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Natural Gas Services Group (NYSE:NGS)

Q4 2012 Earnings Call

March 14, 2013 11:00 am ET


Lindsay Naylor

Stephen C. Taylor - Executive Chairman, Chief Executive Officer and President


Jeffrey Spittel - Global Hunter Securities, LLC, Research Division

Jonathan P. Braatz - Kansas City Capital Associates

Matthew H. Beeby - Williams Financial Group, Inc., Research Division


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

I will now hand the call over to Ms. Naylor. Ms. Naylor, you may begin.

Lindsay Naylor

Thank you, Erica, and good morning, listeners. Please allow me to take a moment to read the following forward-looking statements prior to commencing our earnings call.

Except for the historical information contained herein, the statements in this morning's conference call are forward-looking, and they are made pursuant to the Safe Harbor provisions as outlined in the Private Securities Litigation Reform Act of 1995. Forward-looking statements, as you may know, involve known and unknown risks and uncertainties, which may cause Natural Gas Services Group's actual results in forward periods to differ materially from forecasted results. Those risks include, among other things, the loss of market shares through competition or otherwise; the introduction of competing technologies by other companies; and new governmental safety, health and environmental regulations, which could require Natural Gas Services Group to make significant capital expenditures.

The forward-looking statements included in this conference call are made as of the date of this call, and Natural Gas Services undertakes no obligation to publicly update such forward-looking statements to reflect subsequent events or circumstances. Important factors that could cause actual results to differ materially from the expectations reflected in the forward-looking statements include, but they are not limited to, factors described in our recent press release and also under the caption Risk Factors in the company's annual report on Form 10-K filed with the Securities and Exchange Commission.

Having all that stated, I will turn the call over to Steve Taylor, who is President, Chairman and CEO of Natural Gas Services Group. Steve?

Stephen C. Taylor

Okay. Thanks, Lindsay, and thanks, Erica. And good morning and welcome to Natural Gas Services Group's full year and fourth quarter 2012 earnings review. We had an excellent year and an especially strong fourth quarter, and I'm happy to report that the year was a record setter in a few ways. I'll touch on those points as we go through the numbers, but suffice it to say that we're optimistic going forward and anticipate additional growth into 2013.

From a total revenue standpoint, 2012 full year revenues increased 44% to $93.7 million, up from $65.2 million in 2011. This was a record level revenue for NGS. In the sequential quarters of the fourth quarter of 2012 compared to the third quarter of 2012, total revenues increased $4.3 million or 22%, primarily due to a surge of compressor and flare sales orders delivered in the fourth quarter. In the year-over-year comparative fourth quarters, total revenues increased 26% to $23.5 million.

Comparing the full years of 2011 to 2012, total gross margin increased $9.1 million or 26% to $43.8 million. Gross margin percentage decreased from 53% to 47%, but this is due to a mix shift from predominantly higher-margin compressor rentals and flare sales in 2011 to a stronger blend of compressor sales in 2012. In the sequential quarters of Q3 and Q4 of 2012, gross margin increased 12.3% to $11.4 million, while the year-over-year comparative fourth quarters grew 16%.

SG&A increased about $2 million in the full year of 2012 compared to 2011. However, as a percentage of revenue, it moved from 9% down to 8% in the same annual periods. In the sequential quarters, SG&A was down 9%, increased less than $300,000 in the comparative year-over-year fourth quarters. We expect our SG&A to typically run in the 9% to 10% range.

Again, comparing the full years of 2011 to 2012, operating income increased 36% from $14.9 million to $20.3 million. In sequential quarters, operating income was up 30%, while the year-over-year fourth quarters reflect an 18% increase.

Net income in 2012 was $12.7 million, which was a 30% increase from the $9.8 million earned in 2011. In the sequential quarters of the third quarter of '12 to the fourth quarter of 2012, net income increased almost 37% to $3.6 million, while the comparative fourth quarters of the respective years grew by 18%.

EBITDA increased 21% from $29.7 million in 2011 to $35.9 million in 2012, also a record high and historically a 57% increase in the 2 years since 2010. Looking at the fourth quarter of 2012 compared to the third quarter of that year, EBITDA was up 17% to $9.6 million. EBITDA grew 18% from the fourth quarter of 2011 to the same quarter in 2012. We have consistently seen EBITDA running in the 40%, plus or minus, of revenue range.

On a fully diluted basis, earnings per share for the fourth quarter of 2012 was $0.29 per common share, with the full year finishing at $1.03.

Looking at sales revenues. For the full year comparison of 2011 versus 2012, total sales revenue, which includes compressors, flares and parts, increased 136% from $15 million in 2011 to $36 million in 2012. We saw an appreciable shift towards our sales business over the year and is mainly driven by compressor sales. Not only did we have a large sale of rental equipment at the beginning of 2012 that contributed, but custom fabricated compressors also exhibited strong growth.

Another area of our sales that has grown is our engineered flare and burner systems. Revenues this year are 14% higher than last year at $6.9 million. This doesn't sound like a lot of growth but this was a $2.4 million business in 2009, so it has almost tripled over the past 3 years, plus gross margins run north of 60%.

Total sales revenues increased 69% or $3.4 million sequentially and $3.5 million or 73% in the year-over-year quarters. Looking at compressor sales alone, we saw an increase of almost $21.5 million from $4.8 million up to $26.2 million in 2012. Approximately half of that increase was the extraordinary sales in rental compression, but we still demonstrated good growth in our basic compressor sales business.

As mentioned at the beginning of the call, we had a surge in our compressor sales in the fourth quarter of 2012 compared to the prior and year-earlier quarters. This is primarily due to numerous customer caused changes and delays while building a large compressor order for a major customer. Although we were receiving cash progress payments while the work was in process, we couldn't recognize the revenue until title to the equivalent was transferred to the customer at delivery. This revenue surge simply reflects that delivery and recognition but also demonstrates, once again, the inherent lumpiness in this part of our business.

Gross margins for compressor sales increased from 16% to 19% between 2011 and 2012. Our compressor sales backlog at the end of the year was approximately $6 million, which is where it's been running all through the past year.

Compressor rental revenue had a full year increase of $7.9 million or 16% from $48.6 million in 2011 to $56.5 million for this current year. This growth rate is a bit understated because of the rental revenue that was lost with the sale of some rental equipment earlier in 2012. Without that sale, rental revenues would have approached the 19% growth rate. In spite of that, rental revenues were at a record level.

In the sequential third and fourth quarters of 2012, rental revenues were up 6%, the largest quarterly increase during the year, and increased 11% when comparing the fourth quarter of 2012 to the same 2011 quarter.

Gross margins increased from 57% to 58% of revenue between 2011 and 2012.

We ended the year with a rental fleet unit utilization at 77% and horsepower utilization at 79%. This compares to unit utilization of 74% at the beginning of the year. While a 300-basis-point increase may seem minimal, we have to remember that this was on top of rental fleet growth of 8% to 9%.

Fleet size at the end of the year was 2,279 compressors. This is a net addition of 159 compressors year-to-date, but we actually built and set 208 units this year when you account for the rental equipment sale.

Approximately 35% of our rental fleet is now deployed into oil shale or liquids-oriented plays. This is up from 0 exposure at the beginning of 2010. We built a total of 43 compressors in the fourth quarter, and rental fleet growth capital expense was $30.9 million for all 208 units built in 2012.

And I'll remind everyone, we implemented an average -- we implemented a price increase for all rental compressors, new or used, deployed after October 1, 2012. Our average rental rates across the fleet calculate to be relatively flat over the past year. That's been skewed by the rental compressors sale I've mentioned. However, our pricing progress is evident in the following fleet numbers for 2012. Net fleet unit growth was up 7.5%, and net fleet horsepower growth was up 8.2%. Utilized fleet growth was 11.5% higher, while utilized horsepower growth was a gain of 11.4%.

Now against all that, rental revenues were up 16%, greater than any indicator of fleet growth, thereby showing an average per unit and per horsepower price gain. Further, if we look at the average rental rates on newly contracted units, we're seeing rents running 7.1% higher in all of 2012, with 4.9%, the majority of that coming in the fourth quarter of 2012 after our price increase. This all confirms that our price increase has taken effect.

Going to the balance sheet. Our cash position, net of debt, was approximately $27.2 million as of December 31, 2012. Our debt is less than $1 million is classified as long term, and cash flow from operations for the year was $35.4 million.

Now generally, for 2013, we think our rental activity will continue at the same pace in essentially the same plays, and that we are well positioned to take advantage of that growth. Our Permian Basin, Niobrara shale and Granite Wash business looks like it will grow this year. We are looking for heightened activity from Utica and Barnett Combo that have slowed a bit last year. We're even expecting some added activity from Marcellus.

Equipment requirements will continue along the same path we were seeing with gas-lift-type compressors being the predominant type of equipment needed with an increasing appetite for vapor recovery units, referred to as VRUs.

Gas lift compressors are usually high-pressure units used for gas recirculation/improved recovery in oil or liquids-laden wells, with VRUs being required for low-pressure, low-volume applications for smaller gas premium recovery. Some small gas premium gathering is economic but more and more of it is environmentally driven. I mentioned in our last call that we were successful in securing a VRU supply contract in the fourth quarter of 2012, and we continue to see opportunities in this arena.

As noted, our custom fabrication sales business had a very good year and we hope that continues, but we still do not have enough of a backlog to predict that activity too far into future. And I just described, this business remains the hardest to predict.

We think our business looks positive over the year, and that commodity prices will generally hold on the oil side and potentially increase gas-wise. EIA predicts that Brent crude will average $108 a barrel this year in 2013 and $101 in 2014. And that would increase -- with the increased pipeline capacity, the WTI differential will shrink. If that's so, the realized price in some U.S. areas will actually increase this year or next. While we participate in what can be termed as a derivative oil market, that is associated gas, increased oil price and shale activity is what has driven our business for 3 years now.

From a natural gas perspective, I'm even more bullish even though I can't get a handle on when long-term trends become current. I used to predict when I thought natural gas would turn up. Now I start referencing the never identifiable, always mysterious consensus opinion, and now I just base my views on when the next cold winter hits. When it does happen, I think natural gas can really get busy again. I think we're approaching the long-awaited supply-demand balance, and that demand will take off much quicker than the supply will be available.

EIA notes that natural gas supplies has grown 7% and 4% year-over-year the last couple of years. That will be essentially flat in 2013 and 2014. This is a large anticipated decrease, and I think it can result from higher pricing activity with any increase in demand.

EIA average natural gas price in 2012 was $2.75 per Mcf, and they predict it will be $3.41 this year and $3.63 in 2014. That's a 24% average price increase this year and an added 6% next year. I don't know about you, but a 24% price increase in 1 year sounds like some tightening is predicted. I daresay, if we have a good winter in 2013 and 2014, the natural gas will see $4-plus price levels. If that happens, you'll see a level of activity from oil and gas shales simultaneously that may be hard to keep up with.

Are these predictions a guarantees? Absolutely not, but I think the probability is in our favor. We are encouraged by what we see and hear in the market and from our customers anticipating another growth year for NGS.

Now I know some of you may have dialed in to listen for any political comments I might have, even though I tentatively swore off that in the last call, except for especially egregious situations. Although the regulatory tax and general amnesty of tax continue and politicians continue to try and amend economic principles or repeal physical ones, in the end, free markets triumph, much to the chagrin of some. And because of that and the resourcefulness of our industry, I'm generally optimistic.

Erica, that is the end of my prepared remarks, and I'll turn it back to you for questions anyone might have.

Question-and-Answer Session


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

Jeffrey Spittel - Global Hunter Securities, LLC, Research Division

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

Stephen C. Taylor

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

Jeffrey Spittel - Global Hunter Securities, LLC, Research Division

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

Stephen C. Taylor

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


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

Jonathan P. Braatz - Kansas City Capital Associates

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

Stephen C. Taylor

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

Jonathan P. Braatz - Kansas City Capital Associates

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

Stephen C. Taylor

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

Jonathan P. Braatz - Kansas City Capital Associates

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

Stephen C. Taylor

No, I think it's about the same.

Jonathan P. Braatz - Kansas City Capital Associates

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

Stephen C. Taylor

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

Jonathan P. Braatz - Kansas City Capital Associates

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

Stephen C. Taylor

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


Our next question comes from Matt Beeby from Williams Financial.

Matthew H. Beeby - Williams Financial Group, Inc., Research Division

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

Stephen C. Taylor

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

Matthew H. Beeby - Williams Financial Group, Inc., Research Division

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

Stephen C. Taylor

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

Matthew H. Beeby - Williams Financial Group, Inc., Research Division

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

Stephen C. Taylor

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


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

Stephen C. Taylor

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


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

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