Natural Gas Services Group's (NGS) CEO Steve Taylor on Q2 2016 Results - Earnings Call Transcript

| About: Natural Gas (NGS)

Natural Gas Services Group, Inc. (NYSE:NGS)

Q2 2016 Earnings Conference Call

August 04, 2016 11:00 AM ET

Executives

Alicia Dada - IR

Steve Taylor - Chairman, President and CEO

Analysts

Jason Wagner - Wunderlich

Rob Brown - Lake Street Capital Markets

Peter Van Roden - Spitfire Capital

Operator

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

I will now like to turn the call over to Alicia. You may begin.

Alicia Dada

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

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

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

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

Steve Taylor

Yes. Thank you, Alicia and Ross, and good morning and welcome to Natural Gas Services Group’s second quarter 2016 earnings review. In the second quarter, we continued to see pressure on our business as a consequence of the worst downturn in decades. Notwithstanding recent gains, the rig count has dropped 47% over the last year, with oil prices approximately 60% lower.

While most of the drilling-oriented industry saw their businesses retreat starting in 2015, we are just now seeing the primary impact on ours. NGS is typically shielded from declined activity two to three quarters due to our position on the production side of the business. But with U.S. oil and gas production starting to fall, not to mention last quarter’s extremely low oil price, we have experienced a greater contraction in the business recently.

Rental activity in the second quarter continued to decline as a natural consequence of last quarter’s utilization drop and the bottoming of the oil price experienced in the first quarter. However we have seen this decline begin to mitigate itself from the second quarter and the month of July. Sales activity which is always volatile on a quarter-to-quarter basis also declined but our backlog continues to hold steady.

Our rental gross margins were again very high due to excellent cost control and 53% of every revenue dollar was converted into free cash flow this quarter. The first part of the year has been difficult but continued upon the commodity price, we believe the worst is behind us. I’ll comment in more detail as I’ll review the financials.

Starting with total revenue and looking at the year-over-year comparator quarters, the total revenues decreased 29% or $17 from $24.2 million in the second quarter of 2015 to $17.2 million in the second quarter of this year. Sales in rental revenue saw drops of $2 million and $5 million respectively.

For the sequential quarters of first quarter of ‘16 compared to this current quarter, total revenues were off $4.4 million from $21.6 million to $17.2 million. Decrease was primarily in our sales component which saw a drop of $2.6 million. Rental decreased by $1.75 million.

Reviewing the comparator six months year-to-date periods, total revenues were down 21% with rental revenues decreasing 23% or $9.25 million.

Moving to gross margin and comparing the second quarter of ‘15 to this current quarter, total gross margins declined from $14 million to $9.5 million. We continued to hold strong at 55% of total revenue. Sequentially, total gross margin was down nearly $2.4 million from a little over $11.8 million to $9.5 million. Again total gross margin as a percent of total revenues held steady at 55% this quarter, the same as in first quarter 2016.

On six month year-to-date comparisons, gross margin dollars were down 24% from $28.2 million to $21.3 million. As a percentage of revenue, year-to-date 2016 gross margin is averaging 55% compared to 58% for the prior year-to-date. Due to extraordinary cost control, we are holding our margins steady.

Speaking of high margins and although I’ll address in more details later, I also want to point out that we had a very attractive rental gross margin of 63% this quarter. Our sales, general and administrative expenses decreased $725,000 or 25% in the year-over-year quarters, more than $400,000 in the sequential quarters of the first quarter 2016 compared to this quarter, and nearly $750,000 or 14% in the year-to-date comparisons over prior year.

As a percentage of revenue, our SG&A expenses were roughly averaging 12% over the past 18 months, and we think quarterly cost of $2.5 million or less are sustainable through the rest of the year.

If you recall, in the second quarter of 2015, we took a one-time non-cash charge of $4.5 million, primarily for fleet optimization. In the following commentary I will include references to 2015 results with and without this adjustment.

Operating income increased almost $1 million in the comparative year-over-year quarters, up from $900,000 to $1.9 million with the adjustment but decreased $3.4 million compared to second quarter of 2015 operating income without the adjustment. When comparing year-to-date 2016 to 2015, operating income fell $1.1 million when considering the adjustment, and $5.4 million without the one-time charge. Sequentially operating income fell from $3.8 million to $1.9 million.

In a comparative year-over-year second quarters, net income dropped from $3.5 million to $1.3 million this year without the adjustment. However, it is up $640,000 from the second quarter 2015 when considering the adjustment. Sequentially the second quarter 2016 saw net income decrease from $2.5 million to approximately $1.3 million.

In the six month year-to-date periods, net income decreased $3.4 million to $3.8 million without the charge or little over $500,000 with the charges. On a year-over-year basis, EBITDA increased 8% from $6.8 million in the second quarter of 2015 to $7.3 million in the second quarter of 2016, considering the adjustment or decreased 35% from $11.2 million not considering the adjustment.

Sequentially, EBITDA was down approximately $2 million to $7.3 million at 42% of revenue. On six month year-to-date comparison, EBITDA was down 10% with the adjustments, or were down 27% without the special charges included. However from an operating perspective, we continue to deliver principal cash earnings and maintained EBITDA on an average of 44% of revenue over the last 18 months.

On a fully diluted basis, earnings per share this quarter, was $0.10 per common share. As I review our operating product lines, the comparisons will of course have no impact from the fleet optimization adjustments or charges from 2015. Total sales revenues, which includes compressors, flares and aftermarket activities fell almost $2 million in the year-over-year quarters from $4.3 million in the second quarter of ‘15 to $2.3 million in the second quarter of ‘16.

Through sequential quarters, total sales revenues decreased $2.6 million from $4.9 million to $2.3 million. Reviewing compressor sales alone, in the current quarter, they were $1.7 million compared to $3 million in the second quarter of 2015 and $4 million last quarter. However recall that compressor sales have historically volatile quarter-to-quarter comparing these six months comparative periods shows that year-to-date sales are actually up 5%.

Gross margins for the compressor jobs we completed in the quarter, was over 14%, which is a good margin in this market. But this does not include full absorption of all fabrication overhead. When this is applied, our compressor fabrication business fell into the negative. However our other sales activities, flares, parts and other aftermarket activities covered that deficit but that also minimized the positive contribution we used to get from those activities.

Along these lines, I want to give just a little more detail on the dynamics of our fabrication business and cost during a downturn because we saw some of that downside this quarter. There are minimum fixed costs maintaining our fabrication operation. When things are busy, the equipment being built for regular sale absorbs the fixed cost of the business. However when things slowdown and there is very little fabrication activity, those fixed costs cannot be fully absorbed or allocate to specific activities.

Obviously the variable cost or costs of goods are covered, but the fixed cost becomes stranded, that is those are real cost that are unabsorbed and have to be charged to the income statement. Our compressor and fabrication activity this quarter was at the lowest level we have seen in the last few years. Now because of this and the base level cost to maintain the facilities and our core group of people, the impact on the income statement this quarter was estimated to be $0.02 to $0.03 per share.

Due to the inherent variability we see in fabrication throughput, our compressor sales were down this quarter and our compressor sales backlog continued to maintain the levels we have seen over the past year. Backlog was approximately $4 million on June 30, 2016, compared to approximately $5 million in the last quarter and $4 million at the end of 2015.

Rental revenue had a year-over-year quarterly decrease of little over $5 million from $19.7 million in the second quarter of ‘15 to nearly $14.7 million for this current quarter. Sequentially rental revenues were down $1.75 million from $16.4 million in the first quarter of ‘16. The year-to-date review shows rental revenues down $9.3 million from $40.3 million to $31.3 million for the six months ending in June.

With compressor rentals, the impact from terminations in the one quarter would impact revenue into the next quarter. So this current decline of rental revenues was not unexpected based on the utilization drop we’ve reported last quarter.

With that in mind, the terminations this quarter were at lower rate. So on a positive note, we don’t expect near the rental deterioration going forward. As part of this, our gross margins continue to be very strong. We posted 63% this quarter against 65% last quarter, and year-to-date we’re averaging 64% compared to 63% last year.

Average rental rates across the active fleet increased almost 2% over the second quarter of 2015 and were down 1.7% from the first quarter. However average rental rates for newly set units was more closely reflect the current market are down this quarter a little over 12% when compared to last year’s comparative quarter and 13% lower than last quarter. Obviously price has been much more competitive this quarter.

Some of this price declines and mix shift this quarter contrary to last quarter towards smaller equipment being set but we’ve also seeing what I call predatory price in this year from competitors. I suspected it is driven by the requirements to service debt and make distributions. When our competitors price on a cash basis, you may choose not consider items like depreciation for example in the pricing calculations.

For NGS, depreciation this quarter ran at 37% of our current rental cost. So ignoring it, which we don’t do but others may, would certainly drive pricing down but to unsustainable levels. I suspect that some competitors are pricing in this manner. Fleet size at the end of June was 2,626 compressors which is one unit less than last quarter. This loss of one unit was due to the decommissioning of five older fleet units for conversion to vapor recovery units, plus the building of four new vapor recovery units.

Our active fleet utilization this quarter was 56%. This is a drop of 5 percentage points since last quarter. That also reflects the deceleration of the utilization drop we’ve seen so far this year. Our steepest decline at this downturn was in the first quarter of the year, so with this forming and other factors I’m expecting Q1 to be the worst quarterly decline we will see. Pressures on utilization and price will likely continue but I think the extreme deterioration is past us.

Although oil price dropped significantly at the beginning of the year and the competitive pricing contraction in the market has been severe, NGS had been able to maintain a relative market share. In a market where pricing utilization is constantly under pressure, I think this is an accomplishment, especially when we continue to lead the market and pricing from a premium perspective.

Last call I mentioned that we would earmark $5 million for CapEx in the first six months of the year, but then it was predicated on market demands. In the first quarter of ‘16, we spent a little under $2 million. In this quarter we capitalized only $700,000, so we need the first half of the year spending only little over $2.6 million of capital funds. This is in line with the depressed market we’re in and I think that $5 million mark for the second half of the year will be more than adequate.

As mentioned we have recently approved the building of more VRUs. If you recall, we designed a line of vapor recovery units last year in order to take advantage of new EPA emissions regulations and we’re committed or sold out our initial run, so we have authorized the building of more of it. As I’ve mentioned in the past, this is not a needle mover in the short-term that this significance of any growth at the moment is important and we do think this would be a good future market.

Going to the balance sheet, our total bank debt is $417,000 as of June 30, 2016, and cash at the bank was a little over $52 million. Our cash flow from operations is $9.8 million for the quarter. Free cash flow continues to be strong with $9 million in the second quarter of this year, $1 million higher than last quarter. As a percentage of revenue, free cash flow was 53% this quarter and is average 45% this year.

So for every revenue dollar we generate, we are able to turn almost half of it into real spendable cash. From a macro point of view, things look to get better. The rig count has showed some minor increases recently, and oil supply and demand appears to be roughly balanced at present, however production continues to decline. Wildcard in this picture is a large overhang in crude inventory but that’s just a timing issue and it will get worked off.

Even secondary effects start to show up. For example, rail shipments have all appear to have bottomed and are inching up also. Natural gas is even shying a little brighter. Natural gas consumption exceeded coal share in the U.S. for the first time ever in January this year and consumption this year is trending up. We have even, for the first time in recent memories, set additional dry gas units to some areas.

I don’t think anyone is predicting a boom any time soon but the macro combined with what we see in the market gives us cause to peer out from under the covers now.

Summarizing, NGS has positioned itself well for this downturn, as we have in the past, in spite of times our operating results continue to be enviable. Our margins continue to be among the highest in the business. Our sales backlogs remain steady. We are seeing some traction with our new VRU product and our ability to generate operating free cash is exceptional. Although some of the inherent fixed costs of the business are temporarily impacting our bottom line, these are transient and will be mitigated as activity picks up.

That’s end of my prepared remarks and I’ll turn the call back over to Ross for any questions you may have.

Question-and-Answer Session

Operator

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

Jason Wagner

Good morning, Steve.

Steve Taylor

Hi Jason.

Jason Wagner

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

Steve Taylor

From a well standpoint, it’s not really new wells, it’s some existing - either existing wells that have been turned back on or some displacement of some other competitors and some of the stuff. So but primarily it’s been some new stuff going out. So it’s been - and again there has been a whole lot, you wouldn’t even miss that if you just hadn't seen it long time. It kind of ties in with maybe a couple of little bright spots on natural gas side of it and I’m hesitant to say that because tomorrow gas price will drop.

But it’s not a big deal yet but it’s first time we’ve seen in a little bit. From a geographical standpoint, I hate to say too much about what we’re seeing. Yes, I would just say it seems some very mature areas that we haven't seen much activity out of years actually.

Jason Wagner

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

Steve Taylor

Yes. Our initial run on that stuff and this is - some of these numbers not confusion but a little mix, but yes, if you remember some of that crude run off last year we were refurbishing and recommissioning into VRUs and some of that stuff is more new. So we got a combination of what we’re doing. As I mentioned, we decommissioned five older units and are going to rebuild them as VRUs, there is four of those. You were building some new ones going forward too. So our initial run was in the 10 to 15 unit range. Those are set or committed.

Now aside of that, we’ve done some minor conversions on some existing equipment to place on VRU applications. Not confused to say but not strictly the pure VRU line we’re building but kind of semi-converted enough for customers’ requirements.

So if you do that, you can probably double that if you’re thrown [ph] it into a VRU column. And while we’ve approved some new ones in to the schedule, so we’re adding in five to 10 more by the end of the year in combination with the ones we’re recommissioning.

Jason Wagner

Okay.

Steve Taylor

Yes, not big numbers but certainly biggest thing going.

Jason Wagner

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

Steve Taylor

Right, it is actually [ph].

Jason Wagner

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

Steve Taylor

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

But we’ve still got good high hopes for that line. And it will come about. It’s just in this period right now just not a whole lot of stuff moves out like that.

Jason Wagner

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

Steve Taylor

Okay. Thanks Jason.

Operator

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

Rob Brown

Hi good morning, Steve.

Steve Taylor

Hi Rob.

Rob Brown

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

Steve Taylor

Well, this is all - the bright spots are all relative, right, and not absolute at this point. So we’re talking about deceleration of utilization drops and deceleration of pricing pressures and things like that. We still see it out there. It’s still a very competitive market. As I mentioned in the first call, well and production side we’ve had our lag and now we’re getting hit more so the [indiscernible] obviously production has fallen off and compression and a world like that.

Yes, so that’s - I mean, we still - there is still an advantage of our business being a little behind the curve on some of that stuff but we’re in the middle of the curve now. So I - Bob, I hesitate to even tell you because I wouldn’t have guess two quarters ago where we’d be. We’re 56%. Whether that goes to two, three quarters - I mean, 2 or 3 points a quarter like it was in ‘15. It gets back to that or not, I don’t know and I’m real hesitant to even try to say anything public along those lines what we’re just saying, we’ve seen 13 point drop in last two quarters, which is obviously way more than we were predicted. And that was - I didn’t look but that was probably about four year - that was last year.

So if we can get back into that 3 to 4 points a quarter until it bottoms, I think that’s certainly the good indicator, but boy, I’m real reluctant to tell you what that might be. Now on the plus side essentially just as we’ve shown even with the deterioration in pricing and deterioration in utilization, we’re still - top line obviously gets impacted but we’re still holding bottom line and pretty well from a margin of free cash flow standpoint. So we obviously look at that real close, but I’ll let you put your own market utilization. I’m sorry, I can't help you there more.

Rob Brown

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

Steve Taylor

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

Rob Brown

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

Steve Taylor

I’m glad you mentioned that because our price has been a little more time on that. We’re certainly happy with the progress being made there. We’ve got certainly there are other people watching that and making sure we don’t get too far out. It’s just been good old staying on people and getting paid. And obviously in a market like this you got a bifurcation of customers. You got the big guys that pay you but they drag you out a little more. Then you got little guys that may or may not pay you and they certainly drag you out.

So it’s just good credit management actually and I won't take the credit, I’ll give credit to our credit supervisor. Staying with them, staying close, understand what the customer is going through, what the business is. We don’t hesitate to share equipment in. We don’t hesitate to file liens, sometimes we don’t hesitate to sue to get our money. So we don’t - we do a good job for everybody, we won't get paid for. And I think everybody understands that and we’ve been here with some bankruptcies too. And actually less this downturn than the last downturn but fortunately and of course bankruptcy is not [indiscernible] still thanks to good business strategy but the thing that has changed now versus five or six years ago in the last downturn is you get a lot more prepackaged bankruptcies.

It’s less of a free for all or less of a lawyer’s holiday and more of an organized pre-negotiated sort of business for your organization, which tends to put us from the point if we can be a preferred vendor. We tend to take much less of a pre-petition hit, of course post-petition you’re typically paid, but we tend to come out a little better on those. So that’s helped also just, I guess, a maturation of how bankruptcies work over time. But generally it’s just we have a very good credit person there watching us.

Rob Brown

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

Steve Taylor

Okay. Thanks.

Operator

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

Peter Van Roden

Hey Steve.

Steve Taylor

Hi Peter.

Peter Van Roden

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

Steve Taylor

Well, that’s the average and compared to, I think, sequentially and year-over-year, I think year-over-year we’re still up 2%, sequentially we’re down to about 2%. So if you want, you can say as probably roughly flat with any comparative quarters or periods over the past year on the average. So what happens obviously the new set stuff is more of a current market rate and reflects what’s going on currently. What’s - nobody is real surprise, there is lot of price pressure and price competition out there.

Now the price pressure tends to come is shifted over time. Last year and going into the first quarter, it’s primarily driven by customers. Crude prices drop. They needed some concessions, discounts and that was what drives a lot of the pricing pressure. It’s changed since the first quarter and it’s shifted more so away from operating more towards competitors. As I mentioned and kind of went into a little detail, some of this pricing is just nutty and we don’t - I don’t know if we choose not to participate and I don’t know we just don’t, but that’s why you see that 12%, I think the 12% year-over-year and 13% sequential decrease in current new sets.

Now the bright part of that and this is a dimmed bright point, right, is there is not something new sets going out now or times are busy, so it’s got a muted impact on the overall average. And I think that will continue. Now this is a severest contraction we’ve seen in the pricing on that percentage basis and hopefully we see some relief from that, but again we tend to still be a little more premium priced and the most people as I mentioned we maintain market share with that.

But it probably shows a little more severe with us than anybody else as far as what that pricing contraction might be because we’re coming off a hard point.

Peter Van Roden

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

Steve Taylor

When you say taking offsets, what do you mean?

Peter Van Roden

I guess replacing an NGL.

Steve Taylor

Just replacing competitors or us or anything?

Peter Van Roden

Yes.

Steve Taylor

We don’t see a whole lot of that. We replace - I think we replace more competitors than it happens to us. Everybody is always taking pushups [ph] and everything, right. But I think we’re able to generally hold in pretty well with existing customers. Now sometimes you may have to give discounts obviously to match pricing to the market, but we generally are able to hold in because we could - when you install that our service continues to be superior. So you could protect that piece fairly well.

Where we do see more impact is in new bids, new market bids and things like this where the pricing is what I think is ridiculous. As I mentioned, I think it’s predatory. I define predatory is not sustainable and I think you can do that for a little bit but ultimately you can do that. And as I mentioned, we still mentioned in last call, say it again. We still make net income. We think net income is important and a lot of people don’t. And if you want to price that way, that’s fine but we choose not to. We want to keep the price where we think it’s reasonable and competitive in the market.

But as far defending present installations, I think we do a pretty good job there. It’s the new stuff coming out that’s pretty competitive and sometimes hard to get.

Peter Van Roden

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

Steve Taylor

Well, you got two curves there, right, the revenue curve and the cost curve and they were constantly moving. One of the things that hurt us in Q2 was the sales were down and we have one or two units that moved out a little more than what we anticipated. So we had some misses some absorption there and we’ve continued to pair back and both the fab facilities we’ve got from just a pure operating expense standpoint and unfortunately from headcount standpoint.

So that cost curves continue to coming down, obviously we’re trying to get that revenue curve up a bit and that’s the tougher part. So it’s hard to predict it exactly. And number one, yes, as we always get into volatility quarter-over-quarter on what equipment is that we can put revenue on and recognize that revenue on. And this quarter we had a couple we didn’t get in and there is late a little bit and couldn’t do that. If we had those, we might not have had an issue.

But generally - and this is generally because point of something else that happens to you, generally we think we’ll probably be about breakeven the rest of the year. We won't see any positive or any negative out of it. Obviously we saw negative, as I mentioned $0.02 or $0.03 this quarter. But one thing that impacts this and we do this is we’ve moved some VRUs into the schedule to build from a rental standpoint [indiscernible] sold out. We still have customer demand. We don’t want to go out and market that equipment and not have it available and not build it, all right, because you lose all that effort and money.

But what happens is you move out some of this backlog, right. So we could take the position that, well, hey we’re just going to cram all this sales stuff there because it’s made the day and we got to have and everything else. You already try to bounce the stuff and say, you know what, some of the sold equipment may fall over in the first quarter of next year. We may not see it this year but we need to build from the VRUs from a rental standpoint. So you get into some of these, so we’re trying to make these decisions that are based on the good of the business and sometimes the long-term gets into way the short term and it shouldn’t situation we think. But that ends up causing a little more absorption problem.

So lot of movement parts to it, but short answer is we think now we can probably be essentially neutral for the rest of the year but that’s a quarter-by-quarter decision.

Peter Van Roden

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

Steve Taylor

On the sales side?

Peter Van Roden

Yes.

Steve Taylor

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

Peter Van Roden

All right, got it.

Steve Taylor

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

Peter Van Roden

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

Steve Taylor

Yes, fully absorbed.

Peter Van Roden

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

Steve Taylor

Yes, I think we’ll be able to certainly - let's say it picks up Q1 ‘17. We’ve got enough equipment available that we can just put out, so I don’t think we’ll have appreciable capital expense next year even if the market turns up and even if it turns up appreciably. We can just use equipment we’ve got now. What we will have we saw at the last downturn, we don’t capitalize any maintenance expenses. So unlike a lot of competitors in the business, we expense it all. So when you do that and you start putting equipment out, you had to go through it, check it out, even if nothing is wrong with it, you have some waiver to make sure it’s runnable condition when it gets out there.

So there is expense going into that and that’s an income statement expense. And as we saw last upturn, our gross margins on the rental side may drop somewhat, but because we have expense to put it out but we have no capital to do that. So I think that’s a dynamic you’ll see going forward. And I think we can go 12 to 18 months without any appreciable capital expense and ride the wave of a recovery. So that’s really probably good part of this business is when this thing does turn up, we’ll have very high incremental contribution to the income statement.

Now I hope the capital we do spend is additional VRUs and additional, as a larger horsepower stuff, we want to put out. And I anticipate that’s what our capital will be allocated to.

Now talking about the bottom, and I’m going to let you call a bottom because I’m not going to - the improvements we’re seeing like I say are relative and not absolute at this point. So we’re seeing a relative deceleration, a relative improvement of things like this. We still see pricing pressure. We still see utilization pressure and I think we will, for the rest of the year, I think we’ll bump into long bottom on this but we’re going to bump. But again, I mean we’re well-positioned. We’re in fine shape, but I don’t want to read in the San Francisco paper tomorrow that Steve calls the bottom.

Peter Van Roden

All right, thanks Steve. I appreciate it.

Operator

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

Steve Taylor

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

Operator

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

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