time is a little better for us out there.

Michigan is about the same way. It’s a good market for us, surprisingly. You know, it’s not a big market but we’ve got a commanding share. The newer areas, the Rockies and Appalachia, I think – we haven’t gotten real big in those at this point, so this slowdown shouldn’t hurt our overall results. Those aren’t big pieces of the pie yet. We’ve moved into them 18 months ago and intending to be a long term player. So our plans are still – we’ve got all the people there, our plans are still to get what we can get. But I think those markets would generally deteriorate quicker. The Rockies always does. But if it does, so be it. We’re not as big in those and we can weather that and just be ready to go back in.

Steve Farazone

Post ’09 – obviously you’re trying to maintain cash here, but post ’09 it doesn’t seem like the Barnett, the San Juan Basin necessarily are going to be big growth areas post ’09. Do you have to position yourself now to get more aggressive in those other spaces as gas prices rebound?

Stephen C. Taylor

Yes. We are there. So it’s not a matter that we’re not there and may have to move in. We’ve already got equipment in Appalachia. We’ve got equipment in the Rockies. So we’re already there and we’ll be ready in ‘010 when things pop back or the end of this year or something like that. So I think we’re still in good position there.

We still think there’s probably not as dramatic growth in the Barnett as in the past, or maybe even in San Juan as in the past. We think there’s still good growth for us. And some of that’s market share, taking away from the competition, which we’ve been able to do in some of these areas. And there’s still a lot of potential in the Barnett to do things. So we think still there [inaudible] will be good long term growers over time and the newer areas, Appalachia, the Rockies, we’re there. We can grow as required.

And we’re close enough – if you look at – I mean we’re very strong in the Barnett obviously, but if you look at within 200 miles of the Barnett you’ve got Barnett, [Arcoma], Fayetteville, East Texas, I mean shoot, you know, probably half of the rigs in the U.S. within 200 or 300 miles of Dallas. It does not take a whole lot to move into those areas if we need to. We’ve got a lot of people in there already. We just station a guy somewhere, go rent a building somewhere, do this or that. But we think we’re positioned well in the areas we’ve identified. And certainly as things start to pick back up we can consolidate those, grow those a bit more and then resume some growth into other areas.

Steve Farazone

And then just on the pricing issue, maybe some pressure on the sales side, have you turned around your equipment suppliers yet and tried to get some price concessions?

Stephen C. Taylor

Oh, yes. You know the old saying, “It all flows downhill.” So yes, we’re trying to work with them from the point of what they can do, concessions, terms, things like that. I mean we – you know, this is truly something that everybody’s in at the same time, from the operator to us to our suppliers. So it’s the whole food chain. Everybody’s got to kind of reset a bit and get through it.

Operator

It looks like we have no other questions on queue.

Stephen C. Taylor

Well, listen I appreciate everybody joining –

Operator

We did have one question, but he dropped out, so I do apologize for the interruption.

Stephen C. Taylor

Okay. So that’s it?

Operator

That is it.

Stephen C. Taylor

Okay. Great. Thanks Michelle. Before I close I do want to thank all of our employees obviously, you know, just for their continuing to work. This is a tough time for everybody and it’s hard on us all not knowing exactly where we’re going but I think we’ve got a good crew here and we’re going to be able to get through this thing. I do want to make sure that all the employees know they’re very much appreciated for what they do. I want to thank everybody for joining me on the call and I look forward to visiting with you again next quarter. Thank you.

Operator

Thank you very much, Steve. Ladies and gentlemen this concludes today’s conference call. Thank you all for attending and have a great day.

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